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Why the two-day rally to end last week is significant


Let’s say you wanted to design a program to lower inflation. Wouldn’t you do exactly what Federal Reserve Chair Jerome Powell is doing? You would be raising rates aggressively, and I defy you to say that he isn’t doing just that. You would ignore positive numbers like the weak consumer price index print last week by sending out Chris Waller — one of the more hawkish Fed governors — this past weekend to say that the interest rate hikes are far from over. You would claim no victories whatsoever, including the collapse of the cryptocurrency exchange FTX, which filed for bankruptcy on Friday. You would just stay mum, enabling investors to expect another raise of 75 basis points, especially if retail sales this week come in above expectations.

There are many ways to measure a Fed chief. Most people who comment vociferously and viscerally against the Fed tend to be rich folks who want their wealth preserved, but somehow actually come off as altruistic. Or people in the media regard them as such because they are such prized bookings. That’s probably why they are esteemed in the eyes of the viewers.

The old me would say, “What a bunch of selfish bastards.”  The new me simply says, “I know where they are coming from, but they are ill-advised.”

But let’s use this view as a litmus test. You have to wonder where are all the rich castigators? Maybe they realize that Powell is tougher than they thought? I think so.

Their silence is louder than their protestations. Powell is the real deal and he’s not done until he softens our economy, shrinks our portfolios, reduces our purchasing power, drops our wages, and makes our goods cheaper. The good news so far: He is doing all of that. The amazing news? He’s not hurting corporate earnings in the process. They are shining.

Consider: Last Thursday and Friday were back-to-back winners, something that’s very rare in this year-old bear market. If you bought at the market high on Thursday, you are still up. I can count on one hand how many times that has happened since the peak.

Could it be as significant as many believe? 

That’s a tough question, because in order for the Fed to get all of its boxes checked, Powell needs wages to level off and that has not happened. He needs to see weakness in the CPI beyond the handful of line items that softened things in last week’s reading. Most importantly, he needs to see our purchasing power diminished, and we are most definitively not there yet.

But let me throw you a bizarre curveball. Part and parcel with the spending power reduction is speculation. The speculators overspend because it’s in their nature is borrow too much. What then do we make of the crypto meltdown? How much money is being lost in crypto really? How big are the losses? I am so sick of the Lehman moment nonsense (the collapse of Lehman Brothers in 2008 was the key moment of the 2008 subprime mortgage crisis). I don’t even like the comparisons to the fall of Enron in 2001. As my late mother would say, comparisons are odious — had she lived longer, she might say irrelevant.

What matters is that financial cataclysms like the ruination of FTX CEO Sam Bankman-Fried do make people reassess wealth and spend less — and I don’t just mean those who actually lost and will lose a lot more money in these often worthless crypto coins.

Take it a step further: Another unknown is the amount of money invested in FAANG/M (Facebook, Apple, Amazon, Netflix, Google, Microsoft). If you are in the S&P 500, you are certainly feeling punished, but if you are mostly in FAANG/M, you are feeling broke.

Why does this all matter? Because the Fed would ideally like to stall for time while the supply chains get more efficient, something we are seeing with the lowering costs of logistics. It would sure help, however, if we slowed down spending as a nation. We need both more goods coming to market and fewer goods being sold. Any glut will cause both lower prices and layoffs.

Does it matter if the layoffs are largely concentrated in anything technology, including fintech and real estate tech and retail tech?

At one time I thought these sectors were too small to make a difference. You would need mass layoffs in retail, autos, housing, you name it — all but the insatiable health sector.

Now I am not so sure. Maybe Silicon Valley layoffs have more of an impact on the economy than we thought. Just as tech became a larger part of the S&P, it also became a larger part of the economy. Sure, it’s not nationwide, but tends to be concentrated just in Northern California and Seattle. But the layoffs will be in the tendrils that aren’t in those areas.

Anything that lessens the velocity of spending, coupled with the reduced price of logistics, might lead to lower prices and wages — which should result in slower and smaller rate hikes. That’s why the 2-year Treasury yield has such a hard time staying above 4.5%.

I don’t want to say we are out of the woods when Fed officials are saying we are smack in the woods. I do want to say that Thursday and Friday felt significant to me because they were actually based on softer numbers that seemed unassailable and yet, at the same time, did not portend earnings shortfalls.

Sure, it seems ridiculous that we could get through this whole process with giant earnings blowups. But we have seen the hottest sectors of the economy — tech and the internet — revealed as far more vulnerable than we thought. It’s amazing how much Meta Platforms (META), Alphabet (GOOGL) and even Amazon (AMZN) depend on advertising for their revenue growth and that’s in a tailspin as retailers feel the Fed’s pinch. Microsoft (MSFT) has felt the last of the PC Armageddon. Advanced Micro Devices (AMD) and Nvidia (NVDA) have been walloped by the undeniable weakness in gaming — even as the gaming companies deny the weakness.

Netflix (NFLX) is coming back, but it was never that big. Apple (AAPL) is hanging in there, even as that seems impossible to last. But you know my feeling on Apple: own it, don’t trade it.

I am not including the hundreds of other technology stocks that have collapsed. But if I did, the decline can only be considered seismic. 

Which leads to a logical question: What if tech of all sorts and crypto turn out to be larger than we think? What if they can cause the slowdown that we need to keep the Fed at bay? Do we really need old-line companies to miss their numbers to see the end of the tightening? Maybe the voracious spending that came from these hot sectors cools while the logistical nightmare ends. It could be enough make us wonder if we aren’t further along in the process of breaking inflation than we thought.

As I think about what to say at Thursday’s monthly meeting, remember we will have some really amazing retail sales data to help solve the quandary. The best that can be said, though, is that the two days up to end last week seem significant — especially in light of the collapse of FTX.

Those two days seem to be saying that the Fed is catching a break. Although I would say it is a break of its own making.

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