Atlanta, GA
September 4, 2023
Labor Day weekend is winding down. When markets open Tuesday, they’ll welcome what historically is the most tumultuous time of year.
September, as Mark Twain allegedly observed, is the most dangerous month to speculate in stocks… “along with July, January, April, November, May, March, October, June, December, August – and February.”
Since the Second World War, September is the only month with negative average market returns. Yet as my friend, investor Zach Scheidt, reminds us, “in years when the broad market is up more than 10% heading into September, the month has been much more constructive.”
So we adopt the outlook every investor should have: who knows? But as we wade into dangerous seasonal waters, we’re continuing to tread a treacherous change in the prevailing tide.
We’ve noted repeatedly how in 1913, with the establishment of the Fed, the monetary system got on the wrong track. Then, in 1971, it went off the rails.
By the late 1960s, the US government lacked real money to feed its fiscal furnace. The engine was suddenly incapable of pulling the guns and butter it had promised to haul. So central bank engineers opted to burn paper to keep the train going. For a few years, this kept things rolling.
But the bumps intensified, the smoke thickened, and the rattling increased. When champagne started to spill in the first-class car, elite passengers demanded to be let off the train.
The French were first. They wanted a refund on their diluted billets. But the US porter defaulted on his obligation by withholding their gold.
Then, on August 15, 1971, the head of the railroad sealed the safe. That night, Richard Nixon declared that no one’s ticket would be redeemed. They wouldn’t be taken where they were promised to go. Yet everyone’s gold would remain onboard.
The world was trapped on a ride it hadn’t booked, and had never been on. From that day forward, the monetary train lost touch with the ground.
Henceforth, the dollar would “float”, subject to the political whims of the men at the helm. Almost immediately, without the reliable guidance of sturdy rails, trust dissipated. On board, passengers noticed the cabins getting smaller, the portions shrinking, and the drinks being diluted.
After the dollar detached from gold, prices rose, wages stagnated, and the stock market tanked. In real terms, it fell almost 80% by 1982. As interest rates went thru the roof, bonds fell thru the floor.
There were few places to hide. Among the bunkers were real assets, energy, and precious metals. By the end of the decade, oil quadrupled, and gold rose twenty times.
It was then that Paul Volcker hopped onto the locomotive, blew the whistle, and applied the brakes. He pulled the lever fast, and far. The economy screeched to a halt.
The pile-up was extensive, and the damage severe. But it was a time of low debt that could absorb high rates. That is not the world we’re in today.
As passengers picked themselves up, brushed themselves off, and stumbled away, they swore they’d never again to be taken for a ride. But a new trip was about to begin.
In the early 1980s, equities were declared dead. Then, in the quiet dawn of a neglected cemetery, the bull market rose from the grave.
For several years, it wandered inconspicuous and unrecognized. Then, it got noticed. On an October Monday in 1987, it was brutally beaten and mercilessly mauled. When the carnage was complete, the Dow Jones Industrial Average…the face of the market…had lost almost a quarter of its teeth.
Fed dentists immediately stepped in, pumping monetary novocaine to ease the pain and reassemble a smile. And it worked. For four decades, whenever the market ached, central banks found more laughing gas…injected in the form of funny money.
After bubbles burst in 2000 and 2008, the Fed stepped in like bartenders to a hangover. Rather than “remove the punch bowl”, it spiked it. It tried to cure debilitating debt with additional credit.
The Fed nailed its funds rate to the floor, and began buying assets with counterfeit currency. And, superficially, this film-flam seemed once again to “work.”
But interest rates weren’t merely bound; they were also gagged. Without being able to speak, yields were unable to accurately convey the most important information a market needs: the price of credit.
Prices are more than numbers. They’re signals. They reveal not only which products are in most demand, but how resources should be allocated (across places, people, and time) to discover, design, develop, and deliver them.
When the Fed monkeys with interest rates, it blindfolds the economy, spins it around, and puts banana peels along the path where it encourages it to go.
Under these circumstances, markets (particularly with the Fed standing behind them) can stumble higher for a while (and often, as we’ve seen, for a long while). But at some point, they slip, and aren’t able to get up.
The effectiveness of phony credit wanes as debt levels rise. Steady drips of occasional morphine are no longer sufficient to dull the pain and keep spirits afloat. Manipulated markets needed greater doses of stronger stuff.
Like a drug-addled derelict moving from pot to heroine to get his fix, queered economies need weirder remedies to cure their ills. Like helium into a balloon, “quantitative easing”, “zero-interest rate policy”, “Operation Twist”, financial bailouts, direct “stimulus” payments, and other hallucinogenic shenanigans floated financial assets on a steady flow of hot air.
For almost two generations, stocks and bonds were lifted by the hot air of artificial credit. By the third decade of this century, the global economy was high as a kite.
The pandemic calamities of lockdowns and closures compounded artificial demand by constraining supply. For years, moronic restrictions on hydrocarbons reduced exploration for reliable energy. Idiotic sanctions on Russian sources made matters worse.
Markets, like nature, tend to move in slow sweeping cycles and long predictable waves. For four decades after the Second World War, interest rates rose, and bond prices fell. For the next forty years, they did the opposite.
Now, the primary trend has turned. A couple summers ago, bond yields scraped 5,000 year lows. Since then, they’ve moved higher, and will likely keep going for the rest of our lives.
On the surface, waves will continue to chop and churn. But underneath the current has shifted. So how to stay afloat? When trying not to drown, what assets go overboard, and which stay in the boat?
Next time, we’ll stock the galley and clear the deck.
JD
What an incredibly intelligent, interesting, and insightful review of the last 50 years. Thanks for putting all that thought and effort into writing it!