Jan. 10, 2023

When Money's Free, We Want More

What makes the markets so endlessly fascinating is how incredibly complex they are. Like a rocky shore at sunset, each change of the light and tide presents an entirely different view.

For those who invest in stocks, the market may be a place to view individual companies' prospects and fortunes. At the same time, traders look to the supply and demand of the shares themselves. Fund investors may look to entire sectors of the economy as their view of the "market."

Indeed the market is all of those things and more. Today we look at the markets from a strictly financial point of view. A place that, at its core, allocates money. We'll get down to the dollars and cents behind it all.

Ultimately all the transactions in the market are measured by dollars and cents. All else is merely the periphery. And making the current environment so challenging is that the cost of money is changing. In three weeks, the country's central banker, the Federal Reserve, will decide on the new price of funds when they likely set a new interest rate.

That sounds strange to those who are not finance-oriented, but the cost of money, the cost of funds, is another way to say the interest rate. And for much of last year, the Fed was changing the cost of money. It was the most radical change in the price of money the nation has ever seen.

The cost of money (interest rate) went from zero (1/4%) to well over 4%, with Wall Street estimating that the Fed will raise the cost to over 5% in the next couple of months. Nearly everyone believes that at this meeting, they will once again raise the interest rate bringing us closer to the 5% base level for money costs.

In raising the cost of money, this move by the Fed has turned the financial world on its head. We began last year, as we had for several years, in a low-cost money world. Funds were cheap and readily available. Investors wanted to get as many dollars as possible in such a world. Investors were happy to borrow to heighten their returns.

Remember, the cost of money was cheap. Why not use as many dollars as you could afford, or the bank would lend, to multiply your returns? Capital appreciation became the prime objective. Buy the most of the fastest appreciating assets to maximize your profits.

Cheap money and easy borrowing lead investors to focus on Growth. Growth is the fastest way to maximize your return. Why depend on 2% dividends or interest when you can get 10%, 20%, or 25% return on share price? Cheap money drove investors to grow with companies, and chief among the growth companies were the big five: Apple Computer, Microsoft, Amazon, Google/Alphabet, and Facebook.

It's a cycle we've seen repeated many times before, from the Go-Go '60s to the Dot Com Bubble of the early 2000s, add in a couple of Chinese Real Estate Crazes, and you have a pretty good picture of where the cheap cost of money/capital leads us.

But that was way back last year. Today, the cost of money is no longer cheap. Cash is still less expensive than it has been in the past, but it's a long way from 2021.

And this is creating a massive change in investor behavior, all in reaction to the cost of money. The cost to borrow is now two to three times greater than 12 months ago. Suddenly, alternative investments are beginning to appear. A three-month US Treasury Bill is currently yielding a respectable 4 1/2%, which will interest some investors.

Times have changed for investors. As money costs have risen, for everyone, even those big five companies, returns that used to appear certain aren't any longer. There used to be two companies whose total market capitalization was over $2 Trillion. Today there are none. Every one of the big five companies has seen its stock decline by more than 25%, with Amazon down by 2/3rds and Facebook plummeting.

As Will Rogers said a century ago, investors are not looking for a return on their investment. They're looking for a return OF their investment.

Safety is today's watchword for investors.

As the cost of money rises, the marginal, "barely making it" enterprises won't. A company with a hard time making its debt payments when the cost of funds is 1% will find it impossible when interest rates are 4% or 5%. Look out for those companies with lots of corporate debt.

When will the Federal Reserve stop increasing the cost of money? We don't know. But it usually happens when the economy hits stall speed, otherwise known as a recession.

As one wag put it, look for the Fed to stop raising rates "when something breaks."



Econ Briefs



Markets are taking a second look at the re-opening of the Chinese Economy. Over the weekend, China announced that it would reverse its Zero Covid policy and re-open its Economy. Global financial markets greeted China's Economy back online as good news. With US stocks initially rallying early Monday Morning. The market faded later in the day, but on balance, Americans were enthusiastic about a return to normal by China.

This morning, Pierre Andurand poured cold water over this re-opening party. Andurand is the manager of a $2 billion Hedge Fund and is considered one of the more savvy global oil traders. By Andurand's reckoning, if China's Economy comes back online, it will increase worldwide oil demand by 4%. This excess demand could push the price of a barrel of oil to $140, or nearly double the current oil price.

Wall Street wants none of that. Oil prices that high would immediately put a damper on the American Economy. The result of all this has been lower futures for all the significant financials, stocks, and bonds, both lower as we speak.

Speaking of China, some provocative numbers have been released about their Economy. The Peoples Bank of China reported that loan and money growth grew by better than 11%. Remarkable numbers, given their recent economic lockdown. But even more amazing, considering the demand for loans is a sign of a robust financial push, as is the demand for money. Both are increasing at rates not seen in any other major economy. And yet China reports that their inflation is barely over 1% annually.

That's a neat trick if you can get away with it.

Fed Chairman Jerome Powell is scheduled to speak this hour before a Banking Symposium in Sweden. He will undoubtedly emphasize the fed's determination to continue hiking interest rates. Look for this speech to produce headlines later in the day.