The Fed Will Derail the Bull Market in an Attempt to Cool Inflation

By James Dale Davidson
James Dale Davidson
James Dale Davidson
James Dale Davidson is a highly acclaimed economist and financial forecaster who has cemented his legacy through his renown investment newsletter Strategic Investment, which has been in publication since 1987. One of Davidson’s biggest fans include billionaire Peter Thiel, who says Davidson inspired him to start PayPal and cited Davidson as “his favorite stock picker.”
January 4, 2022Updated: January 4, 2022


Savvy investors adhere to an ancient adage and do not oppose the Federal Reserve. In 2020, as the severity of COVID-19 became clear for the first time, the Federal Reserve cut interest rates to zero. They then embarked on an unprecedented bond-buying program that flooded the world with enough liquidity to not only prevent the mother of all stock market crashes but also set the Dow Jones on its way to almost doubling from 19,000 to over 36,000. Thus, even with the globe on the edge of a catastrophic pandemic that might kill tens of millions and evolve into a virus capable of killing hundreds of millions, the Federal Reserve’s immense authority could avoid a worldwide financial meltdown.

With inflation threatening to exceed 6 percent and upwards to 9 percent, the Federal Reserve has declared that it will reduce asset purchases and start raising interest rates. By the spring, the federal-funds goal rate will have risen from the present rock-bottom 0 percent to 0.25 percent to as much as .75 percent to 1 percent.

This is the first of three increases in the federal-funds goal rate. According to the FOMC’s “dot plot” of forecasts of committee members, their median guess is for three quarter-point increases by the end of 2022; I believe there will be at least four upward adjustments that will push the target to 1 percent to 1.25 percent and that another three to four hikes in 2023 will send the target to above 2 percent, and by the end of 2024 to over 3 percent, a rate that will bring us back to reality.

While most recognize that we are witnessing a major shift in monetary and economic policy, few are paying close enough attention to Federal Chairman Jerome Powell’s admission that inflation has proven to be anything other than transitory (with the T-word removed from the FOMC’s policy statement), as President Joe Biden and the Treasury Secretary have insisted. At Powell’s news conference last week, he recognized that the job market has moved more quickly than projected toward the central bank’s objective of full employment. The fact that there are 11.4 million unfilled jobs adds to the case that we are approaching a true stage of full employment.

Powell did an amazing job explaining how the world has evolved and how many of the Federal Reserve’s projections were based on inaccurate assumptions during his hearing testimony before Congress and subsequent press conference.

In effect, Powell has reached the point where he acknowledges that managing inflation and a labor market that has, for all intents and purposes, healed. This means that the necessity to pump hundreds of billions of dollars in liquidity to avert a global and domestic economic disaster has passed.

Investors must not disregard the Federal Reserve’s remarkable reversal. It’s time to acknowledge that financial markets, including stocks, will now face a strong headwind from central bank tightening required to bring about the decline in inflation envisioned in the Summary of Economic Projections, which will return to a target of 2 percent from the current 6 percent to 8 percent we’re experiencing.

This suggests that the major market indexes are unlikely to fall by double digits in 2022. Still, they may fall by double digits in 2023 and 2024 in the United States and globally. The sooner investors grasp that we are approaching a market climate in which stock selecting and shorting stock indexes at advantageous periods will be beneficial, the sooner stock prices will react to the inevitable lower earnings reports that will follow.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.

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