Physicians' Guide to Wealth

A guide for anyone pursuing financial independence

Q
Jerome Powell the Giant Slayer

Jun 22, 2022

Since late last year, Jerome Powell, Chairman of the Federal Reserve, has become the giant slayer attacking the formidable giant of hyper-inflation. His one goal is to bring this giant to his knees and slow its impact on society. His primary strategy is suffocating the giant’s appetite with rising interest rates.
Inflation has been labeled by the media as a negative, with headlines comparing current inflation to the 80s. It was the 70”s that set the stage for the 1980’s hyperinflation going back to the 1972 OPEC oil embargo. The previous year in 1971, President Nixon withdrew the US dollar from the gold standard and replaced it with….nothing. Paul Volcker, then 1980’s Federal Reserve Chairman, slew his hyperinflation dragon by instituting a policy of steady interest rate hikes that reversed the rise of inflation and the beginning of an 18-year bull market. The point is that the rate of inflation rising or falling is the result of government policies and events that occurred years before.  
 
The cause of the current state of high inflation can be traced back to the worldwide whipsaw during the pandemic that has caused a tsunami of artificial fluctuation in supply and demand. As with all tsunamis, the damage is not just when the first waves hit the shores but also the aftereffects of secondary and tertiary impacts such as lost power and destroyed infrastructure. 2020 was like the sleepy beach town totally unprepared for the tsunami that was brewing. 2019 ended on another high note for economies around the world, and the US finished with record corporate earnings along with the highest level of employment participation for all races in recorded history. 
 
However, the Covid-19 tsunami hit the shores in January, and nearly overnight, consumers were dictated by governments and health agencies on how to live, work, breathe, and even how to purchase goods with specific rules and policies. The same agencies implemented restrictive policies on businesses on how they could interact and serve their customers. The result was significant supply chain issues and social dysfunction. This was not a regional or even a national phenomenon, and this was a worldwide catastrophe that continues in many countries to this day.  
 
Suddenly it was illegal to go to dine-in restaurants. Food take-out restaurants exploded with demand, with city block lines for hamburgers and fries.
We added Chipotle (CMG) stock to our portfolios in March 2020, rallied 130%, and then as dine-in was temporarily allowed later that year on a limited basis, we added Cheesecake Factory (CAKE) to the portfolios in September 2020 for another 100%+ gain. 
 
Demand for certain products such as fitness equipment, food staples, home entertainment, office equipment for residences, and casual clothing soared in demand that catching retailers off-guard who were woefully unprepared. Prices for never noticed items like barbells, weights for fitness, stretch cords, and jump ropes increased 200% to 400% and disappeared from the store shelves with month-long backlogs. Same for camping equipment, RVs, fishing supplies, hiking shoes, and anything for outdoor activities were quickly bought with TBD availability. I remembered in the spring of 2020, going to REI to buy some camping equipment for a multi-day backpacking trip and there was one (count them) tent left for sale.  
 
Demand was so hot that people were willing to pay any price, and when demand like this exceeds supply, prices soar. The economic imbalance was exacerbated by the sudden liquidity of money. Household savings increased 100% from historical averages as trillions of dollars were raining down from Washington to people for not working and to millions of small employers to pay their non-working employees. Subsidies did not stop there; landlords were prohibited from evicting non-paying tenants who ultimately had years of rent-free housing that still exists to this day. Courts were closed, police departments defunded, and criminal charges relaxed, prompting people to walk into stores and take whatever they wanted without arrest. 
 
I was in Home Depot one night and allegedly (I can neither confirm nor deny) when a man walked past me to the electric jackhammers and rolled a jackhammer cart out the front doors towards his truck! It was not the Home Depot personnel that stopped him but me and several customers that ran after him who panicked and took off in his truck.
 
The US economy began to recover as health restrictions were being relaxed in early 2021, and the next tidal wave was now swelling. I trust that most government and health officials acted in the best interest of society and were overwhelmed with the events of the time, having no experience with worldwide viral disease. Nonetheless, government policies in 2020 created a series of tidal waves that hit in 2021 with rampant price increases due to consumers hungry for goods and services with their Covid-19 money. Near full employment and rising home values exacerbated the imbalance as people with steady paychecks fueled people’s appetite to spend for their new stay-at-home work-life for necessities like bigger big-screen TVs and Peloton bikes.
 
