Financial Napalm: The Fed Needed Stocks To Fall. Credit Suisse Strategist Zoltan Pozsar Warned Us Last Month. How Our Response Has Worked Out

Zoltan Pozsar Warned Us

In a post about a month ago (The Fed Isn't Your Friend), we wrote about Zoltan Pozsar's warning that the Fed's helicopters were going to be dropping "financial" napalm on the stock market. 

The NY Fed wunderkind-turned-Credit Suisse strategist on why the Fed's helicopters are dropping "financial napalm" this time. $SH $WEAT $TECS $BOIL

— Portfolio Armor (@PortfolioArmor) May 17, 2022

In a nutshell, Pozsar's argument was that the Fed needed a reverse wealth effect (a poverty effect?) to reign in inflation: 

The Fed Needs Stocks to Fall

This is what they actually mean when they talk about the need to "tighten financial conditions". In support of this claim, Poszar cites a Bloomberg column by his former boss, former NY Fed President Bill Dudley, ominously titled, "If Stocks Don't Fall, The Fed Needs To Force Them". The Fed also needs real estate to fall and (more controversially), unemployment to rise, per Poszar.

This all makes sense intuitively, if you think about it. You just need to invert the status quo since the Fed last conquered inflation in the early '80s under Paul Volker. After that, and up until the COVID lockdowns, the Fed's primary concern was deflation, rather than inflation. In a deflationary environment, consumers are hesitant to spend, because they're waiting for prices to drop further. That, in turn, can fuel more deflation. One way to encourage consumers to spend is though the wealth effect. If they see their IRAs and 401(k)s balances rise, they feel richer, and are more inclined to spend money. 

If rising stocks make consumers want to spend more, heating up inflation with their demand, what would make them want to spend less, cooling inflation down? Correctamundo, readers: falling stocks is the answer.

Positioning In Response To Poszar's Warning

At the time, we noted how our system was positioned in response to Poszar's warning: 

If Poszar is right, it would seem you'd want to be short stocks now, with the possible exception of companies benefiting from demand side inflation like oil majors. With that in mind, take a look at Portfolio Armor's top ten names from May 9th.