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The big news yesterday from CNBC:

Fed raises rates a quarter point, expects 'ongoing' increases

Aligning with market expectations, the rate-setting Federal Open Market Committee boosted the federal funds rate by 0.25 percentage point. That takes it to a target range of 4.5%-4.75%, the highest since October 2007.

The move marked the eighth increase in a process that began in March 2022. By itself, the funds rate sets what banks charge each other for overnight borrowing, but it also spills through to many consumer debt products.

The Fed is targeting the hikes to bring down inflation that, despite recent signs of slowing, is still running near its highest level since the early 1980s.

Baby Steps

Today, we pick up where we left off yesterday. Let’s begin by noting that ‘investors’ recovered from a 500-point drop on the Dow yesterday, after the Fed announced its baby-step rate increase. But why? How would higher interest rates increase the value of stocks? Why would the Fed’s pledge to keep raising rates increase corporate profits? Why would ‘investors’ buy stocks rather than sell them?

Oh, dear reader…you ask too many questions!

But thanks, we wanted an opportunity to explain. The only real investment in one where you participate in real earnings. A business has to produce products or services and sell them at a profit. An investor gets part of the gain.

Cut in Thirds

Everything else is speculation…gambling…taking a flier. Sometimes people speculate on a stock. Probably the most extreme examples happened when they bought “meme” stocks…companies that couldn’t possibly be worth their market capitalizations...in the hope that other speculators would buy them too. Sometimes they made money; most often, they lost it.  

Another extreme example was the run-up in the crypto market. Cryptos – apart from some shady deals that promised “interest” – were never even intended to earn money. They produced nothing. Some did provide a service (helping people make financial transactions)…but the earnings were tiny. For the most part, cryptos were pure speculation. Out of a total of nearly $3 trillion in market capitalization at the peak, incredibly, about one-third (~$1 trillion) remains.

While speculators gamble on individual stocks, sometimes the whole market becomes ‘speculative.’ That’s what happened to Wall Street in the 21^st century. In the ‘80s and ‘90s analysts noticed that stocks seemed to go up reliably. They began to proclaim the virtue of ‘stocks for the long run.’ The idea was that ‘the market’ always goes up…so all an investor has to do is to put his money into an ETF and he will make money.

Of course, we’ve seen that it isn’t true. In terms of real money – gold – stocks are worth no more today than they were 98 years ago. Still, speculating on stocks can be rewarding…as long as stocks are going up. In our estimation, stocks rose mostly for the right reasons – an expanding economy – from 1982 to the mid-‘90s. Then there was the dot.com speculative blow-off, followed by another huge surge in stock prices. But after 1999, stocks rose for the wrong reasons; the Fed was manipulating the market.

Sea Change Ahead

Many investors soon forgot about ‘investing’ all together. The Fed was pushing interest rates down and pushing stocks up. That was all they had to know. Actual business profits rose…but only in line with increases in real output. Stocks, though, soared…by 2021, prices were 3 times what they were in 1999. Speculating paid off. 

And now, ‘investors’ are so accustomed to a rising market…so used to the Fed goosing up prices…that they believe it must be helping them even when it raises rates. But there has been a major sea change. The primary trend is running in the other direction – towards higher interest rates and lower asset prices. Speculating on higher prices is not likely to pay off.

“Inflation is coming down,” the speculators say to one another. “The Fed is easing off. It’s clear sailing again.”

But interest rates are still going up, though more slowly. And every increase – no matter how small – pinches households, businesses, and the government itself.Consumers have less money to spend. Business revenues fall as their debt service costs rise; profits drop. And the feds grow more desperate. 

Speculators may buy. Investors sell.

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