Market Ramblings from a Delusional Dreamer

Just two weeks into the year and the market is already grappling with the prospect and the impact of Federal Reserve policy change. Largely ignored during the final quarter of 2021, the Fed has clearly indicated to the market that it will begin tapering its asset purchases and raising interest rates this year. Wednesday, we got another glimpse of the reasons why they are having to change course. The Consumer Price Index for January was released, and it showed a 7% increase in prices for 2021.

Once considered “transitory”, the Fed has now acknowledged that rising prices is very problematic for the US economy. More troublesome is that real wages for 2021 (wage increases minus inflation) fell 2.4%. In other words, the US consumer is significantly worse off today than one year prior. Higher prices and lower real wages cannot portend well for demand for US goods and services, which ultimately threatens sustainable growth for the economy. So, it is not surprising that the stock market is getting a little jittery. That being said, maybe it should be more surprising that the market’s trembling, so far, is only illustrated by a mere drop of 2.1% since January 1 for the S&P 500.

One of the many mantras on Wall Street is that the stock market is not the economy. While that is and can be mostly true in my opinion, I think that markets can tell stories about the economy if we dig around enough. One of the less followed indices, at least by most retail investors, is the Russell 2000. The Russell 2000 is an index of the 2000 small cap stocks. It does not include, obviously, the likes of Google, Facebook, Apple, Amazon, and Microsoft. Russell stocks don’t have the luxury of size to bully competitors via pricing and influence. These companies seem more susceptible to the actual underlying economic conditions that also effect everyday Americans. I like the Russell 2000 because, heck who doesn’t like an underdog.

While over the past year, the more widely followed indices (Nasdaq 100, Dow Jones 30, and the S&P 500) have flourished, rising 25%, 18%, and 21% respectively; the Russell 2000 limped through 2021 with a more modest 8.9% return. The 8.9% return certainly feels closer to the economic realities of our country than the 25% return of the S&P 500. Furthermore, since March 2021 when inflation first started to become more troublesome, the Russell 2000 has posted a return of -10%, which certainly feels more in line with the potential headwinds facing our economy.

But in a country where winning is everything, the lagging performance of the Russell becomes an ignored reality. We prefer highlighting the performance of Tesla and Apple just as we prefer rooting for Tom Brady to win is umpteenth Super Bowl. But the market conundrum is more dire. Federal Reserve policies since 2008 have potentially only succeeded in expanding the difference between the wealthiest members of our society and the rest. We may love a winner, but we may want to accept that in this case we may not be it.

Perpetuating a situation where real interest rates are significantly negative seems to uniquely reward those with the means to take risk and the means to acquire the leverage to do so. But I’ve learned one important lesson the hard way in this business, shouting into the wind is a wasted breath. As misguided as I may think Fed policy may be, I don’t foresee it changing anytime soon. I don’t see the Fed abandoning Quantitative Easing as a solution to the next recession or drop in the market. I don’t see the Fed normalizing short-term lending rates to breakeven anytime in the future. Therefore, I don’t see a sustained sell off in the S&P 500 without a reaction from the Federal Reserve. However, all that being said, the unknown question will be will the market respond as it has in the past. After all, the markets are a bit of a shell game. It isn’t just what the Fed is capable of, but whether anyone trusts their omnipotence.

Thanks for reading,

Zach and Dave

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