Federal Reserve Monetary Policies and Your Portfolio – Part 2
Hey, I’m Chris Perras, Chief Investment Officer with Oak Harvest Financial Group. This is our investment team’s mid-week release when we examine a news item, headline, or story making the rounds from publicly available sources and ask, “Is it News or Noise?”
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So here we go..
This week new or noise topic? The Federal Reserve and their balance sheet policies. Straight up front, viewers this is news for sure to your money.
I would say this topic has been the subject the investment team at Oak Harvest has message to our clients more times since the Covid market bottom in late March of 2020 than any other. Why? Because the Federal Reserve’s job is first and foremost still, about two things. It’s about money, its availability and its stability. and about employment and job creation.
It’s the Federal Reserve, their monetary policies, and their policy changes that matter more to your money than politicians, elections, or weekly covid statistics and weekly government economic data. Sure enough, for the first two weeks of 2022 we have been flooded by Federal Reserve members discussing upcoming policy shifts throughout the coming year in order to combat the rise in inflation we have seen the last 12-15 months that is partly due to their own actions of keeping short term interest rates anchored near zero for too long and maintaining their QE4 Treasury and Mortgage bond purchases at too high a level for too long.
So, since December, the chorus of economists calling for multiple short term interest rate increases in 2022, at first two and now potentially 4 or more rate increases for the upcoming year, has grown louder. See the expectations chart here Recall viewers, the Fed largely controls short term rates, while market prices tend to drive longer term interest rates. No one knows how many times the Fed will raise rates in 2022, however that the overall stock markets, as represented by the SP500, has absorbed this talk and both higher overall long-term rates with the S&P selling off about -5% so far from its all-time highs, is pretty good in my book. For what its worth, the person with the loudest voice and most influence on this decision, Jerome Powell, has been very measured and cautious about messaging the speed of the Feds next moves.
The issue that is most worrisome the OHFG investment team isn’t the one of interest rate increases, we can monitor that at the markets response in real time. So far, the market volatility and overall SP500 decline is very typical of early Fed tightening cycles and very much in line with our 1st half 2022 outlook. Sloppy, choppy, higher realized volatility, and a decline of 7-10%+ back toward the 200-day MVA OF 4450. Call it roundtripping November and year end 2021 gains.
It’s the other tool the Fed has used for monetary stimulus that the market seems more worried about. That tool is its balance sheet and its QE4 policy. Our team has discussed and shared our analysis of the Fed Balance sheet with our clients for 2 years now. There is only one precedent time period for the upcoming Fed balance sheet reduction, and it is NOT a perfect fit, nothing ever is. What’s that time period? Yes, if you have been watching our content, you guessed it 2018. We have messaged for over 6 months that we expected the first half of 2022 to play out in a similar manner as to 2018, and sure enough, so far it has.
However, the last time that the Fed stopped buying bonds for its balance sheet and started to let their maturing portfolio runoff, which is also known as Quantitative Tightening or QT, was 2018 and back then real yields rose materially at the same time inflation expectations ground to a halt and declined. What does this mean to investors? It means contrary to what you are hearing on TV or are reading in investment newsletters, investments such as TIPS, or inflation protected Treasuries would NOT, I repeat, not be good places to park cash for most of 2022. While retail investors are plowing money into those tools, big professional investors look to have been selling them as the TIP ETF is now down -3% year to date. That’s barely outperforming the broad based SP500 performance as of this recording. I ask you. That’s an inflation hedge?
As for the Fed’s balance sheet and its expansion and or contraction relative the stock markets? Viewers, our investment team was very early to the scene in 2nd quarter 2020 discussing this correlation and following the weekly data, however it is NOT, I repeat not the singular reason for the stock markets large gains the last 18 months. Even, if you argued that the Fed’s balance sheet to SP500 return was a perfect correlation, which is the argument bears have made for 2 years, and no correlation is ever perfect, guess what this correlation to the SP500 would be telling you? We have the data. We have known the Fed’s schedule. We can calculate the % returns. Here’s the chart. As you can see the rate of change is slowing.
However, because the Fed has been very transparent in their actions, it would have told you months ago, in November of 2021, that the risk to the overall market in the 1st quarter of 2022 was down to a level on the SP500 of about? 4450. That about a -5-.5% move down from where we closed the SP500 on Nov 4th but that up 20% year over year from where the markets stood at the end of January 2021. This level in the SP500 coincides almost exactly to other metrics, triangulations, or chart projections for a market pullback and timing this cycle. That’s a pullback in the SP500 to its rising 200 day moving average.
Viewers, this period of digesting Federal Reserve policy changes will be tough and more volatile than the last year and a half. If you are watching your portfolios daily or weekly. we ask you to try not to do it. We are doing it for you. And while we expect this volatility around the Federal Reserve and their policies to continue for the upcoming quarters, we do expect the overall markets to regain its footing and continue its bull market ways. But until then, the news you hear about the Federal Reserve, well, that news is investment newsworthy, and it will likely continue to cause tremors throughout the markets in the months ahead.
From the whole team at Oak Harvest, thank you for your support and trust throughout 2021, and we hope we can continue to be your partner and provide you with value added service in 2022.
And Viewers, feel free to give us a call here to speak to one of our advisors. Let us help you craft a financial plan that meets your retirement goals and needs first, and your greed’s second. Call us at (877) 896-0040 we are here to help you on your financial journey into and throughout your retirement years.
News or Noise: News
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