The Powell Pivot

Our hometown Cleveland Cavaliers are the surprise team of the first half of the NBA season, posting one of the best records in the Eastern Conference despite being expected to be one of the worst teams in the league. The addition of a couple good players, improvement in others, and a team-first/unselfish style of play have led to the turnaround. A recent key injury may derail the Cavs’ season, but with Golden State on top in the West, it has felt like the good ole days, when the Cavs and Warriors faced each other four straight years in the Finals.

One of the fundamentals of basketball is that a player who has picked up his dribble can evade trouble by pivoting away from a defender. This works well - until a player is double-teamed and has nowhere to turn. With consumer prices rising at the fastest rate in nearly four decades, Federal Reserve Chairman Powell pivoted his stance on inflation and monetary policy in the fourth quarter. For much of the last two years, Powell has described the rise in inflation as “transitory,” but as it has persisted, it became clear that the adjective needed to be dropped, and it was. Finally concerned, the Federal Reserve (Fed) abruptly changed course, announcing a gradual tapering of its asset purchases and soon after declaring an acceleration of that timeline. The Fed now expects to end its asset purchases by the end of March and to implement three interest rate hikes by the end of 2022. All of this follows a not too long ago move away from its price stability mandate and its pronouncement that inflation at or above 2% is not only acceptable but perhaps desirable. Be careful what you wish for. The spike in inflation isn’t entirely the Fed’s fault (supply-chain disruptions have been a factor), but its policies have contributed.

Despite the imminent Fed tightening, stocks kept climbing, with the S&P 500 returning double-digits in the quarter. Growth led value, and small stocks lagged significantly. The move higher in stocks in the face of a more hawkish Fed is an interesting development. It’s always difficult to ascertain the forces affecting stock prices, but it may be the case that the tremendous liquidity that still exists in the economy – via the Fed’s loose policy and the enormous federal government stimulus – is overwhelming the typically-negative effects on asset prices of a tighter Fed and higher inflation. One market commentator stated earlier this year that the market’s pricing mechanism is broken. It’s dangerous to make a habit of thinking the market is wrong in how it is pricing certain assets, but he may have been onto something. A tidal wave of liquidity can do that.