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WEEK AHEAD
August 26-30, 2024
Last week, the Federal Reserve’s announcement regarding potential adjustments to monetary policy, particularly the planned reduction in interest rates, underscored our key economic indicators, further bolstering the bullish outlook for a fully invested portfolio.
Last week, the Fed Chair strutted through the financial markets like a Broadway star on opening night—confident, if a tad nervous, about the coming reviews. The U.S. economy, ever the reliable understudy, held the stage with grace, continuing to churn out jobs and keeping the unemployment rate at applause-worthy lows. The next act focuses on the Fed's policies as global dynamics unfold.
All eyes were on the Fed's annual Jackson Hole Economic Symposium, where Jerome Powell, ever the maestro, conducted his usual balancing act, signaling the central bank's resolve to tame inflation without snuffing out the economic recovery – the dual mandate. His performance was met with applause, and Wall Street enjoyed a solid week buoyed by the tech sector's continued love for artificial intelligence yet a love affair with retail. The S&P 500, never one to miss an opportunity for a comeback, posted +1.47% in gains as investors breathed a collective sigh of relief after weeks of fretting over the Fed's plans to cut interest rates. The bond market, part of the choreography, also rallied by +0.67% as the 10-year yield narrowed from 3.89% to 3.81%.
Retail was among the leading sectors for the week, benefiting from the signal of reduced interest rates and strong earnings being posted. Lowe's, TJX, and Target, all bellwether retail companies, posted positive earnings surprises, including raising their earnings outlook, resulting in their stocks gaining 3.7%, 7.2%, and 10.0%, respectively.
The week ahead will continue to gain momentum from closing out the remaining companies reporting 2nd quarter earnings, including a number of big-tech favorites like NVIDIA, Dell, and Salesforce. Next week's reports on GDP, Personal Spending, and Core PCE prices are critical to the Fed's accommodative decisions. With the next highly anticipated FOMC meeting scheduled for September 17, investors' sentiment will continue to seek evidence of a rate cut to be priced into the markets.
"Overall, the economy continues to grow at a solid pace. But the inflation and labor market data show an evolving situation. The upside risks to inflation have diminished. And the downside risks to employment have increased. As we highlighted in our last FOMC statement, we are attentive to the risks to both sides of our dual mandate. The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."
— Chair Powell Jackson Hole Symposium, August 23, 2024
Price Controls – Just "Don't" Do It
On August 15, 1971, when inflation was about 3% at an annual rate. To control inflation, President Nixon announced he was freezing wages and prices for ninety days, raising tariffs on certain imports, and ending the direct international convertibility of the dollar. The set of policies was labeled "the Nixon Shock." Ultimately, they failed to calm inflation because they ignored the Fed and monetary policy's role in determining the inflation level.
Restrictions on price increases for gasoline and oil remained after the ninety-day period and eventually transformed into an effort to eliminate price "gouging" when prices rose in 1973 after the Organization of Arab Petroleum Exporting Countries imposed an embargo on oil shipments to the U.S. The controls pushed gasoline and oil prices below a market-clearing price stimulated demand for these products, and simultaneously discouraged supply. With the price controls in place, consumers in the U.S. were faced with gasoline rationing and long lines waiting at gas stations for access to gasoline.
The price controls were not effective. The price of oil rose from roughly $3.50 per barrel in 1971 to more than $12.00 per barrel in 1975. The price controls on oil remained in place through 1980 when oil prices reached more than $37.00 per barrel. Once price controls were removed, the price of oil declined to just over $14.00 per barrel in 1986.
The general price level showed a similar trajectory. From 1971 to 1981, the annual average inflation rate, as measured by changes in the Consumer Price Index, was about 8.4% per year. This inflation rate was far above the roughly 2.5% rate experienced from 1913, the year in which the Fed was established, to 1971. President Reagan ended all price controls in 1981, and from 1981 to 2020, inflation averaged 2.7% at an annual rate. After 2020, inflation rose to an average annual rate of about 5% per year as the Fed increased liquidity in response to an economic slowdown following COVID-19-related policies.
Stock market participants did not fare well in the aftermath of "The Nixon Shock." Over the ten years from August 1971 to August 1981, the after-inflation return generated by the S&P 500 Index was -1.0% per year. Once price controls were eliminated entirely, the stock market performed much better. From August of 1981 to July of 2024, the annual after-inflation return for the market was 8.7%.
Price controls were manifestations of much more significant problems that the "Nixon Shock" did not address. Inflation in 1971 was rising as the money supply increased at a rapid rate, and the budget deficit as a percentage of GDP increased mainly because of expenditures related to the Vietnam War. The price of gold rose on the open market above the official price, and President Nixon was compelled to close the Gold Window. Once this happened, the Fed was relieved of all effective restraints on monetary policy.
The forces that destabilized the U.S. economy in the 1970s are similar to those currently existing. The Treasury is running a large deficit, the Fed will be forced to monetize part of that deficit, and inflation will remain problematic. Efforts to reduce inflation by implementing price controls will fail just as they did in the 1970s. Price controls on food will reduce supplies, rent controls will reduce the housing supply. Policymakers must be aware that inflation is everywhere and, at all times, a monetary phenomenon. Monetary policy reflects the size of the budget deficit. Until the deficit's size is reduced, inflationary pressures will grow.
Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.