Inflation is going higher regardless of the Fed’s actions at its March meeting. The noise around whether the Fed will raise by 25 or 50 basis points is almost inconsequential as it relates to inflation as the inflation we are experiencing is a function of the dramatic increase in M1 during 2020 and 2021. The Fed’s money printing results in price increases for goods and services, albeit those price increases occur with a lag. Thus, we expect robust CPI growth through 2022.
The Fed is hardly in a position to curb inflation given that public debt stands at $30 Trillion. It would be impossible for the Fed to take the Fed Funds Rate into double digit percentage territory as former Fed Chairman Volcker did as the interest expense on the $30 Trillion in debt outstanding would be cost prohibitive. Even a 3% Fed Funds Rate feels steep. A 2% Fed Fuds Rate would crash the equity markets but would do little to curb inflation.
Out bet is simple: 2022 is the year the Fed will crash the equity markets. In addition, Real GDP will weaken further as the U.S. economy enters recession this year, not 2023 as some predict.
It’s comical when talking heads proclaim that the market has “priced in” a “50 basis point hike” for the Fed’s March meeting or that “The market has priced in X rate hikes for 2022”. It is difficult to know what is priced in, especially given that retail investors have been so active in the market over the past couple of years.
For example, what is main street’s expectation for rate hikes in 2022? Are rate hikes even on retail investors’ radar?
Our view is that many retail investors will be caught flat-footed as the Fed begins to hike interest rates. Each hike during 2022 is likely to be a negative surprise for some cohort of investors, especially retail investors. Therefore we expect equities to sell off in general as we move through 2022.
Where will investors store their redemption proceeds? Many retail investors will likely move more of their holdings to cash in 2022. High multiple Technology stocks will continue to be hit the hardest and many richly-valued Technology names have a long way to fall. Not every software company deserves to trade at 15-20x Revenue and 40-50x Earnings or more. The NASDAQ Composite is down only 16% YTD and has much further to fall as inflation and rate hikes squeeze valuations. Another 30% downside to the NASDAQ Composite over the next two years is not unrealisitc.