"The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy."
-Ludvig von Mises
At the time of my last commentary, the Bureau of Labor Statistics (BLS) had not yet reported the July US inflation rate as measured by the Consumer Price Index (CPI).
I noted that I expected the inflation reports for July and August to be relatively tame before potentially beginning to rise again due to base effects. So far, I got the first part right. CPI for July came in at 2.9%, which was lower than the 3.0% reported for June and lower than the 3.0% economists were expecting. Then, on Tuesday, the August CPI was reported at 2.5%, which was in line with economists’ expectations. This was the lowest annual inflation rate since February 2021, before the not-so-transitory spike to 9% began.
All this leads me and everyone else to expect the Fed to cut its policy rate by 0.25% when its meeting ends next week on Wednesday the 18th. I don’t necessarily think they should cut the rate, but I do think they will, for better or worse.
Remember, all else equal, rate cuts lead to higher inflation. The Fed’s stated objective is 2%. Inflation is higher by any measure. In fact, so-called “Core” inflation, which excludes the costs of food and energy on the basis that those prices are “volatile,” was actually reported at 3.2% for the year and was accelerating higher on a monthly basis.
Also remember, (going back to the base effects) that August 2023 was the highest CPI reading in the past year, which means that August 2024 (just reported) was the easiest annual comparison in the series. It was the easiest month to report a lower CPI reading from the year before. From here on out, it gets more difficult in rate of change terms.
So, why would the Fed consider cutting its policy rate when inflation is still well above its stated target?
Answer: It is terrified of the job market cooling and rising unemployment. These are hallmark signs of impending (or perhaps already occurring) recession, as historically indicated by the Sahm Rule, which I discussed last month.
This begs the question, how is that good for the stock market?
Answer: It isn’t.
On our recent Elevate Market Chat podcast, which you can find wherever you listen to podcasts, I outlined how this could be yet another “buy-the-rumor, sell-the-news” event.
Basically, everyone knows that the Fed is going to cut rates. Lower rates lead to higher inflation and prices, including stock prices. If everyone already knows this, chances are that everyone who wants to buy stocks will do so before the event takes place, and once the news is official, the market is left with more sellers than buyers, and stocks actually fall.
This is a frequent human behavioral pattern that plays out over and over again in the markets. That’s why I like to think of price charts of stocks and indexes as really being charts of human behavior – which hasn’t changed since the beginning of time. As the famous Jesse Livermore pointed out:
“…there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.”
Before I move on, let's take a quick look at inflation today vs. history. While the current Chairman of the Fed, Jerome Powell, has not directly mentioned Arthur Burns, the chairman of the Fed back in the 70s, his statements suggest he is keenly aware of the historical lessons to be learned from Burns’ time in the role and is determined not to repeat the same mistake of declaring inflation whipped before it really is. Despite those comments, he could be on the verge of repeating the mistake anyway.
In the chart above, you can see that after an initial period of high inflation in the 1970s, it fell for a couple of years before rallying once more – to an even higher peak than the first. I am not “predicting” that this is what will happen, I am simply pointing out that it could, as it has before.
Other recession indicators we’ve been watching are flashing “red.”
Last month, I once again pointed out that the spread between the 10-year treasury yield and the 2-year treasury yield (10’s minus 2’s) which has been negative for the longest stretch in history, was threatening to “revert” to positive for the first time in over two years. Well, that finally happened. The spread is currently 0.03%. So, it hasn’t reverted by much, and there is no guarantee that it won't invert again in the near term.
If you look closely at the chart above, you will notice that the recession doesn’t start the moment the 10’s minus 2’s reverts to positive, either. It generally takes several months. So, who knows how high the market can go before the next recession? Not me.
Contrary to what you may think, I am not in the business of predicting recessions. My job is to prepare for them and a wide range of other outcomes.
