Recession Or Inflation Which Is It?

|
Includes: DIA, IWM, QQQ, SPY
by: Lee Hoffman

Summary

Correct answer to this question key to successful investing.

Is the Fed the right gauge to figure it out.

Who wins, who looses.

Much has been written and said regarding the conflicting statements from certain Fed governors regarding the condition of the US economy and the direction the Fed will take regarding interest rates. Regardless of what real impact the Fed actually still has (see my article here ) the real direction of where the economy is heading provides investors with significant insight as to where and how to invest.

If the economy is truly expanding and inflation is actually a threat of significant import to motivate the Federal Reserve to "normalize" the rate structures, (real meaning) increase short term overnight lending rates than going long in this market even with the short term impact of a Fed rate hike is the only appropriate direction.

Conversely, if the economy is in distress and recession is truly in the cards, than reducing holdings by selling into the most recent market run up and waiting for the inevitable market correction caused by recession is the only course of action.

As an investor, it becomes increasingly important to attempt to read the tea leaves successfully or at least to attempt to identify all the potential factors involved. One of my favorite sayings is that the answers are always obvious, it's the questions you didn't know about that ruin the outcome.

So, if the economy is not really doing that well, why would the Fed be so anxious to talk up a rate hike? Well, for one thing a rate hike would hurt US exports, but would be helpful to foreign countries attempting to gain traction in the global economy. If the Fed believes (and I believe they do), that it is impossible for the US economy to prosper while the rest of the world recesses, then putting a damper on US exports (relatively small part of the US economy) would be a short term detriment for the long term benefit.

Perhaps more importantly, the Fed is concerned with having some place to move if there IS a recession. How does one lower interest rates that are already at zero, unless you adopt the negative interest rate scenario? While my prior articles have identified the fact that the Fed has created a defacto negative interest rate environment, to be forced to announce this would be devastating for the Fed's reputation and the psychology of the economy in general.

Based on the above (presuming you agree with the logic), then the Federal Reserve and its members are a poor barometer by which to measure the strength or weakness of the US economy. While this statement is counter to any post war recession or expansion, one must consider that recent times are not in any way a replication of any of the economic events since WWII. Thus economists who for the most part are students of past events and utilize those events to prognosticate the future, may very well be out of their element in predicting the future for the US (and world) economy.

So what exactly DO we know. Well, we know that the economy is growing at around 2% a year or less. The most anemic growth to ever have occurred in a post recession recovery. We know that unemployment is dropping, but the labor participation rate is the lowest it's been in decades, indicating an abandonment of job seeking, or alternatively and additionally, an unwillingness to accept employment that doesn't pay significantly more than unemployment benefits.

We know that commodities have dropped precipitously, and that the demand world wide for those commodities is greatly reduced. We know that countries who have built their economies on commodity exportation are suffering and in recession.

We know that the European Central Bank has reduced it's interest rates to negative in an attempt to stimulate it's own economy, that Japan has done the same, and that none of it to date seems to have generated the anticipated results. China is slowing or has slowed, and regardless of whether there will be a "hard" landing or a "soft" landing for that country there will nevertheless be a landing.

Well, with all of those backdrops it would seem that the world (excepting the US) is either in recession, will be in recession, or never reported accurate numbers in the past to tell the difference. Which begs the question as to whether the US can muddle along while everyone else is stumbling.

So, what exactly is "good"? Well, for one thing, banks are flush with cash and regardless of whether they are lending it now, eventually with the proper remediation of policy makers they will.

Energy has saved the US economy billions of dollars in expense. Interest rates are low not only short term but longer term as well and is a world wide phenomenon. Finally, the US may in fact be the only safe haven for not only domestic investors, but foreign investors as well.

Moreover, nothing really has fundamentally changed in the environment which has driven the markets to unprecedented highs. Companies have expanded their bottom lines by cutting costs and expenses, and with commodity prices rock bottom, that trend just may continue. While corporate profits have leveled off or have suffered those reduced earnings seem to be centered in the oil and energy fields. Finally, the financial pressure on some of our international antagonists, just may cause a reduction in their desire to expand their militaristic adventures.

Additionally, the housing market while still having it's regional issues, seems to have at the very least partially recovered. As an added benefit, consumer sentiment and consumerism seems to be on the rise.

While the factual evidence does indeed favor the darkening rather than the light at the end of the tunnel, the market marches on albeit in spurts of activity. As an investor one must consider the macro events surrounding the economy. However, the present scenario would seem to indicate that a muddling economy is good for the markets and that an economic breakout could signal even higher movements for this market.

If the economy expands even marginal, but the Fed is concerned with all of the aforementioned, not to mention a potential recession it could signal the best of all worlds. A tepid growth but growth nonetheless, and not vehemently enough to signal a dramatic movement on the part of the fed. The economy seems to be holding the Fed by the nose, while kicking them in the pants.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.