There's been a good bit of what I'd call cognitive dissonance in the markets lately. According to Webster's, "cognitive dissonance" is defined as "anxiety that results from simultaneously holding contradictory or otherwise incompatible attitudes, beliefs, or the like." And that's definitely been evident in the markets of late.
It seems the markets have recently determined that a return to normalcy from the economic insanity that ensued from the 2008-09 financial crisis is somehow a threat. The markets lamented numerous threats that persisted during the long, slow, Fed-supported recovery. Now that the economy is standing on its own two feet - not dependent on Fed intervention like a crack addict surviving on the next stimulative fix - the markets are wringing their collective hands over the very recovery from those previous threats.
To wit:
- As I noted in a previous post, the markets have long lamented the stagnant wage growth we've experienced since the Great Recession. So when last month's jobs report revealed year-over-year growth in average hourly earnings of 2.8% (healthy, but not stellar), the markets reacted with a 1,175-point selloff in the Dow over fears of wage inflation that would drive interest rates higher. People, healthy wage growth is good, not bad.
- Also noted previously, the markets have been concerned that a flat yield curve (relatively small difference between long- and short-term yields) might be a concern, as flat yield curves tend to precede recessions (which I noted is true, but that correlation is coincidental, not causal). So when the 10-year Treasury yield increased due to the inflationary fears noted above, the markets sold off. Yet the markets should have been relieved that we were seeing a return to a more normal, steeper yield curve (greater difference between long- and short-term yields).
- Finally, last week we learned that inflation increased last month. The core (excluding the volatile food and energy price components) consumer price index (CPI) rose from 1.7% year-over-year to 1.8%. On that day, CNBC featured a banner on their screen asking, "Is the era of low inflation over?"
To that last point, understand that core CPI year-over-year has averaged nearly 3% since 1958. That includes the era of Paul Volcker as Fed Chairman (1979-1987), when inflation peaked at 13.6% year-over-year, but it also includes the most recent period of extreme low inflation since the housing bubble burst, during which time inflation averaged - guess what? - 1.8% year-over-year.
So no, the era of low inflation, low interest rates, and slow wage growth isn't necessarily over. But for those who only look at the last ten years, it might look that way.
Let's put this in perspective. The average 30-year mortgage rate is now about 5%. That may seem high to someone with a perspective that only goes back a decade or less. My first home was purchased with a mortgage at a rate of 10.5%, and I felt lucky to get that, since mortgage rates over the prior ten years had been as high as 18%. Historically speaking, a mortgage rate of 8% or less is pretty darn good.
For many years, companies pegged their annual salary increases at 3-5%, because that was the prevailing year-over-year inflation rate for many, many years. So an inflation rate of 1.8% isn't high by any means. (The Fed's own target for inflation is 2.0%; we're below that, yet they're already raising rates.)
And a ten-year Treasury yield of 2.94% - where we are today - is incredibly low by historical standards. The average since the early 1980s - after the era of extremely high rates during the time of Paul Volcker's Fed Chairmanship - is around 5-6%.
And then there's the recent tariff madness, which I addressed in my last post.
And then there's the recent tariff madness, which I addressed in my last post.
Here's my concern with all of this: there are a lot of millennials that are buying homes and beginning to invest for retirement. Their historical perspective is the last ten years. So they see the "norm" as historically low interest rates (the lowest in our nation's history), low inflation, and stagnant wage growth.
So as we recover from this unprecedented era - an era that is their "normal" - it looks like a brave new world to them. But it isn't a brave new world. It's a brave old world, recovering from a cowardly new world.
I say "cowardly" because the Fed's retreat to zero interest rates and quantitative easing was a cowardly approach to dealing with a difficult problem that demanded the courage of a Paul Volcker, in my view - a monetary policy approach that would have been willing to swallow the bitter pill of depression to avoid some of the adverse effects that will likely result from the Fed's extreme accommodation over the past decade.
It's cowardly to create moral hazard by bailing out banks and automakers for their own mistakes that lead to financial disruptions. It's cowardly to cut rates to such low levels that bubbles are inflated (and the Fed has a poor track record of foreseeing bubbles that some of us could easily foresee, from the dot-com bubble to the housing bubble).
