by Jim Rickards, Daily Reckoning:
The stock market was up big today, but it was nothing compared to last Thursday’s huge rally. In fact, last Thursday was one of the wildest days of trading in the history of Wall Street.
But don’t mistake that for the return of good times. It simply serves as a good example of just how volatile markets are these days — and the power of narratives to challenge fundamental analysis.
In other words, there’s a lot less there than meets the eye. Let’s break it all down…
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The action started at 8:30 Thursday morning when the government released inflation data that showed consumer prices had surged 8.2% in September on a year-over-year basis.
The clear implication of this was that the Fed would continue tightening including a 0.75% rate hike on Nov. 2 because the fight against inflation was nowhere near over.
That suggests stocks should fall, and they did. From a closing level of 29,210 on Oct. 12, the Dow Jones Industrial Average plunged to 28,709 by 9:40 a.m. on Oct. 13, a 501-point dive, down 1.7% in a matter of minutes.
Then the narrative took over and stocks soared.
By the close on Oct. 13, the Dow was at 30,038, a 1,329-point gain, or 4.6% surge from the lows of the day. What had changed?
Bad News Is Good News
Substantively nothing had changed. But a new narrative took over market psychology. What was it? The narrative is a version of the old saying “Bad news is good news.”
Traders said that the more extreme version of Fed tightening expected would kill inflation faster than expected and set the stage for interest rate cuts early next year. Those expected rate cuts would be good for stocks, so it makes sense to buy stocks now!
But this narrative is nonsense for several reasons. The first is that the Fed has made it clear they have no intention of cutting rates anytime soon.
September inflation rose 8.2% on a year-over-year basis, near the highest rate of inflation in 40 years. It was also higher than expectations. Importantly, core inflation (which excludes food and energy costs) also rose 6.6% on a year-over-year basis, the highest since August 1982.
Inflation may come down but the Fed’s target rate is 2% and the current 8.2% is still a long way away.
The second problem is that if the Fed actually did cut rates early next year it would not be a sign of success but a sign of dismal failure. It would mean that the economy was in a severe recession, which would be awful for stocks.
The Thursday turnaround was a highly condensed version of the Fed pivot narrative that caused stocks to rally in late July until mid-August. Markets seemed to come to their senses on Friday when a sharp decline occurred in response to the previous day’s rally.
There will be no Fed pivot, at least not for a while. It’s just another bear market trap. Don’t fall for it.
Meanwhile, I want to address a conundrum that the Fed faces with respect to inflation…
Doesn’t the Fed Want Inflation?
The national debt is over $31 trillion. Total U.S. debt, public and private, is over $92.6 trillion. Inflation lowers the real value of debt, which makes that debt easier to pay.
That raises a fundamental question: If inflation is one way to manage excessive debt by melting the real value of the debt, why is the Fed so dead set against inflation?
Why is it trying to reduce inflation if inflation is the ultimate way out of the debt?
Of course, taxation is one way that governments take money from citizens to pay off government debt. But taxes are unpopular and hard to get approved by Congress.
Inflation works much better.
It reduces your real income since the dollars you earn are worth less. It reduces the government debt because the money the government owes is easier to repay for the same reason — the dollars are worth less.
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