Dear Dr. Per Cap:
The markets are in a nose dive and my 401k is getting hammered. I’m freaking out and keep hearing it’s only gonna get worse. What can the big shots in Washington do to save the sinking economy?
Dear Worried Investor,
What’s been touted as the longest bull market in history is hanging on by a pretty thin thread. The S&P 500, the most commonly used benchmark to measure the stock market, is down about 20% from an all-time record high set on the first trading day of 2022.
You, me, my Uncle Joe, and anyone else who owns a mutual fund or a few shares of their favorite tech stock is feeling the pinch. And unfortunately the Federal Reserve, the nation’s central bank which investors look to in times of market turbulence and crisis, can’t offer much to folks clamoring for the lifeboats.
Ordinarily during times of a steep market decline the Fed can divert a free fall by tweaking the federal funds rate. That’s a short term interest rate that banks charge each other to loan their excess reserves, financial shorthand for the extra money that banks hold beyond what’s required in case of a bank run.
By lowering the federal funds rate money is pumped into the economy at favorable terms which encourages individuals and businesses to spend. In theory this blast of fresh money is enough to win investors’ confidence and prevent a broad market sell off.
But here’s the problem. We’re in the midst of some of the worst inflation since the days of colored toilet paper. Remember those lovely pink and blue rolls of Charmin?
This means the Fed can’t lower interest rates anymore because flooding the economy with cash will only make the inflation worse. Not feeling $4.50 for a gallon of gas? Try paying $6 or $7 a gallon.
Instead the Fed is in the really uncomfortable position of having one option to fight two very different beasts. It can’t lower rates, but if it raises rates instead to slow inflation the chances of an economic recession increase. Well, the Fed has chosen the latter option and has begun to raise rates. This leaves investors hoping they don’t raise them too much or too quickly.
One of my favorite books is a World War 2 novel called Catch-22. It describes a complicated dilemma in which the only fix creates an even bigger dilemma and a self-defeating solution. The Federal Reserve, aka your big shots in Washington, is stuck in a Catch-22.
So unfortunately, we’re probably going to see things get worse before they improve. But like I’ve said before – if you’re a buy and hold, long term investor which anyone reading should be – don’t get caught up in short term drama.