The government ought not to be in the business of business. If the banks or the automakers screw up, let them fail. Yes, there will be severe disruptions in the short run. Is that any more risky than the long-term implications of huge deficits due to fiscal stimulus, bubbles inflated by extremely accommodative monetary policy, or the risks associated with unwinding a $4 trillion Fed balance sheet?
It's like the old Tootsie Roll Pop commercials featuring the wise old owl. When asked, "How many licks does it take to get to the center of a Tootsie Roll Pop?", the owl grabs one and starts licking and counting: "One, two, three ..." Then he bites it, going straight to the chocolate center, and says, "The world may never know."
So it is with the question of whether allowing major banks to fail would destroy global financial markets, absent extreme monetary and fiscal intervention. Would it destroy world economies? The world may never know, because governments cannot resist the temptation to bite - in the form of providing massive stimulus that might have even more drastic consequences than just allowing market forces to work as intended.
I say "cowardly" because the Fed's retreat to zero interest rates and quantitative easing was a cowardly approach to dealing with a difficult problem that demanded the courage of a Paul Volcker, in my view - a monetary policy approach that would have been willing to swallow the bitter pill of depression to avoid some of the adverse effects that will likely result from the Fed's extreme accommodation over the past decade.
It's cowardly to create moral hazard by bailing out banks and automakers for their own mistakes that lead to financial disruptions. It's cowardly to cut rates to such low levels that bubbles are inflated (and the Fed has a poor track record of foreseeing bubbles that some of us could easily foresee, from the dot-com bubble to the housing bubble).
The government ought not to be in the business of business. If the banks or the automakers screw up, let them fail. Yes, there will be severe disruptions in the short run. Is that any more risky than the long-term implications of huge deficits due to fiscal stimulus, bubbles inflated by extremely accommodative monetary policy, or the risks associated with unwinding a $4 trillion Fed balance sheet?
It's like the old Tootsie Roll Pop commercials featuring the wise old owl. When asked, "How many licks does it take to get to the center of a Tootsie Roll Pop?", the owl grabs one and starts licking and counting: "One, two, three ..." Then he bites it, going straight to the chocolate center, and says, "The world may never know."
So it is with the question of whether allowing major banks to fail would destroy global financial markets, absent extreme monetary and fiscal intervention. Would it destroy world economies? The world may never know, because governments cannot resist the temptation to bite - in the form of providing massive stimulus that might have even more drastic consequences than just allowing market forces to work as intended.
Back to those who see the past decade as "normal." If those people see the current trend as a departure from the "norm" they know, rather than a return to the real norm, they may hold off on making major expenditures.
They may withdraw their money from the stock market - at the worst possible time - thinking that a return to higher wages, higher (but not historically high) interest rates, and higher (but not historically high) inflation is a bad thing. And in so doing, they may miss out on a significant opportunity in the equity markets, because the fundamentals today are very strong, and support a continued bull market for at least another 12 months.
They may hold off on buying homes until conditions return to what they see as "normal," when in fact a return to normal may mean even higher mortgage rates. In other words, they may delay buying a home because the mortgage rate is at 7%, expecting a return to their "normal" of 3%. But we may never go back there; instead, mortgage rates may return to the true historical "normal" of around 8%.
They may withdraw their money from the stock market - at the worst possible time - thinking that a return to higher wages, higher (but not historically high) interest rates, and higher (but not historically high) inflation is a bad thing. And in so doing, they may miss out on a significant opportunity in the equity markets, because the fundamentals today are very strong, and support a continued bull market for at least another 12 months.
They may hold off on buying homes until conditions return to what they see as "normal," when in fact a return to normal may mean even higher mortgage rates. In other words, they may delay buying a home because the mortgage rate is at 7%, expecting a return to their "normal" of 3%. But we may never go back there; instead, mortgage rates may return to the true historical "normal" of around 8%.
And that could turn all of this market dissonance into a self-fulfilling prophecy. By not buying homes, they might trigger a decline in home prices that adversely impacts the current economic strength. As George H.W. Bush noted, "As housing goes, so goes the economy." By exiting the stock market, they might trigger a sell-off that results in something more than a 10% correction.
So my message to those who might have a short-term perspective is this: Fear not. We are simply seeing a return to a normal state after the most extraordinary period in most of our economic lifetimes, other than those who also lived through the Great Depression of the 1930s. This is not a brave new world. It's a return to the brave old world that persisted long before the housing bubble burst in 2007.
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