Every year since 1982 the Kansas City Federal Reserve has hosted an economic symposium at the Jackson Lake Lodge in Wyoming. It is a meeting of the Who’s Who in the economic and academic community. It used to be more about research with very little fanfare, but for the last decade starting circa 2009 with the Federal Reserve’s Chairman at the time, Ben Bernanke, the Jackson Hole symposium has captured the full attention of the investing public. Jackson Hole is now reserved for important monetary policy and interest rate announcements. And this year was no different. Current Fed Chair Jay Powell shook up the Wyoming crowd and the financial world during his Jackson Hole speech announcing that the Fed would no longer attempt to target a 2% inflation ceiling, but that they would look to a 2% average of inflation over a period of time. We will let that financial revelation sink in for a few seconds…. If you are like most, your appropriate response would be, “What?”
As benign as that sounds, it is actually a major policy shift in the Fed’s view of short-term interest rates and inflation. Here is the breakdown. Previously, the Federal Reserve has had a hard target ceiling for inflation of 2%. This meant that as inflation approached 2%, the Fed as a rule would increase short term interest rates to attempt to head off inflation moving beyond the 2% target rate. Since the Great Financial Crisis of 2009, raising rates has been cause for concern for most investors. Over the past ten years, we have had many examples of equity markets reacting very negatively to even the mere thought of rates rising. Here is where the policy shift comes into play. The aim is no longer to prevent that 2% number from ever being reached, but it is now to manage an average of 2% over an unspecified period of time.
Let’s look at an example. If in year 1 inflation is at 1%, then in year 2 inflation moves up to 2.5%. The average inflation rate over the period is 1.75% and inside the Fed’s target. So even though the economy ran above 2% inflation for a year, the average inflation rate over the period was still below 2%, and therefore the Fed could leave its official rates un-touched. The importance of this is that rates now could potentially stay very low for an extremely long period of time. The real benefit is that the new policy gives the Fed a longer runway for a thoughtful approach concerning the economic recovery, inflation and employment in a post-COVID world. The other is that lower rates should—over the long run—remain as a positive tailwind for stocks.
Up until the last few trading days, we have definitely seen signs of this Fed aided tailwind in the stock market, especially in technology. (See our last month’s “Notes” where we breakdown the various sectors and their performance.) While the market has definitely hit a recent rough patch, the research firm GreenRock took the opportunity to give a possible explanation for the sell off. GreenRock noted that while the S&P index was still in positive territory for the year through August, many stocks were not participating in this positive performance. They pointed out that the S&P Index’s rise is being driven primarily by six well-known and large tech-stocks benefitting from the current environment: Apple, Amazon, Facebook, Google, Microsoft, and Netflix. As of the end of August—before the tech sell-off of early September—these six stocks contributed 16% to the year-to-date total return (which includes dividends) of the index. Since the S&P Index had a total return of almost 10% at the time, the remaining 494 stocks making up the rest of the S&P Index collectively subtracted 6% from the total return. In their view, a correction in technology stocks was inevitable given their high valuations. Their moves off of the March lows of this year had outpaced GreenRock’s assessment of their growth potential.
For Stone Bridge these types of disconnects between various sectors and the overall index provide opportunities to be active and selective for our clients’ portfolios. This also supports the case for continued diversification that over time provides for a less volatile investment experience.
Speaking of investment experience, we hope you all have received your invitation to our upcoming virtual event. Professor Scott Quatro, PhD will help us make sense of the emotions we may be experiencing in the market with a talk entitled: “Buy! Sell! Hold! Decision Making and Human Psychology.”
Dr. Quatro is a behavioral scientist and serves as Professor of Management and Chair of the Business Department at Covenant College, where he teaches courses in Management, Organizational Behavior, Strategic Management, Human Resource Management, and Business Ethics. Some of you may remember Dr. Quatro from last summer as he energized the crowd during one of our previous panel discussions. We are very happy to have Dr. Quatro back with us as he breaks down the human psyche and puts some rationale around the human condition and what we are experiencing.
Our virtual event will be held September 16th at 12:00 noon. Check your email for more details, including registration information. We hope you can attend.
Please reach out to us with any thoughts or questions.