Stan Druckenmiller, who is the Tiger Woods of the investing world, says, “Never invest in the present”. This quote is applicable in many ways, not only to investments and financial markets, but also to our personal lives:
From here, let’s take an even deeper dive into the fiscal and monetary policy reference. In March of 2020, there was an unprecedented response to a once in a lifetime event where government stimulus, government Covid policies, and cheap credit added fuel to a potential inflationary fire. Over the following year, these seemingly necessary policies had a side effect of creating a false sense of wealth and prosperity, which added to the mass consumerism seen over the past two years, and ultimately contributed to the “easy money” bubble that has been slowly deflating during 2022.
In 1946, economist Henry Hazlitt wrote in his book (Economics in One Lesson), “Today is already the tomorrow which the bad economist yesterday urged us to ignore”. He then goes on to write, “The art of economics consists in looking not at the immediate but at the longer-term effects of any act or policy: it consists in tracing the consequences of that policy not merely for one group but for all groups”.
The first part of the quote is a phenomenon that has been repeated many times before. Most recently, last year’s comments from the Fed and Treasury Secretary calling inflation “transitory” were certainly shortsighted at best and political at worst. Similarly, back in 2007, then Fed Chairman Ben Bernanke uttered this infamous statement: “We believe the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system”. Well, we all know how that turned out with the Great Financial Crisis. By the way, Ben Bernanke just won the Nobel Prize in economics.
The quote from Hazlett also references the much broader umbrella of potential policy mistakes and outcomes for NOT considering the longer-term effects of any policy. In considering the monetary and fiscal policies intended to abate financial stress stemming from the Covid pandemic, should policy makers have been able to foresee the follow-on implications of the asset bubble that ensued in 2021? Likely not, or such unintended consequences may have been considered a low probability event that could be dealt with in the future. An argument can even be made that current policy decisions are at least somewhat reactions to those that were made by the Ben Bernanke-led Fed during the GFC in 2008-2009 where quantitative easing originated.
In the years following the GFC, quantitative easing artificially lowered interest rates, making credit and capital cheap and accessible for many companies and consumers alike. As a result, many growth-oriented companies, in particular, were able to continue innovation and capital investments without ever experiencing a true and competitive business cycle where companies compete against one another for scarce and valuable capital to grow and sustain their business. This environment, where there has been an ubiquitous supply of capital, has enabled many unprofitable and uncompetitive companies to remain in business for years, representing excesses in the market and preventing a natural state of business equilibrium.
Furthermore, these policy actions have also created a form of herd mentality within individual investor psychology to be ready to buy market weakness anytime there is a hint of monetary easing once again. In short, not only have the Federal Reserve’s actions from 13-14 years ago impacted the financial markets, consumer behavior, and the competitive dynamics of the business cycle, but they have also impacted recent policy decisions as we see them today, that left an indelible impression on the mindset of investors and other market participants.
Another policy action that has impacted inflation and financial markets has been the steps leading to and implemented in reaction to rising oil and gas prices, a significant driver of inflation. Global oil supply challenges have been building for years due to a lack of capital investment in oil production capacity and infrastructure, not just in the US, but globally. However, these challenges have been exacerbated by the war in Ukraine, OPEC production cuts, and a focus on investing in clean energy, which have led to oil inventories trending to their lowest levels in 15 years. Now, the US government is releasing the Strategic Petroleum Reserves (SPR) into the market in an attempt to artificially suppress oil and gas prices. The result may create a short-term impact, but is unlikely to have the desired long-term outcomes, since the policy does not address the root problem of low global oil inventories.
The chart below shows US crude oil inventories, which include the SPR inventories.
Finally, both the price of oil and long-term interest rates have broken multi-year downtrends. If oil, food, and shelter prices, along with wages, remain higher for longer, higher inflation levels could remain persistent, leading to FED policy that could continue to be “hawkish” and focused on inflation. This is not all bad news in the longer-term. While there could be some short-term economic pain, it is good for fixed-income or bond investors to be able to earn higher current income on their investments. Furthermore, this environment could bring back competitive balance and equilibrium to the business marketplace. The higher cost of capital will naturally end up causing some companies to go out of business, but it will force companies to compete more vigorously for that capital. That being said, not only will this help this help to set the stage for a return to the natural state of equilibrium in the business marketplace, where the strongest and most profitable companies survive and thrive, but it will also help establish the foundation for a new bull market in equities, once these excesses have been washed out of the financial system.
The challenge for investors and policymakers alike is balancing the lessons of the past, the information of the present, and the implications into the future when making decisions. In the investment industry, we are reminded that “past results are not indicative of future returns” and logic dictates that the future is impossible to predict. This leaves the present as a common lens for making policy or investment decisions, which can be misguided as well. With no clear “right” answers, it is important for both investors and policymakers to utilize a disciplined decision-making process that considers the longer-term implications of their decisions, rather than just looking at and reacting to today’s news and the short-term noise.
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Index definitions: “U.S. Large Cap” represented by the S&P 500 Index. “U.S. Small Cap” represented by the S&P 600 Index. “International” represented by the MSCI Europe, Australasia, Far East (EAFE) Net Return Index. “Emerging” represented by the MSCI Emerging Markets Net Return Index. “U.S. Aggregate” represented by the Bloomberg U.S. Aggregate Bond Index. “Treasuries” represented by the Bloomberg U.S. Treasury Bond Index. “Short Term Bond” represented by the Bloomberg 1-5 year gov/credit Index. “U.S. High Yield” represented by the Bloomberg U.S. Corporate High Yield Index. “Real Estate” represented by the Dow Jones REIT Index. “Gold” represented by the LBMA Gold Price Index. “Bitcoin” represented by the Bitcoin Galaxy Index.