Are more gains on the way? … where the Fed might be wrong … more wasteful government spending is likely coming … an election prediction from Louis Navellier and Charles Sizemore
Despite today’s selloff, we could be on the verge of a huge stock melt-up.
Now, I write that as someone who’s concerned about this market’s lofty valuation. Frankly, I don’t believe a melt-up from here is warranted by fundamentals.
And yet, I highlight this as a real possibility…
One, a Fed that appears at risk of getting it wrong – again…
Two, a fresh wave of debt spending from the next president that will juice our economy, regardless of who takes office.
Let’s look at each.
Is the Fed setting up for another batch of egg on its face?
In recent months, I’ve made the case for why caution is needed in today’s market. We’ve referenced nosebleed valuation indicators, greedy sentiment indicators, and various red-flag contrarian indicators, among other things. Frankly, it doesn’t take much to build a bearish case today.
But…
All of that might pale in comparison to the bullish variables possibly driving stock prices higher in the coming quarters. Let’s begin with the Fed.
It’s beginning to appear that the Fed got it wrong by going big with its jumbo 50-basis-point rate cut in September. And if the Fed continues cutting rates as traders expect, get ready for a resurgence in inflation and an asset bubble.
Stepping back, the Fed’s goal (as highlighted in its September’s SEP report) is to get long-term inflation back to 2.9% over the next few years. This is their estimate of the “neutral” rate, which is the theoretical rate at which the Fed is neither helping nor hurting the economy.
To be clear, this neutral rate is always changing, and it can’t directly be measured. This gray area creates the potential for error, often leading to the Fed applying too much gas or too much brake, sometimes resulting in bubbles and bursts.
Now, what if the Fed – which has been wrong about a lot since the Covid Pandemic – is wrong yet again about the neutral rate at 2.9%?
They are, according to Louis Navellier’s favorite economist, Ed Yardeni.
Yardeni pegs today’s neutral rate at minimally 4%, if not higher
In making the case for this, he highlights a handful of economic factors. But I want to zero in on the most significant one – our government’s spending.
From Yardeni:
Productivity growth may be one of the most important factors in determining the neutral interest rate. There are lots of other moving parts undoubtedly, including the federal budget deficit.
Over the past three years, it has been at a record high during a period of solid economic growth. Yet inflation has moderated.
Large fiscal deficits have boosted economic growth and offset the recessionary impact of the tightening of monetary policy.
Again, the conclusion must be that the neutral interest rate has been increased by the current administration’s fiscal policy. Fed officials may be in denial about this because they are so committed to being nonpolitical that they avoid discussing fiscal policy.
What Yardeni is saying helps explain why we never suffered the recession that virtually all economists predicted would hit us in 2023. After all, it’s hard to have a recession when your government floods the economy with trillions and trillions of newly created currency.
If you forgot what that looks like, here’s our M2 Money Stock after 2020…
Source: Federal Reserve data
Much of which found its way onto the Fed’s balance sheet…
Source: Federal Reserve data
Source: Federal Reserve data
So, if the Fed is wrong about the neutral rate, then its 50-basis-point cut in September and whatever cuts we get from here risk overshooting the mark. And that risks spurring inflation and an asset-price runup.
Keep in mind, if Yardeni is correct that the neutral rate is at least 4% – let’s call it 4.25% – then the Fed’s current target rate of 4.75% – 5.00% isn’t much higher than where we already are.
Here’s Yardeni’s bottom line:
Our conclusion is that if the Fed continues to lower the federal funds rate, monetary policy will most likely stimulate an economy that doesn’t need to be stimulated.
The result could be rebounds in both price and asset inflation rates. The latter is certainly underway in the stock market.
Speaking of “an economy that doesn’t need to be stimulated”…
This morning, we got the latest reading on the Fed’s favorite inflation – the Personal Consumption Expenditures (PCE) Price Index.
Headline year-over-year inflation came in at 2.1%, which was in line with estimates.
However, core PCE (which the Fed prefers since it excludes volatile food and energy prices) came in at 2.7% on the year and 0.3% on the month. The annual rate was 0.1% higher than forecasts.
