A Soft Landing?

Quantitative Tightening is a big, boring, and somewhat scary term. Yet, albeit boring, we are going to dive into this concept together because asset prices in the investment world have the potential to fall in a spectacular fashion should the federal reserve mismanage its quantitative tightening agenda. Outside of the investment markets, prices for household staples could continue to skyrocket, rent and home payments could rise quickly, and the labor force could see reshuffling in the coming years.

So what is it? In times of great fear where a recession seems to be near impossible to avoid, the Federal Reserve, known as the central banking system of the United States of America, recently employed a strategy to buy U.S. bonds off of the public market. This action essentially introduces more cash into the money supply of the economy, thereby hopefully increasing the amount of goods and services each household can purchase. Buoyed purchasing is thought to ease decreases in economic growth and even provide a smooth transition out of recessionary pressures. When faced with a potential catastrophic production shutdown, the Federal Reserve acted quickly by cutting interest rates and buying government securities.

Fortunately for the realists who are reading, our current monetary policy is quite reactionary to economic data. Meaning, the Federal Reserve will not shift course until the original goal is reached or encounters a problem in the present time. Virtue Capital Group expounded on the methods and causes of inflation precisely one year ago today, after which we’ve now seen prices of consumer goods increase by over 8% year-over-year. This is the highest inflation the U.S. economy has seen in over forty years at this time. Fearing that the soaring prices could trigger an uncontrolled recession, the Federal Reserve is now faced with the byproduct of their quick action to buy U.S. Treasuries in March 2020. Adding fuel to the flames is the ongoing Ukrainian-Russian conflict, which will no doubt have a profound impact on food production costs as Russia accounts for nearly a fifth of all imported fertilizers compounds worldwide.

Entering into the arena is the Federal Reserve’s newer tool of Quantitative Tightening; shorthand for an attempt to reduce the purchasing power for consumers and businesses alike in order to cool the red-hot spending we’ve been seeing as of late. You have likely seen headlines each month about the Federal Reserve raising interest rates as well as selling assets off their balance sheet. The aim is to cool inflation and engineer a “soft landing,” where we will see price pressures cool without hampering the growth of the world’s largest economy.

There is one problem though, the soft landing will likely not be achieved. The Federal Reserve seems to be hell-bent on cooling inflation so much so that they are foregoing the risks posed to investment markets and consumers’ job security alike. The last time the Federal Reserve attempted this tactic was in 2018, as they attempted to offload assets that were first purchased in response to the 2008 recession. In 2018, the Federal Reserve had approximately $4.46 Trillion worth of assets on its balance. They were able to offload about 10% of this before the tactic spurred liquidity issues across a majority of National Banks. Cash reserves held by banks became historically low, and interest rates spiked rapidly. Markets responded negatively by decreasing prices around the board before the tactic was tapered off.

This time around, some four years later, the Federal Reserve has $9.94 Trillion worth of assets on its balance sheet. Additionally, we are now dealing with hyperinflation, world conflicts, manic market behavior, a housing supply shortage, and supply chain issues throughout our economy. The idea that there will be a soft landing is ludicrous. Never in the history of the United States have we been able to cool inflation by more than two percent before triggering an economic recession. Faced with an extensive litany of problems, we see no reason why this should be any different.

Armed with the knowledge that we are likely headed towards a recessionary period, the magnitude and duration of which are still unknown, how should we respond as investors? Well, the saying goes that you can make money in any bull market, but fortunes are made in bear markets. As it stands, we are just beginning to see public equities return to “normal” prices and residential housing begin to cut price targets rather than being bid up on all cash offers. In short, things seem to be at equilibrium right now. But the goal of any investor worth their salt is to find undervalued opportunities, not fairly valued. As such, we continue to hold a large position of cash. Waiting for the ample opportunity which smacks us over the head. We are able to deploy this cash here and there in an attempt to generate returns, which at this point in time serves to dampen the losses experienced in this market's current correction. As investors, we stand ready and poised to purchase a hefty position at the most contrarian moment. The moment where there is maximum fear in markets, when we see desperation, when the senseless speculation ceases, and when sky-high valuations of companies that have never produced earnings falter, that is when we will be ready to back up the truck to make a large investment. For reference, in late 2020 and 2021, articles were written by a wide variety of sources speaking to how financial markets were forever changed and never going to deliver negative returns. We would like to see the inverse true in the near future before pulling the trigger on a new opportunity.

Now then, what should we do as individuals? This is going to impact your fuel bill, grocery costs, housing loans, job security, and social life. Things have a large probability of feeling tighter in the coming months, if not already. It has the potential to be hard not only on yourself but also on your community. Our opinion favors recommending adopting a more cautious outlook towards your spending. Look into your spending patterns and see what was frivolous and prepare for potentially increasing costs. That being said, historically times of hardship strengthen communities and produce innovative solutions. It stands to reason that this time around will not be different.

As always, it is a pleasure to serve. We enjoy sharing our thoughts with you but would also love the opportunity to hear your thoughts and receive the gift of feedback. We cannot show enough appreciation to you for your ongoing support, and for this we humbly thank you.

Warmly,

Zach Terpstra

Principal