Federal Reserve officials are not beating around the bush: The central bank and its chairman, Jerome Powell, believe the 2% inflation target is sacrosanct and will risk a recession and bear market to get there.
So why are markets rallying strongly, as if Powell is about to cut interest rates soon, not raise them?
The answer is that many traders and investors are convinced that what was once the least political layer of government, the Federal Reserve, has become one of the most politicized. Powell, whose main job is to keep inflation lowhe will scrap the inflation target for something much nicer to appease Democrats in Congress and economists in the Biden administration.
It is fashionable in leftist circles to accept inflation as necessary. Rising prices don’t matter as long as government budgets continue to rise.
How soon they forget the terrible stagflation of the 1970s, when the economy slowed while prices soared. It didn’t matter if you had a job. He couldn’t afford to put enough food on the table and gas in his car, let alone buy a new one or eat at a restaurant.
So where is Powell’s head?
Equity traders say Powell’s track record of monetary accommodation and recent dovish statements are sure signs he will give back on the 2% target for something higher, perhaps much higher. So they are in a buying mood.
By contrast, Fed watchers who have sources in Powell’s inner circle tell me that the central bank understands the need to make inflation disappear. That means higher rates, market crashes and a possible recession.
Neel Kashkari, the mercurial chairman of the Minneapolis Fed, echoed much of this sentiment at the Aspen Institute Conference last week. Sure, he and his colleagues like the direction of the Consumer Price Index, which fell to 8.5% in July from 9.1% the previous month. However, he made it clear that the Fed is “far, far from declaring victory” over inflation.
In the meantime, what we have is a classic disconnect from the market, which is never a good thing because shareholders might not recognize the tsunami that is coming their way. Unfortunately, it has its roots in Powell’s diminishing credibility as an inflation fighter, I am told. He is derisively known as “Blinky” at the trading tables and not because there is anything wrong with his vision.
Based on his track record, the belief at the trading desks is that Powell is looking for a way out of his rate hikes. He will soon “blink” and rationalize a higher inflation target rather than become the target of the powerful leftist contingent currently running President Biden’s economic policy.
July’s drop in inflation, however minuscule, gives it the cover to start to turn around.
Of course, stock traders have been wrong before and colossal. At the end of 2007, the Dow hit a record high of around 14,000 points, signaling an economic recovery. A financial crisis and the Great Recession soon followed.
They could be wrong again, unless Blinky blinks. It could be good for the markets in the short term. The rest of us, not so much.
AMC ‘gift’ to the ‘Apes’
Adam Aron, the CEO of AMC Theaters, has a tough job. Streaming was already putting pressure on his business long before COVID shut it down. With the pandemic largely a bad memory and blockbusters like “Top Gun: Maverick,” your business keeps losing money.
Also, their investors are a group of retail traders who get involved in conspiracy theories. They call themselves the “Apes” for reasons best known to themselves. They think they will get rich buying AMC stock because they discovered an evil cabal of short sellers who want to destroy the company.
If they buy enough, they’ll crush the shorts and make a mint.
Crazy, yes, but Aron needs the crazy apes to keep buying his stock because they’re the only thing standing between AMC and a meaningful chance of a Chapter 11 restructuring. To that end, he’s trumpeting a plan to make the apes hungrier. of its shares with the gift of a special dividend in the form of a new preferred share.
Once that happens, he says the company will prosper through a financial technique known as “good dilution.”
Apes love what they hear. Aron is affectionately known to people as the “silverback,” and the stock is up 31% since the announcement.
“AMC shares, which traded at $3.19 on March 16, 2020, the day the pandemic forced its theaters to close, closed Thursday at $25.46. That’s a 698% increase,” Aron tells me.
That’s fine, but the stock is also down 66% from its peak last year, and don’t try to search Investopedia for the term “good dilution” because it doesn’t exist. There is only dilution and that means your holdings are worth less because there are more shares floating around.
Delve into Aron’s plan as well, as professional traders like Marc Cohodes did, and you’ll discover that there is an interesting transfer of wealth with all this “good dilution.”
Once Aron issues the new shares, Cohodes says, the Apes will hand Aron and the bondholders a check. That check will help you pay off debt benefiting the big institutions that hold AMC’s debt while the apes keep AMC from going bankrupt.
Perhaps the real definition of “good dilution” is “rescue”.