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April 2023 Monthly Review

"I Fought the Law and the Law Won"

By Loyd Johnson, Chief Investment Officer
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Loyd Johnson PhotoA Look Back

The above title is from a song first recorded by Buddy Holly’s group, The Crickets, after Holly’s untimely death. It became a top ten hit in 1966 and was later ranked the 175th best song of all-time on the Rolling Stone list of the 500 greatest songs in 2004. I had not heard this catchy tune until recently, and it made me think how true the line would be if you substituted “Fed” for “Law.”

There is an old saying in the markets that I learned early on when I started managing money in 1986…Don’t Fight the Fed. We have gone through several Fed leaders and regimes over the years, but that simple line has always held true. It has been true when they embarked on a massive Fed Funds rate reduction in the Great Recession and Covid timeframes, and it has certainly been true when they are in the rate-hiking mood like the last 16 months.

Even though we have seen much higher absolute Fed Funds rates in the past (in the early 1980’s the Fed Funds rate hit 20%) one could argue the swiftness of the move upwards recently rivals any other rate-hiking period given all of the ancillary implications playing out now in the economy. Remember, rate movements are always somewhat of a two-sided coin. Higher rates mean increased borrowing costs for individuals and corporations alike, but they give savers a real alternative for shorter term investments. Lower levels, like we saw from 2009 through the end of 2021, make it easier for people to buy homes, cars and other big-ticket items. Corporations can issue debt at much lower levels and put their capital to work for the good of the overall economy. It is our belief that we need to find a better balance…much like the three bears and Goldilocks. We need shorter-term rates that are reasonable, or as the Fed calls it, a terminal rate...”the final interest rate the Fed aims to achieve at the end of a monetary loosening or tightening cycle.” The Fed has said that they would like that terminal rate to end up somewhere around 2.5-3%, or around half of where we are now. We need to get away from the violent yanking of the rates that we have seen over the last 15 years. Zero percent Fed Funds rates like we have seen in the past can have some perverse outcomes and can lead to people taking more risks than they would normally.

April was a positive month for Large-Cap domestic and International Developed stocks. So far this year, that puts the S&P 500 up over 9% and EAFE higher by more than 11.5%. Additionally, core bonds that were such a drag in 2022, have bounced back to deliver a 3.59% return in the first four months of 2023.

A Look Ahead

Let’s face it…the first four months of 2023 have been a positive and welcome surprise so far in the financial markets. The table above would be just fine in a normal 12-month period. The Fed just raised the Fed Funds rate another .25% last week to 5.25% and signaled that they are likely to pause. The most recent Jobs number came out last week as well and were much better than expected. 253,000 jobs were added in April versus the 180,000 forecast and the actual unemployment rate fell to 3.4%, the lowest level since 1969. These are not the numbers that we typically associate with recessions, and yet that is the fear. The CPI report comes out this week and may shed more light on where the Fed is in their fight against inflation. For now, we remain cautious with an overweight to Cash, and plan on not fighting the law or the Fed anytime soon.