Federal Reserve officials do not mince words: the central bank and its chairman, Jerome Powell, believe that the 2% inflation target is sacrosanct and will risk a recession and a bear market to achieve it.
So why are the 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 Fed – has become one of the most politicized. Powell, whose main job is to keep inflation low, will ditch the inflation target for something much more palatable to appease the Dems in Congress and the economists in the Biden administration.
It is fashionable in left-wing circles to accept inflation as necessary. Rising prices don’t matter as long as government budgets keep growing.
How long have they forgotten the terrible stagflation of the 1970s when the economy slowed as prices soared. It didn’t matter that you had a job. You couldn’t afford to put enough food on the table and gas in your car, let alone buy a new one or eat out.
So where is Powell’s head?
Stock traders say Powell’s history of monetary accommodation and recent dovish statements are sure signs he will give in on the 2% target for something higher, possibly much higher . So they are in the mood to buy.
Conversely, Fed watchers who have sources in Powell’s inner circle tell me that the central bank understands the need to make inflation go away. This means higher rates, market declines and a possible recession.
Neel Kashkari, the talkative Minneapolis Fed Chairman, echoed much of that sentiment at the Aspen Institute conference last week. Of course, he and his colleagues like the direction of the consumer price index, falling to 8.5% in July from 9.1% the previous month. Yet he made it clear that the Fed is “far, far away from declaring victory” on inflation.
In the meantime, we have a classic market disconnect, which is never a good thing as shareholders might not recognize the tsunami heading their way. It is rooted, unfortunately, in Powell’s waning credibility as an inflation fighter, I am told. He is nicknamed “Blinky” out of derision on the trading desks and not because there is anything wrong with his vision.
Based on his record, the belief on 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 left-wing contingent currently directing President Biden’s economic policy.
July’s drop in inflation, minimal as it is, gives it the cover to begin to turn the tide.
Of course, stock traders have been wrong before and colossally wrong. At the end of 2007, the Dow hit a record high of around 14,000, pricing in an economic recovery. A financial crisis and the Great Recession soon followed.
They could still be wrong, unless Blinky blinks. This could be good for short-term markets. The rest of us, not so much.
AMC ‘gift’ to the ‘Monkeys’
Adam Aron, the CEO of AMC Theaters, has a tough job. Streaming was already putting pressure on his business long before it was shut down by COVID. With the pandemic largely a bad memory and box office hits like “Top Gun: Maverick,” his business is still losing money.
Moreover, its investors are a group of retail traders who indulge in conspiracy theories. They call themselves the “Monkeys” for reasons better known to themselves. They think they’re going to get rich buying AMC stock because they’ve uncovered 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 monkeys 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 coming up with a plan. to make the monkeys more greedy for his stock with a gift of a special dividend in the form of a new preferred stock.
Once that happens, he says the business will thrive thanks to a financial technique known as “good dilution”.
Monkeys like what they hear. Aron is affectionately referred to as the “silver back” among people, and shares are up 31% since the announcement.
“AMC stock 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.
Okay, but the stock is also down about 66% from its peak last year, and don’t try to search for the term “good dilution” on Investopedia because it doesn’t exist. There is just dilution and that means your holdings are worth less because there are more stocks floating around.
Also dig deeper into Aron’s plan, as professional traders like Marc Cohodes have done, and you’ll find there’s an interesting transfer of wealth with all that “good dilution.”
Once Aron issues the new shares, Cohodes points out, the monkeys will deliver a check to Aron and the bondholders. This check will help him pay off the debt for the benefit of the big institutions that hold AMC’s debt as the monkeys keep AMC from going bankrupt.
Maybe the real definition of “good dilution” is “bailout.”