Remember, the Fed’s goal is 2% inflation, and it just came in at 2.7%. So, inflation remains 35% above target, and yet the Fed has already eased up on the brake via a 50-basis-point cut, and even more easing appears to be on the way.
Perhaps the neutral rate really is at 2.9%. But if it’s at 4%+, let’s remember Yardeni’s warning above:
The result could be rebounds in both price and asset inflation rates. The latter is certainly underway in the stock market.
The second variable that could prompt a stock market melt-up is enormous spending from the next president
Vice President Harris and former President Trump have their differences, but both are likely to spend ungodly amounts of money as president.
Here’s the Committee for a Responsible Federal Budget:
Our large and growing national debt threatens to slow economic growth, boost interest rates and payments, weaken national security, constrain policy choices, and increase the risk of an eventual fiscal crisis.
However, neither major candidate running in the 2024 presidential election has put forward a plan to address this rising debt burden.
In fact, our comprehensive analysis of the candidates’ tax and spending plans finds that both Vice President Kamala Harris and former President Donald Trump would likely further increase deficits and debt above levels projected under current law.
The report goes on to estimate that under Harris, debt would jump by nearly $4 trillion by 2035. Under Trump, the forecast is almost $8 trillion.
With this in mind, let’s again revisit Yardeni:
Large fiscal deficits have boosted economic growth and offset the recessionary impact of the tightening of monetary policy.
$4 trillion here… $8 trillion there…
Based on the melt-up in asset prices after the trillions of pandemic-related debt spending from the government, it is not crazy to expect another inflation/asset price surge.
One wildcard is if Trump is elected, and he follows through on his proposal to make Elon Musk his federal spending cost-cutting czar
Speaking on a “telephone town hall” with supporters Tuesday, Musk said:
We have to reduce spending to live within our means. That necessarily involves some temporary hardship, but it will ensure long-term prosperity…
I think once the election takes place we’ll immediately begin looking at where to take the most immediate action.
He described government spending as “a room full of targets. Like, you can’t miss.”
When a commentor heard this and predicted on X that the fallout would be: “An initial severe overreaction in the economy” and that “Markets will tumble,” Musk didn’t push back. He wrote back:
Sounds about right.
To me, this has shades of Argentinian President Javier Milei and his “chainsaw” approach to government waste. It could have an enormous impact on capital flows in the stock market.
For example, billionaire investor John Paulson said he would work with Musk on cutting federal spending. And according to The Wall Street Journal, President Biden’s green energy subsidies would be on the chopping block:
“All of these tax subsidies for solar, for wind, inefficient, uneconomic energy sources,” said Paulson. “Eliminate that. That brings down spending.”
While I find the idea of cutting waste appealing, I’m skeptical. Our entrenched government bureaucracy – the direct beneficiary of this wasteful spending – will do everything in its power to preserve its existence.
Circling back to a potential melt-up…
It seems improbable that the market might continue to soar after its incredible performance here in 2024 (up 20%).
But we have a Fed that appears at risk of inadvertently juicing the economy by misreading the neutral rate. And we have a new president that – barring a Black Swan, Elon Musk slash-a-thon – will continue to spend trillions, further juicing our economy.
Yes, the rational, valuation-oriented part of me is screaming “beware this market!” and I do remain cautious.
But history shows that valuations can soar far higher than would seem rational when huge, macro forces are driving them.
Our challenge is to be prepared for both scenarios.
Before we sign off…
If you missed legendary investor Louis Navellier and our geopolitical expert, Charles Sizemore speak about the potential for election chaos this past Tuesday, I recommend you check out the free replay as soon as you can. They made a prediction about what’s coming, and I doubt it’s what you think it is.
I’ll note that these two experts are no strangers to bold predictions that play out. It was last December that they said Joe Biden would be replaced on the Democratic ticket.
If you’re concerned about post-election volatility and how to address it in your portfolio, I recommend you listen to their latest prediction, and what they’re urging investors to do about it.
We’ll keep you updated on all this here in the Digest.
Have a good evening, and a Happy Halloween,
Have a good evening,
Jeff Remsburg