Equity Markets Waking Up to Reality: The Impact of Interest Rates and Inflation

Jan 13, 2022

Equity markets finally waking up to reality (and it’s bad)

Interest rates low? Stocks grow. Interest rates high? Stocks die.

Tonight we explore why today’s Federal Reserve no longer offers a safe port in a very dangerous storm.

“No need to run because there’s no place to hide.”

– Glevle Godvoice

Imagine you're being chased by some “bad hombres” and have the good fortune to see a police station ahead, only to find out that the entire station is abandoned.

And on fire.

And the safety you thought you'd found turned out to be even more dangerous than the danger that chased you there in the first place…

It sounds crazy, sure, but this is a good analogy for stock investors today who simply have no good place left to hide.

It used to be that when stocks sold off, bonds were a safe haven. However, that’s only the case when bonds offer protection. But who wants to buy a 10-yr treasury that pays 1.7% when inflation is raging at 7%?

This is a big problem for those holding paper assets.

The Fed is now singing in unison that they are finally going to raise interest rates.

But does anyone think a slowdown of asset purchases on the balance sheet, or a quarter-point interest rate hike, is going to suddenly make bonds appealing to investors?

Bonds are about as attractive as an abandoned police station on fire.

With no place to hide, we might as well be back in 2018 all over again, when stocks and bonds were both crushed as the Fed attempted to raise interest rates.

The Federal Reserve finds itself right back where it was then, with interest rates at 0% while seeking to tighten monetary policy. The main difference is that three years later, even though it’s the same u-turn taking place, we’re now doing it from a starting point way further down the road.

The national debt today is 50% higher than it was in 2018. Stocks and bonds are also 50% higher, and inflation, which was only at 1.5% in 2018, is now the highest it’s been in 40 years, clocking in at 7% year over year.

This is what happens when you print trillions of dollars in new money and give it away via direct deposit into people’s bank accounts.

Inflation is changing everything.

For most investors, the road ahead is even worse than it may appear on the surface. Retail leverage has never been higher, which means stock drawdowns can happen very quickly. Volatility, recently a forgotten player in the markets, is now a thing we are all becoming reacquainted with on a daily basis.

And volatility can strike fast.

Anyone forgetting that reality need only look at the last 30 minutes of today’s trading to remember. Markets tumbled to close the day. The Dow Jones dropped 0.5%, the S&P 500 dropped 1.38%, and the Nasdaq plummeted 2.5%.

The Nasdaq is now 8% off its all-time highs reached just two weeks ago.

And there’s not a lot of hope on the horizon.

The quit rate in the economy has never been greater. The BBB plan looks dead on arrival, and fiscal stimulus, which was $3.5 trillion in 2021, is falling off a cliff in 2022.

This is what it looks like when the party's over and no one bothers to pick up after themselves, leaving their trash behind.

The Fed woke up in 2022 on the wrong side of the bed, and they are looking very cranky. “Accommodation” is no longer the song. The word “transitory” has been retired, and their plan to let inflation “run hot” is no longer the goal.

They are shutting this party down.

Inflation is now public enemy number one. At least that’s what Lael Brainard testified in front of Congress today, stating: “Fighting inflation is “our most important task.”

This is not what stocks and bonds want to hear, which is why we must remember the old four line maxim:

Interest rates low? Stocks grow.

Interest rates high? Stocks die.

It’s why in a deflationary environment you want to own stocks and bonds.

In an inflationary environment, you want to own commodities.

This is how it is and forever will be.

On Tuesday, I’ll lay out that story in detail, as well as how to cash in on it over the next few years.

Click here to register for the free event now

We are in the midst of the passing of the baton from four decades of deflation to an era of inflation. Unfortunately, that transition is taking place at a time when the world economy is on very thin ice.

Oh, and in case you were wondering? Gold prices held firm in the face of a monster sell-off and rose higher heading into the close of the day.

Now that the Fed is returning everyone to reality, don’t be surprised if precious metals become the new hiding spot.

Best,

Adam Baratta

Editor-in-Chief

Brentwood Research