Second Half Outlook Breakdown – Part Two: Federal Reserve Liquidity

Chris Perras continues to break down OHFG’s 2021 market outlook. Part 2 in this breakdown series takes a look at the Federal Reserves’ monetary stimulus, its effect on equity markets, and our thoughts on the timing of both a “tapering” announcement and actual tapering actions.

Chris: Hey, Happy Friday. I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group. We’re an investment management and financial advisor here in Houston, Texas. Welcome to our July 2nd, weekly Stock Talk podcast: Keeping you connected to your money. Last week, we released the first of our multi-part series on our second-half outlook for 2021. That outlook entitled, Let The Good Times Roll. Troy and I will be releasing a YouTube video version of this outlook in the upcoming week or so.

Listeners can go to oakharvestsfg.com, look under the Investment Management tab in our Market Commentary section, and pull up both an audio podcast as well as an analog version of the report.

As I previously mentioned, I wanted to break down this forecast into four to six segments, focusing each segment on a different topic currently on investor minds. While I thought about discussing what I see in the next set of sector rotations developing in the markets in the early third quarter, I’ve decided to stick instead to the second in the series and its title, Federal Reserve Liquidity, All The Right Moves.

Since mid-second quarter of 2020, the investment team at Oak Harvest has tried to keep our investors and prospects focused, first and foremost, on one thing, the monetary actions of Jerome Powell and the Federal Reserve. We’ve tried to keep them focused on the historic financial market reactions since the Great Financial Crisis of 2008 and 2009 to such Federal Reserve actions. Time and time again, we try to keep listeners from thinking and listening to others who parroted the phrase, “This time it’s different,” and, “What we’re seeing is ‘unprecedented’.”

We’ve tried to present the real-time data as much as possible to show that the financial markets continue upon a relatively normal recovery path since the second quarter of 2020 and at least a normal recovery path since the cycle began in early 2009, over the last 12 years. While the speed of the economic and market recovery has been historic in nature, it hasn’t, and should not come as a surprise to those who have followed the financial markets throughout the Federal Reserve and other central banks’ monetary easing policies over the last 12 years.

Clients can go ahead and log on to the Oak Harvest web portal and see the next few charts and tables I’ll be referencing. This is the chart of the total assets of the Federal Reserve balance sheet versus the S&P 500. It is taken straight from the St. Louis Federal Reserve’s website, and it can be accessed by anyone for free. All you have to do is google “Federal Reserve Bank of St. Louis, Federal Reserve balance sheet versus the S&P 500.” That’ll take you right to this chart.

As one can see from the chart, there has been a very strong positive correlation between the Federal Reserve’s balance sheet size and growth rate to the level and percent return of the S&P 500. If one believed in perfect correlations, which there are none, one would guesstimate from the chart that the S&P 500 could reach 4,850 plus over the next 9 to 12 months before it was overvalued or at risk of a substantial market decline.

This is also one of the three metrics that the Oak Harvest investment team has been using since the third quarter of 2020 last year, pre-presidential election cycle, to triangulate our optimistic upside case for the markets into first quarter of next year, that is 2022. Looking at this chart, one should see that the S&P 500 has risen even when the Federal Reserve balance sheet was no longer growing, but instead, at a stable level. All you have to do is look at 2017 through early 2018 to see that.

I mention this point because so much is being made in the financial press and news networks of the possible outcome of just an announcement on when the Federal Reserve will start tapering, or slowing their balance sheet expansion, let alone an outright reduction in its size. History would say that X may be a few days or weeks. These events such as an announcement should not materially affect the markets, except for maybe a few hours, days, or maybe a few weeks as short-term traders might not be positioned correctly.

I know it’s hard to do, but as my dad likes to say, don’t sweat the small stuff. Unless you are margined up to wazoo in a trading account, the timing of the tapering announcement should be noise. Should the market overreact to such a mispositioning, we would take advantage of any small pullback to add the positions for clients.

I expect an announcement of the tapering schedule later this summer, with the possibility of the Federal Reserve slowing the pace of purchases, probably of mortgages, starting later in the year, more likely, say February of 2022. The reason I think it may be pushed out to early next year is the slower than expected jobs recovery that we’re going through. There’s a very good chance the Fed pushes all of its tapering actions out into the first quarter of 2022 as not to create a mistake like the one they created in the fourth quarter of 2018 into Christmas Eve.

I think most investors remember that, the markets going straight down in November and bottoming on Christmas Eve of 2018. I think Jerome Powell will do everything within his power not to make the Federal Reserve the Grinch that stole Christmas in 2021.

Once we start the second half, we continue to see a very strong second-half stock return, hence our title, taken from The Cars classic, Let The Good Times Roll. Short term, I expect the third quarter to begin with rising long-term interest rates, and a return to the value on commodity trade that everyone was huddled into at the wrong time, and it looks like they were busy dumping at the end of the second quarter. I would look for industrial stocks, agriculture, grains, metals, and other commodities to bounce considerably in July, and probably August.

I would venture to guess that things like nickel and lithium get talked about once again as leadership groups. Why? Because there’s financial TV commentators, who were recommending them at exactly the wrong time, and the tops have now all run to the other side of the boat to join the bullish moving technology stocks, five to six weeks after it started. Moreover, fundamentally between electric vehicle demand and residential and industrial battery backup power demand for electric battery storage, battery storage remains strong and should accelerate further as auto capacity restarts later in the year with increased semiconductor availability.

Additionally, commodity supplies are still tight in the areas of nickel, lithium, and palladium, because of mine strikes in Canada, and the resurgence in COVID cases in both South America and Australia. However, listeners, this is what happens in bull markets. Leadership rotates from one group to another. It’s very normal and very bullish behavior unless you’re late in and out of each one of these sector moves. It’s summer and as far as the Oak Harvest team is concerned, so far, it’s a very normal one. The Oak Harvest projection for where the S&P closes the year-end of 2021 and early 2022 hasn’t changed. If anything, it’s inching higher.

It remains well over 4,600. It’s edging closer to 4,800 or higher into early 2022. The sell-off we experienced in late first quarter 2020 is much closer in behavior to the 1987 stock market crash that merely interrupted an ongoing bull market. It didn’t create a secular bear market or period of stagnation. If you want more detail on our outlook, keep listening to this series of podcasts detailing our second-half outlook. Let the good times roll. I’m Chris Perras, have a great weekend. Enjoy your 4th holiday. Give us a call at Oak Harvest here in Houston, Texas, 281-822-1350. We are here to help you on your financial journey into and through your retirement years with a customized retirement planning.

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