“Insulin is not a cure for diabetes; it is a treatment. It enables the diabetic to burn sufficient carbohydrates so that proteins and fats may be added to the diet in sufficient quantities to provide energy for the economic burdens of life.”
-Federick Banting
A diabetic who has too much insulin in their system is at risk of going into a “diabetic coma.” When this happens, the person needs to “stimulate” their system with sugar. Not getting enough sugar into their system to counter the insulin is the most dangerous short-term risk faced by every diabetic. The long-term risks are the result of too much “stimulus” or sugar in their system as it raises their A1C level and can lead to organ failure and loss of limbs and eyesight.
In response to the Financial Crisis of 2008, the Federal Reserve determined that that deflation (too much insulin) was the real threat to the economy. In fact, they saw the threat as so significant that, if they did not act, the economy (the diabetic) could suffer irreparable harm. In response to the failure of our elected officials to act, the Federal Reserve embarked on an unprecedented effort to stimulate (feed sugar) to the economy. Some politicians and investors were so worried about the long-term negative effects of stimulus (sugar) that they resisted administering it to the economy. The Federal Reserve, thankfully, was not deterred and continued to administer stimulus until the risk of a full-scale depression (diabetic coma) had passed. Essentially, the Federal Reserve threw the kitchen sink at the threat, long-term risks be damned!
The economy began to respond positively to the stimulus. By the end of 2015, the Federal Reserve realized the risk of deflation was truly beginning to fade and turned their attention to tightening monetary policy by raising rates (insulin). Since December 2015, the Federal Reserve has raised interest rates (reduced the sugar and increased the insulin) 5 times and is likely to do so 3 more times this year.
This shift from stimulus (sugar) to tightening (insulin) is the result of the economy (diabetic) improving as the risk of deflation (diabetic coma) recedes. Now their attention turns from saving the economy to managing the recovery. Just like a diabetic who receives emergency stimulus to prevent a life-threating plunge in blood sugar, the economy needs time to get its “legs” under it. Further, the same stimulus that saved it from disaster must be moderated or else it could lead to another kind of disaster in the other direction. In the case of the economy, this means the risk of run-away inflation. If the Federal Reserve leaves interest rates too low for too long, it can lead to an overheating (surge in blood sugar) of the economy and they will need to raise rates (inject insulin) quickly. A whipsaw between high and low blood sugar levels is very uncomfortable for diabetics. Similar volatility between monetary stimulus and tightening makes markets unstable.
Managing diabetes requires constant monitoring to maintain a consistent blood sugar level. Sometimes those levels get out of order and dramatic steps must be taken. The same is true for the economy. It is impossible to achieve perfect stability in either case.
We are still in recovery mode from the Financial Crisis. The Federal Reserve has gone from an all-hands-on-deck crisis mode to one of surgical precision and stable monitoring. The risks of deflation seem to be gone for now which is terrific for all of us. Now the risk is reducing the stimulus at just the right pace to prevent a return to deflation while preventing inflation from taking root. They will not get it perfect but that is OK. The economy, just like the human body, is dynamic and does not operate in a vacuum. It adapts and adjust to its surroundings and this will be true for the economy as well.
The volatility we are experiencing is part and parcel of the recovery from the “near-death” experience of the Financial Crisis 10 years ago. The analogy above is meant to add perspective to what may seem like the “beginning of the end” to some. It is not.
We expect the choppy price action in stocks to continue until the recent lows are re-visited and hold. This weakness is coming earlier in the year than we expected but it feels orderly and refreshing. Our advice is to stay calm, avoid watching CNBC and look forward to warmer weather as we believe higher stock prices are around the corner.
Sincerely,
Kessler Investment Group, LLC