When my girls were younger, and we were at a playdate or birthday party, I found it very helpful to give them a five-minute warning that we were about to leave. As a parent, you can usually sense when it’s time to go. Some common signs: you see some kids painting the dog’s toenails and another group fashioning pizza boxes into siege implements (shields for their imaginary battles).
The five-minute warning always gave my kids a little time to process the idea that a transition was coming and that the craziness of the party was going to soon settle down. Even adults tend to do better when they have a little time to get used to change. Right now, the Federal Reserve is taking a somewhat parental role in our economy. They are signaling their intentions well in advance about how they are going to balance out the business cycle highs and the lows.
Parents also know that it’s best to try to smooth out the highs and the lows. Parents want their kids to have fun and not get wildly out of control. So, plucking them out of a party before potential mayhem erupts is usually the right choice.
Recently, the Fed flashed us its equivalent of the five-minute warning by starting to talk about tapering, meaning they will soon halt the bond-buying program they started in March 2020. This is the first step toward pulling back monetary stimuli – very much like parents grabbing their kids’ coats as they prep to leave a gathering. If tapering goes well, the next step would be to start raising interest rates to put the Fed in a neutral mode.
Dealing with dysfunctional ‘parents’
Have you ever noticed that some pairs of parents at a party give their children conflicting messages? One parent may be overly permissive and happy to have the party continue. Meanwhile, the other parent is overly controlling and wishes the kids were in the car five minutes ago. It’s difficult for kids as they watch their parents try to negotiate a unified policy. I believe that’s how the market feels as it looks toward its parent-like leaders in Washington.
We market participants can live with just about any outcome. However, what we and the market struggle with is the uncertainty of outcomes around spending and tax policies. The sooner Congress can come to a firm decision about spending and taxes, the better. Once we know what changes are coming, the market and economy can be very adept at improvising and evolving.
What do upcoming changes mean for the markets?
We have experienced a very strong market recovery since the lows of March 2020. While the economic recovery has been a little uneven, some parts of the economy have done much better than others. The stock market has had a similarly uneven recovery; almost every area of the market has recovered from the decline, but some areas, such as tech, have had extraordinary returns.
Overall, we expect that the economy will likely continue to be strong. There are a lot of stimuli in the economy: consumers are in excellent financial shape and corporate earnings continue to grow. The recovery has been so strong, in fact, that we have experienced inflation and some labor shortages. Again, that’s why the Fed is flashing its proverbial five-minute warning.
The economy is strong, but keep in mind that the market and the economy are not the one and the same. Markets are trying to forecast what the economy will do, and those predictions are often clouded by people’s emotions. The pandemic continues to lead the concerns of most people. While outcomes continue to improve, there is still risk and fear weighing down the markets. Uncertainty always is the bane of markets.
So in the midst of this kind of ambiguity, do the kids get into the car, content to be onto the next adventure? Or do they melt down in a puddle of tears?
Every parent has experienced both of these outcomes and it’s often hard to tell which parenting moves have made the most difference. This unpredictability is the essence of human nature, and the markets, as we know, follow human nature. Financially, we believe the economy is in good shape, we feel good about the Fed’s long-term signaling and we have faith that our “dysfunctional parents” in Washington will eventually reach a compromise. We expect the markets to move contentedly on to their next adventures, but just the same, we remain ever watchful for any potential meltdowns.
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