Fed's Odd Rate Cut Adds to the Froth
The big Fed Funds rate cut creates more mystery around the economy's true health and inflation's true outlook at a time when we're already in bubble territory.
You've reached your free article limit
You've read 0 of 1 free Pro articles.
After moving sharply down to start September with the worse weekly performances from both the Nasdaq and the S&P 500 all year to open the month, all the major indexes are already back to all-time highs. All it took was Fed Chairman Jerome Powell to bring back the punch bowl in the form of a half-percentage point cut to the Fed Funds rate.
I was hoping for just quarter-point reduction as a half a point to me signals that the central bank might already be behind the curve. After all, this is the same group of sharpshooters that consistently stated inflation was "temporary" and "transitionary" throughout 2021. This resulted in one of worst monetary policy errors in my lifetime and helped trigger the highest levels of inflation since the early 1980s.
In addition, the last two times the Federal Reserve has commenced a rate reduction cycle with a half of one percent cut, it hasn’t exactly worked out well for either the economy or markets as Doug Kass pointed out in his Daily Diary on Thursday. While Chairman Powell insisted the U.S. economy was strong, one has to wonder if that is really so given the decision to go with a half-point cut rather than just a quarter-point reduction. It is like going to your doctor for your annual check-up and being told you are in good shape but being given a prescription for some strong new medicine you need to take daily now. If a "strong" economy merited half-point action, thank goodness the U.S. economy is not going gangbusters, or we might have seen three-quarters percentage point slashed from the Fed Funds rate.
I have two major concerns with the central bank cutting rates by a half point, while both residential real estate prices and the stock market are at all-time highs. First, I don’t want the Fed to take its eyes off of inflation as that fight is hardly fully won. In addition, the "real" rate of inflation is higher than the "official" rate the consumer price index reports. Unless you believe, as they do, that health care premiums have dropped over the past few years and items like taxes and user fees should not be part of the Bureau of Labor Statistic's calculation of inflation.
The second concern I have was the market was already in bubble territory using many traditional valuation measures such as Warren Buffett’s favorite market cap to national gross domestic product ratio. That was already at an all-time high and a key reason the Oracle of Omaha is sitting on a record amount of cash. In addition, some of the areas that most benefit from falling interest rates have already fully priced in several interest rate cuts.
This includes the home building sector, which is at an all-time high, despite existing home sales being at 30-year lows. As a whole home builders are trading at an absurd 2.3-times book value. They are vulnerable to any piece of bad news. Take the giant home builder Lennar LEN, which is trading down in early trading today despite "beating" quarterly estimates after the bell on Thursday.
I love all the green in my portfolio this week from the rally following the Federal Open Market Committee meeting. Who doesn’t? But I remain cautious as the beginning of a rate cutting cycle isn’t sending an all-clear signal to investors with equities at these valuations.
At the time of publication, Jensen had no position in any security mentioned.
