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Don’t fight the Fed.
You’ve probably heard this saying before.
For years, “not fighting the Fed” meant “buying the dip” in stocks.
The idea was simple:
The Fed had the market’s back… It was there to support the market during selloffs…
And you could ride stocks to big profits as the Fed injected more and more cash into the economy.
This was on full display during the COVID-19 crash. The Fed pumped trillions of dollars into the market to keep it from crumbling. And after crashing 36% in early 2020, the S&P 500 bottomed out quick and came roaring back to gain 120% over 21 months.
And that’s just one example.
Since the 2008 global financial crisis, the Fed has bought trillions of dollars’ worth of bonds, mortgages, and other assets to prop up the market. And the market’s climbed 500% since 2008 lows.
But now, “not fighting the Fed” has a whole new meaning…
In March, the world’s most important central bank raised its key interest rate for the first time since December 20, 2018.
On May 4, the Fed raised rates again, this time by 0.5%. That’s the largest rate hike in over two decades.
The Fed’s also pulling liquidity out of financial markets and tightening its balance sheet.
A couple months ago, the Fed stopped purchasing assets as part of its quantitative easing program, which it used to prop up the economy and markets during the COVID crash.
In short, the Fed is no longer engaging in “easy money policies.”
It’s tightening.
And it’s doing so to combat inflation.
Inflation measures how quickly prices for everyday goods and services are rising.
Last month, inflation jumped 8.5% from the same period a year prior. That’s the highest reading in four decades!
It was also the fourth month in a row where inflation came in north of 7%.
Of course, inflation isn’t just hurting the purchasing power of everyday people…
It’s also eating away at people’s nest eggs.
Many investors are now scrambling to protect themselves.
I know because many friends, family, and RiskHedge subscribers have reached out to me.
They want to know how they can shield their wealth from inflation. They view cash as trash.
And I get the logic behind this.
To truly make money on your investments, they must generate a return higher than the rate of inflation. Right now, that means making at least a 9% annual return.
That’s historically been doable in stocks. The average return of the S&P 500 since 1957 is just under 11%.
Many investors conclude they must own stocks in order to beat high inflation.
This conclusion is likely correct over longer periods of time. But right now, and for the next few months, it may be the wrong move to hold too many stocks. Because…
The Fed is waging a war on inflation…
You see, interest rates are the cost of money.
When they rise, it becomes more expensive to borrow money.
This makes it harder for most people to buy homes, cars, and anything on credit.
In other words, the Fed is trying to crush consumer demand, which will cause inflation to fall.
So far, it’s working…
According to the Mortgage Bankers Association, mortgage applications dropped 8% for the week ending April 22, hitting the lowest rate in three years. There were 70% less refinance applications than there were in April 2021.
The Fed’s war on inflation is likely far from over…
After the Fed’s meeting, Chairman Jerome Powell said, “inflation is much too high.”
In other words, investors can expect more rate hikes in the coming months. In fact, the market has already priced in 0.5% rate hikes for June and July.
Investors are not used to this kind of environment.
For years, monetary conditions under the Fed were easy.
This conditioned investors to buy the dip no matter what was going on. This strategy worked brilliantly when the Fed had the market’s back. But that’s no longer the case.
Now, it’s pulling away the punch bowl.
This should be a clear signal to most investors to go on the defensive.
Unfortunately, we don’t know when the Fed will bring back easy money policies.
Until then, my guidance is simple.
The most important thing you can do today is hold more cash than usual.
Now is also a great time to start compiling a wish list if you’re a long-term investor.
That means getting ready to buy great businesses you plan on holding for three, four, five years, or longer.
One industry I’m stalking closely is software.
Software companies operate highly scalable businesses. The best ones can grow rapidly for years on end. Not only that, cloud computing adoption is still very much in its early innings.
Today, many software companies are still growing explosively. But I’m most focused on profitable software companies. Shares in these companies will likely be the first to rebound once the next bull market kicks off.
If you’re more of a trader, I suggest exercising patience.
It’s incredibly important to not rush into trades with the market being so volatile.
Instead, I’d wait for the next market leaders to present themselves. Right now, there simply isn’t true market leadership.
Even the strongest industries like oil and gas stocks remain vulnerable to a recession caused by higher interest rates.
So, I suggest waiting for more attractive setups to present themselves. I also suggest betting smaller than you normally would if you choose to trade during these volatile market conditions.
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