Fed have Projected Caution

Macro Perspectives

As we start the fourth quarter, let's take a look at year-to-date major asset class performance;

• Stocks are down 24% (S&P 500).

• Government bonds are down 14% (the 10-year U.S. Treasury note)-yields are up 153%.

• Corporate bonds are down 18% (Bloomberg Baa Index).  

• Real estate is up 8.5% (existing home median sales price).

• Commodities are up 4% (S&P GSCI equal weighted index).

• Cash is up just less than 1% (money market fund).

After adjusting for inflation, it's all negative (except real estate, which is flattish). A collection of popular ETFs representing the above is shown below.

The performance in asset prices has less to do with whether or not the economy can withstand a 3% interest rate and more to do with a Fed that has explicitly and continually (over the past six months) threatened to destroy demand and jobs. The Fed has manufactured the desired slowdown in economic activity (again, with just a 3% interest rate, which is still below the long-term average).

The first two quarters have already been booked as negative GDP growth. So the recession is not questionable. It is here.

We now have the valuation on stocks at 15 times next year's earnings (less than the long-term average P/E on the S&P 500, at 16x). That's on earnings growth expectations that have been dialed down to 3%-that would be negative real earnings growth (after the effect of inflation).

So the Fed has manufactured a recession without taking rates above the rate of inflation (not even close). They've killed the wealth effect of rising asset prices. And they've cut the valuation on stocks from very overvalued to slightly undervalued (relative to long-term historical valuation).

To top it off last week, the Fed pushed the limits to the point of destabilizing the financial system (given the events in the U.K.).

With midterm elections six weeks away, this seems like a good time for the Fed to step back.

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