Enter giant slayer Jerome Powell, Federal Reserve Chairman, who has had enough of the dominating giant of hyper-inflation and announced he and his committee would stop the giant and economy, if necessary, with Paul Volcker’s weapons of an interest rate increasing policy. 
 
Hyperinflation consists of many giants in Mr. Powell’s sights, with the biggest giants to conquer are housing, consumer spending, and energy.
 
Mortgage refinances were immediately impacted by the Fed’s rising rates. Why refinance with a higher interest rate? The flow of new refi applications plummeted by 90% during certain weeks following the Fed’s rate increases. The continued rise of mortgage rates has shuttled the new home and existing home market, with 30-year fixed rates increasing 100% in 90 days. According to June’s National Association of Realtors report, sales of existing homes are so depressed that their May reports indicated the weakest activity since June 2020 – during the pandemic. Applications for new home mortgages are 52.7% lower than at the same time last year, according to the Mortgage Bankers Association of America.

The Housing Market Index, a survey of realtors and buyers on their view of housing, also dropped to levels not seen since June 2020.

The first giant was wounded and dropped to his knees. Expect housing prices to continue to soften into 2023.
 
Mr. Powell’s next giant is rampant consumer spending. This is a tougher battle as consumers are sitting on a boat load of money and don’t need to borrow. This battle was not entirely won by raising interest rates but by propaganda. The doom and gloom of the ills of hyper-inflation reported by his committee and blaring alarms by the main media are finally having an impact on the public. Month over Month (MoM) increase of retail sales growth started to slow in January, and May’s retail sales changed negatively for the first time this year. 
Consumers are spending less, and with that will be slowing demand for goods and services. Reduced demand with the same supply will eventually reduce prices.
 
Mr. Powell’s second giant is behaving (for now).  
 
The last giant is energy. Gas, oil, and energy prices are another formidable giant with many facets outside the Federal committee’s reach. However, the oil, gas, and energy imbalance created by aggressive previous years of green energy policies compounded by Russia and worldwide sanctions against Russia is beginning to be resolved. US politicians and around the world are tabling their anti-oil campaigns and reversing green energy policies. Last week the Biden administration asked – correction, demanded ¬ – for oil companies to increase production and coal and natural gas plants to increase energy supplies. Germany's natural gas reserves are at 57% capacity and potentially insufficient to carry the country through the cold winter months. As a result, the Economy Minister Robert Habeck announced on Sunday the increase in coal plant production for electricity to reduce the consumption of natural gas to generate electricity. OPEC is jumping into the game by increasing production to profit on ridiculous high crude oil prices. Like all asset imbalances, re-stabilizing supply and demand take time, but the wheels are in motion to increase supply and offset Russia’s influence, which will eventually reverse the rise of energy prices. On Sunday, Treasury Secretary Janet Yellen suggested implementing a Federal gas tax holiday – 18.4 cents per gallon – to “ameliorate the burden of soaring gas prices.” Expect approval weeks before the November elections.
 
The third giant is wavering, and Jerome Powell is winning his battles. 

What Does This Mean to Me?

The stock market has been in a correction since the first day of 2022. The headwinds concerning institutional investors are the impact on earnings during a period of hyperinflation and rising interest rates. As these two factors slow, along with the Federal Reserve eventually slowing their discount rate increases, investors will return to the buying tables and restart the next stage of rising stock prices, economic growth, and consumer spending. The fortunate aspect of this current re-balance cycle is that the middle- and lower-class demographics, typically cannon fodder, have not lost their jobs, and their fixed-rate mortgages remain permanently affordable (until they refinance). The re-balance process is far from completion, and the stock market may remain volatile through the balance of this year. However, as reported in previous Weekly Briefs, there are many analysts predicting a full recovery of the stock market by the end of the year. This would be unfortunate as humans need more than a few months to change behavior. If the stock market does fully recover and housing resumes its price increases, expect another market correction in 2023. Our hope is a modest recovery of the stock market and housing to remain flat for the next 12 -18 months. That would stabilize the economy with realistic and sustainable growth.  
 
Give us a call if you have any questions about this Weekly Brief. We are here for you if you need assistance with your investments and navigating your finances towards financial independence.

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