Page 28 - BusinessWest March 20, 2023

Using History as Our Guide
It Shows That Our Pain May Be Followed by Some Gains
BY JEFF LIGUORI
“ The repricing
of assets has wide-ranging implications and is often disruptive to an economy.”
According to Google searches, the popularity of the term ‘infla- tion’ hit its highest peak in at least five years during the sec- ond week of August of last year.
For the sake of comparison, the term ‘stock market’ is one of the more popular Google searches. On average, ‘stock market’ is three times more popular than ‘inflation.’ For further comparison, the search for ‘Lebron James’ is regularly much higher than ‘inflation,’ but still not quite as popular as ‘stock market’ on average. Yet, in August of last year, ‘inflation’ bested both terms, by a wide margin.
Higher consumer prices are causing anxiety. The Federal Reserve, with its dual mandate of full employment and low infla- tion, has been working to ease prices through higher interest rates, which led to weak performance in both stock and bond markets in 2022 — a rare phenomenon when both markets sell off in tandem.
When the Fed raises the federal funds rate, an interest rate that banks charge to one another for overnight lending, it has a ripple effect, putting upward pressure on all interest rates, from mortgages to treasury bills. In turn, all assets get ‘repriced’; stock prices adjust lower (usually) because higher rates often mean profit margins for those businesses shrink, which equates to a lower valuation for that company’s stock price. The repricing of assets has wide-ranging implications and is often disruptive to an economy.
Is the Fed acting appropriately? Wall Street, with no lack of vary- ing opinions, either believes the Fed has overstepped by tighten-
ing too quickly and too late, or the Fed should be more aggressive in the next two sessions and then be done. Finding an economist or strategist that thinks Jerome Powell and his crew are precisely doing the right thing is nearly impossible.
Instead of opining on the Fed’s actions — I’m not an economist,
more of an ‘investment historian’ — let’s put the discussion in the context of past cycles of rising inflation and what it might mean for investors.
From January 1966 to August 1969, the federal funds rate more than doubled from 4.5% to 10.25%, in what was then seen as aggressive action by the Fed to tame inflation. In August 1969, the Fed reversed course, cutting interest rates as the economy slowed and the country faced increasing job losses. To safeguard the econ- omy, the Fed quickly went from raising to easing interest rates, mov- ing the effective rate back to about 5% in March 1971, as unemploy- ment started to tick up.
But the story doesn’t end there. Inflation was persistent even with a slowing economy because of a burgeoning energy crisis. Once again, the Fed moved to a tightening stance, this time increas- ing interest rates by more than 300% from the spring of 1971 to the summer of 1973. Interest rates skyrocketed, and stocks suf- fered badly, declining by more than 40% in the 14 months following the start of that new tightening cycle, before bottoming in October 1974.
Interestingly, interest rates remained historically elevated throughout the 1980s, but stocks managed to do quite well. From the low in October 1974, the S&P 500 had an impressive run until the tech meltdown in 2001, appreciating 460% into late 2000. The data is compelling.
Following the Fed pause in 1974, in 21 of the subsequent 28 years leading up to the
tech bubble, stocks generated a positive annual return. The
History
Continued on page 29
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