Fundamentally good things are happening behind the dour news scenes, and few are noticing. Yes, there are a lot of economic challenges for individuals and corporations right now, but we have been discussing the same fears for over a year, and they are losing their impact to affect markets.
Challenges everyone is aware of are extremely volatile inflation rates, the housing market decline, currency markets, fixed income markets, crypto markets, the Federal Reserve, a recession, and declining equity markets (don’t forget about the war). Individually and combined, they reflect a lot of uncertainty, but this isn’t new, and their ability to continue to hurt markets is withering. Let me provide an example: Are you surprised if any of the above categories worsened or fully came to fruition? No, and that’s what lets us know the negative pricing power connected to those fears is baked into capital markets.
Even good news in the media is often painted as bad. “Continued strength in consumer and business spending will keep the Federal Reserve on track to tighten monetary policy further, though subsiding inflation gives the US central bank room to scale back the size of its interest rate hikes.” How is consumer strength a negative? Last time I checked, it is one of the most significant driving forces in developed country economies.
From an economic standpoint, positive factors like robust loan growth, fading supply-chain problems, rising retail sales, low unemployment, growing travel demand, and increasing bank assets and decreasing liabilities should give investors some optimism. Instead, reactions to positive economic signs suggest that sentiment continues to minimize reality, and the easing supply chain is one of the biggest positives no one is discussing. This is a large, underappreciated positive sign that reality may turn out better than many think as corporations demonstrate their ability to adapt to changing price signals and pressures.
Maybe the most significant unnoticed positive is that there is no history of a recession on the horizon when bank loan growth is robust in the United States (14.3%). Since the Federal Reserve has been increasing rates, loan growth has increased, and many are missing this point. They don’t understand the mechanics—when a fractional reserve banking system wants to increase the quantity of money, the net banking system does this by increasing its outstanding loans. When a central bank wants to discontinue that process, they try to make it less profitable by increasing the cost of bank deposit requirements. What has gone ignored is that the Federal Reserve has fundamentally lost its ability to pull this lever because they no longer have requirements for reserve deposits. The Fed ended this practice in 2020, tied to Covid fears, by making the expense requirement zero percent of deposits.
That said, banks now have most of their deposit base, costing them almost nothing. So, as the Fed raises rates, it increases banks’ profitability and motivates them to lend more, not less—a significant economic positive. Although this can be a double-edged sword because it can contribute to the future risk of inflation, it also shows the Fed doesn’t understand what they are entirely doing—no surprise. I agree with Milton Freidman that governments should have limited involvement in free-market activities and that the best outcomes result when markets freely allocate resources in an economy—including the Federal Reserve. Friedman believed the Fed should be required to target the growth rate of money to equal the real GDP growth rate, leaving the price level unchanged. He also acknowledged that while governments have a role in the monetary system, the Federal Reserve has poor performance and should be abolished. I am not as adamant as Friedman about abolishing the Federal Reserve. Still, I agree that the Federal Reserve System could probably be replaced with a computer program that would make fewer errors.
Furthermore, no one seems to be mentioning that total revolving consumer credit remains positive, delinquency rates on consumer loans are down significantly below long-term averages, consumer credit is increasing, and revolving consumer credit owned and securitized is rising—none of these positives are what we see in a recession.
So remember, the Fed’s economic influence is often glorified, particularly in this rate hike cycle, because bank short-term funding costs haven’t risen with fed-funds rates, keeping lending profitable, and with long rates rising, lending incentives are strong—and so is loan growth. This is underappreciated, forward-looking evidence supporting a bull market that might not be far off and could have already started. So, please keep your eyes open for positive economic items not getting attention in the market. They will have good surprise power and push markets higher when they do.