Colonel Jessup (Powell) is on an Interest Rate Raising Code Red

“You can’t handle the truth!”

I LOVE movies and TV. I grew up with the TV being the proverbial babysitter when my parents weren’t available. It was The Three Stooges in the morning while my mom got ready for work. And then it was cartoons in the evening until my dad got home.

As I grew up, I rarely missed Happy Days, Fantasy Island, The Love Boat, Three’s Company, etc. My 8pm-10pm entertainment. 

Then I became a huge movie fan as I got old enough to go to the theater. 

All of this time spent watching TV and movies is why I know Jay Powell has matured from a sitcom laugh track Federal Reserve Chairman, to academy award winning actor Jack Nicholson.

At the end of 2018, then sitcom star Powell, announced he would be raising interest rates as the economy was in good shape and rates were abnormally low. The market threw a fit. 

In true sitcom fashion, with a laugh track running underneath the dialogue, Powell could be heard to say…”I said LOWER interest rates, not raise them…hahahahahahahahahahaha…why would I ever say raise rates????”

Then, during the pandemic, when it was necessary to save the economy, Powell matured into a Robin Williams (may he rest in peace) style character in Good Morning Vietnam. 

He had grown from the Mork and Mindy days, to a troubled yet still lovable character, working the system for his benefit and to help those around him. “Gooooood Morning U.S. Economy…I can print money all day, take a nap at the Hanoi, I mean Pennsylvania Avenue, Hilton, and be printing again in the afternoon.”

But now, Chairman Powell is taking on his biggest role. And, he’s right on the brink of nailing it. He keeps practicing his lines in public, but hasn’t quite got to the set yet. 

And for that breakthrough performance, Powell is going to be reprising the role of Jack Nicholson as Colonel Nathan Jessup in A Few Good Men (for which Mr. Nicholson received an Academy Award nomination).

You Can’t Handle the Truth

If you recall (or if you haven’t seen the movie) Colonel Jessup gives a rousing speech, in which he rumbles (like a jet engine going full blast) the words “You can’t handle the truth!”

“The truth” is, and I’m paraphrasing here, that weak Marines must be punished (unfortunately for the weak Marine in the movie, the severe punishment leads to his death) in order to preserve the sheer domination that must be projected to the enemy. 

This projection of strength is to ensure the enemy never even thinks of attacking. In the movie, Colonel Jessup’s line of reasoning is, in essence, if necessary, we can and will kill the weak in our own ranks to preserve the all important strength. (Clearly a 300, the movie, kind of approach.)

Chairman Powell now has a “truth”, for which he’s been rehearsing Colonel Jessup’s line in the press, to Congress, etc. That “truth” is that he must and will kill inflation. And, in order to do that…and this is the “truth” that most stock investors “can’t handle”…he must raise rates in order to kill demand. (You know, demand…as in when consumers go to the store or online and buy something, or “demand” it…the thing that gives businesses their earnings?)

And, unfortunately, just like the code red issued in A Few Good Men resulted in the unfortunate demise of the “weak” Marine, Powell’s code red, which he will have to issue several times this year (and I mean raising rates, if that’s not clear, lol) will kill off some of the weaker (no revenue/earnings) stocks in the market. 

As we talked about the last few months, this will be one of several factors that force the liquidation of a large number of pre-LOI SPACs later this year. 

Now, the good news is that a LOT of damage has already been done to both speculative and not so speculative tech names. Powell’s rehearsing of his lines, or his “I will fight inflation” mantra, has jawboned the market lower, and interest rates higher already without the Fed acting yet. 

The bad news, for those that only play on the long side, is that I think his actual delivery of interest rate hikes…which, I think are necessary to kill inflation…which begins next week, will be a headwind to the market for the next several months. 

We just began seeing the demand destruction caused by inflation (not rising interest rates…they both destroy demand, fun right)  this quarter with Amazon earnings. And, I think we have a fair amount of demand destruction coming down the pipeline. 

The flip side of this is that the market trades with anywhere from a three to six to nine month lead time on where the economy will be…or at least where the market thinks it will be…in the future. 

It’s my take that we’re still on a downward slope for GDP, earnings, and the market in general. But, I also think that the recession, which I do think is coming, will be relatively mild and shouldn’t completely kill the market. 

There was a great question in the Discord that katalyst asked a few days ago. “At what point will tech/growth stocks come back up?” 

The answer is when inflation is killed, or, more precisely, when the market thinks inflation is killed, and therefore rates don’t have to rise further. Or, even more precisely, when the market thinks that Chairman Powell believes inflation is dead, and he does not need to call anymore code reds, I mean raise rates further. 

My best guess is that we have a two to four month continuation of this negative cycle in the market. Which should cover between two and three interest rate hikes by the Fed.

During the next two to four months we could see a further decline in the 10-15% range on the QQQ, with an outside chance at 20%, which would put a stock like Apple around $125. Basically the range we were in a year ago at this time. 

From there, we could rally into year end, with a much clearer view of where inflation stands, how many more (if any) rate hikes would be forthcoming, and also a better handle on the Ukraine war, government policy, etc. 

In four months we’ll also be on the doorstep of midterm elections, which should give the market an added boost going into year end. 

Ironically, the coming give back of SPAC funds I talked about in the last few newsletters, will actually provide a bit of cushion for investors as those funds are returned. It’s not the equivalent in size of a government stimulus. But, it won’t hurt having those funds rotate out of bank vaults back into the market in the second half of the year.