Earlier this week the Federal Open Market Committee (FOMC) meeting held few surprises. Instead, we got another 75 basis points hike on interest rates and no forward guidance on when they'll taper their hiking regime.
What they did say may have sounded like it has substance, but it didn't. When they talked about taking cumulative hikes and lags into consideration (as in, the lag time it takes for hikes to translate into economic activity), it was merely their way of saying, "We're data dependent," nothing more.
Well, duh. Literally every financial institution in the world, public or private, is data dependent.
Traders and investors seem to think - or want to believe - that the Fed's frontloading means they'll have to reduce the amount they hike going forward, and that they're likely to pause hiking when the fed funds rate gets to 5%.
But that isn't the point. How much they hike, or how long they hike, isn't what matters.
What matters to everyone is how long they'll have to keep rates at an elevated level, whatever that level is, to subdue inflation down to the 2% annual level they've identified as acceptable.
By my calculations and analysis, they won't get it anywhere near 2% for at least a year. That matters because the longer rates are elevated - especially if we're talking months, quarters, or longer - the worse the economic hit is going to be. And when that hit comes, registering in higher unemployment, dampened demand, and a hard-landing recession, the stock market could selloff by another 25%.
I know that because I've lived through a lot of recessions and have data, and I think we're in a rougher ride than most people want to admit.
The Past Four Recessions, In a Nutshell
The July 1981 to November 1982's 16-month recession, which saw GDP decline 2.9% and unemployment peak at 10.8%, became known as the "double-dip" recession since it closely followed the January-July 1980 recession that saw fed funds peak at 20%. Fed funds subsequently got to 19% in the second half of the double-dip, but high rates got inflation down from 11% to 5% in October 1982.
Does that mean we have to see fed funds well into double digits to get inflation now 8.2% down to 2%? Well, let's look a little further down the road.
The Gulf War Recession (July 1990 to March 1991) lasted 8 months and saw GDP decline by only 1.5%, with unemployment peaking at 6.8%. One reason the recession was short-lived was fed funds had been declining since the early 1980s to a low of 5.84% by October 1986. But an upturn in inflation from 1986 to 1990, with CPI rising from 2.2% to 3.9% (yeah, that's all it rose to, which is nothing compared to today's 8.2%), drove fed funds up from 6.5% in February 1988 to 9.75% in May 1989.
If the Fed was worried about inflation at 3.9% and powered fed funds up to 9.75% to tamp it down... what do you think they'll do with inflation at 8.2%?
As bad as the Dot-Bomb Recession seemed, it only lasted 8 months, from March 2001 to November 2001. GDP declined 0.3% and unemployment peaked at 5.5%. One reason speculative fever broke on Wall Street was that fed funds rose from 4.75% in early 1999 to 6.5% by July 2000. The September 11 attacks and economic panic shortened the recession as the Fed lowered the fed funds rate quickly, to a low of 1% by mid-2003.
But we don't have a catalyst like that at present. Any chance the Fed's going to lower rates now can be measured on a scale between zero and none.
The 18-month long Great Recession, from December 2007 to June 2009, was another story altogether. Artificially manipulated lower rates for a lot longer fed leverage and speculation in subprime instruments as yield-hungry investors - including banks, investment banks, global players, and NINJAs (no-income, no job, no problem) home buyers and flippers - got into the game. The fallout from tanking house prices saw the stock market fall 57%, unemployment rise to 9.5%, and GDP decline 4.3%.
To aid and abet recovery from the GR, the Fed, of course, tamped down rates even lower for longer.
From a high of 5.3% in April 2007, fed funds tanked to 0.22% in February 2009. They stayed well below 1% up to July 2017, when they finally got above 1%.
That 10-year run of artificially low rates spawned the greatest bull market in history.
As the Fed began to "normalize" rates, meaning move them off the zero-bound level, and raised fed funds to 2.4% at the end of 2018, the S&P 500 frighteningly dropped 20%.
So, the Fed, in what I described at the time as their Third Mandate, turned tail and began lowering rates to stabilize the stock market. But there was no inflation then, none.
And off the economy and stock market went, higher and higher. Until Covid.
The Covid Recession lasted all of 2-months, from the end of February 2020 to April 2020. Unemployment climbed from 3.5% to 14.7%, because understandably everything was closed or about to close. GDP fell 19.2% in a heartbeat. But with fed funds back at zero in a nanosecond, $5 trillion in pandemic relief spending, and the Federal Reserve expanding its balance sheet by another $5 trillion, unemployment rebounded and was back below 4% by the end of 2021.
The economy began growing again and the stock market skyrocketed.
But that's all behind us now.
There's no more fiscal fist-pumping unless the Democrats surprise everyone in the upcoming midterms. There's no more Fed money printing, no more quantitative easing (QE). It's quantitative tightening (QT) on deck now.
All that largesse leading to 1980s-style inflation has to be wrenched out of the economy, and it's going to take high rates for longer to come anywhere close.
That's why the stock market can fall another 25%. Anyone loading up now expecting a rally could be facing serious pain soon.
As always, I'll be watching things and let you know when I think we've hit a real, investable bottom. Keep an eye on your inboxes.
Sincerely,
Shah Gilani
Until then, have a great week.
Shah Gilani
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.