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The market began the year with a plunge. Then it rebounded a bit.
Now it has the jitters, with multiple sell-offs and rallies.
The culprit is inflation. Consumer prices have risen at a 7% rate, the fastest level in 40 years.
Inflation is the thief that robs us all.
It crimps purchasing power. It reduces profit margins. And it erodes our standard of living.
Moreover, it causes interest rates to rise and equity values – based on discounted cash flow analysis – to contract.
Today’s high inflation rate is largely due to a bungled pandemic response by the U.S. government, as well as many governments overseas.
Economic lockdowns hurt manufacturing, transportation and retailing – and completely derailed the global supply chain.
(They also destroyed many businesses and livelihoods.)
Trillions of dollars of overly generous “stimulus and relief” spending fattened pocketbooks and encouraged millions of people not to work, exacerbating a labor shortage.
The Federal Reserve was completely behind the curve, holding short-term rates near zero and continuing its massive quantitative easing program, even as it became clear that prices were rising sharply.
Consumers are angry.
They don’t like high prices at the grocery store. They don’t like $50 fill-ups at the pump. And they don’t like having less to spend after they pay their overhead.
Investors are unhappy too. Many believe high inflation is here to stay.
But it’s not.
You want to know why bond yields are still under 2% and gold has hardly budged?
Because inflation will abate by midyear and fall by more than half by year’s end.
Relief Is Around the Corner
The Fed knows it screwed up. That’s why Jerome Powell and company put the world on notice that short-term rates are headed up and quantitative easing is coming off.
Higher rates make it more expensive for consumers and businesses to borrow. That helps reduce pressure on prices.
“Build Back Better” – with its additional trillions of dollars in deficit spending – is dead.
Yes, Democrats will pass some of the provisions in the bill into law this year. But it won’t have nearly the fiscal impact.
Washington’s inflationary spending is about to peter out.
The economy expanded at a 6.9% rate in last year’s fourth quarter. That helped deliver the strongest GDP growth since 1984.
But that is already yesterday’s news.
Economists project a slowdown from the big reopening quarter in last year’s first quarter.
Indeed, the Federal Reserve Bank of Atlanta just forecast GDP growth of a paltry 0.1% for this quarter.
Slowing economic growth dampens inflation too.
Also, the pandemic caused consumers to spend much less on services.
(When you are discouraged from leaving home, you will spend less on dining, leisure, travel and entertainment.)
Flush with government cash, consumers picked up their spending for goods online instead.
They bought computers, furniture, in-home exercise equipment and electronic gadgets galore.
Goods averaged 31% of total personal consumption in the two years before the pandemic. That soared to 36% by last spring.
With omicron on the wane, however, a major shift is occurring.
The Commerce Department reports that spending on goods is down and – surprise, surprise – spending on services is up.
How will that help reduce inflation?
When consumers buy more services and fewer goods, it eases the pressure on the supply chain.
And waning pandemic aid will motivate more people to go back to work, easing the labor shortage.
In short, the slowing of the economy, the end of pandemic relief, a less accommodative Fed, a rising labor pool and the demand for more services at the expense of goods will cause prices to come back down to earth.
This will ease the pressure on the Fed to raise rates, especially in an election year.
That’s positive for the economy, retail sales, corporate profits and, ultimately, the stock market.
P.S. I wanted to let you know that one of the highlights of 2022 is fast approaching: our Wealth, Wine & Wander Retreat in northern Italy.
This June 11-22, join me and European travel expert Fritz Satran on an epic yet luxurious journey to Milan, Lake Como, Verona and Venice.
We’ll explore this extraordinary region – long recognized as Italy’s capital of finance, fashion and fine living – together, and I’ll share exclusive financial insights along the way.
You don’t want to miss this Italian adventure. You can find more details here.
Click here to watch Alex’s latest video update.