I heard a great comment related to this recently from Morgan Housel. He said:
“I think at the high level you can say, ‘I have no idea what’s going to cause the next recession or when it’ll occur, but I have a very good idea of how people will respond to it, because that’s really never changed,’ the same with bear markets and whatnot. I think the vast majority of attention in the financial world is put towards forecasting when these things are going to occur, and the track record of that is very poor. I think it’s just much better to have a good idea of what happens whenever they do occur, because that is something that we can learn from history. And you know that these behaviors have been happening for hundreds of years. Go back and look at how people are responding to bear markets in the 1800s and recessions in the 1800s, it’s no different than it is today.
I’ve talked about this example many times, but there’s an incredible investing book called The Great Depression: A Diary, it was written by this Ohio bankruptcy attorney named Benjamin Roth, who kept a very elaborate diary during the Great Depression in the 1930s. And if you read that diary, it will instantly occur to you that exactly what he’s describing in 1932, 1933 is what happened in 2008, how people were responding to it, the behaviors were no different. And then Benjamin Roth himself has a diary entry where he says, ‘What is so astounding about 1932 is that it seems like exactly what people were experiencing in 1894,’ whenever the previous Great Depression was. And so these things are just keep repeating over and over again, even if the events that caused them are very different.”
So, who knows if we are headed for a recession or not. I aim to be prepared either way.
Moving on to the indexes we’ve been tracking this year and some technical analysis.
Here is a look at where we stand year-to-date (YTD).
And here is a look at how they performed last month.
In my commentary last month, I shared a chart of the S&P 500 and said that if the price could bounce high enough to break out above the downtrend line connecting the lower highs and then above the 50-day moving average, then the pullback from mid-July to early August was probably just a healthy technical correction. Well, both of those things have happened.
However, as you can see in the chart above, the S&P 500 failed to make a new high (above 5,667.21) after that strong rally. It then dipped back below the 50-day moving average (red line) and then bounced back again. So now we are in a “consolidation” phase.
During consolidation, the price moves between a support and a resistance, in this case, marked by the black horizontal line at 5,667.21 and the upward-sloping dashed purple line. The black line is resistance, and the dashed purple line is support. In this case, I would say that the support line is the weaker of the two. The price movements tend to get smaller and smaller as the pattern “tightens up” before the price finally must pick a direction to go one way or the other, either up (breakout) or down (breakdown).
Which way this one goes is anyone’s guess. Once again, we are prepared for either outcome.
I will keep this one relatively short, but before I wrap up for this month, I want to address the 35 trillion dollar elephant in the room…
You may have heard there was a presidential debate on Tuesday… you probably knew that because it was the second most watched event of 2024, right behind the Super Bowl. They say that more than 67 million people tuned in. While we heard a little bit of everything from both candidates, one thing we heard nothing about was a plan to repay any of the $35 trillion we owe. There was no plan to reduce our interest costs or stop adding to the debt during the next four years.
Today, the US Treasury released data that showed our annual budget deficit surged in August. To be clear, the deficit is the amount spent over and above the amount taken in via tax receipts. In August alone, we spent $380 billion we don’t have, bringing the 11-month deficit to a staggering $1.9 trillion. That’s right, our government spent $1.9 trillion that we don’t have in just 11 months. And as I pointed out last month, the Congressional Budget Office is projecting that to be pretty standard over the next ten years.
I am no mathematician, but $1.9 trillion times ten years is $19 trillion… that means our national debt is projected to grow from $35 trillion today to around $54 trillion by 2034, pretty much regardless of which party is in office. I am willing to bet it will be A LOT more than that when all is said and done.
Also according to the data released today, more than half of that $1.9 trillion deficit was spent on interest! Seriously, our government has spent $1.05 trillion on interest alone in the past 11 months. Friends, this is madness. It is unsustainable… at best. I think it is criminal. Imagine if you ran your household this way. Yes, I realize that many people do. But let me ask you this – how dangerous is that? How vulnerable are they? How secure are they?
Until next time, I thank God for each of you, and I thank each of you for reading this commentary.
Clients, I encourage you to click here to access your personalized performance portal to see how your portfolio performed vs. the markets last month.
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisors
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