The Hibernating Bear

4700 words (15 minutes)

It's very human to get seduced by concepts in your head that don't map to the limits or reality of how the physical world works. I seem to be less burdened by this phenomenon because the only things in my head are tumbleweeds and crickets. Recently, I promoted myself to chief economist at my house, and I hosted a symposium in my basement called Rages In The Cages. My announcement as keynote speaker was met with mockery and derision. A hater might describe the attendance at this inaugural event next to the laundry room as underwhelming. In fact, the only one who showed up was my five-pound yorkie who I tricked there with her favorite treat, and even she left during intermission when the bagpipes came out. Despite the profound lack of media coverage, I remain undeterred. What follows are the highlights from my speech "Monkeys Throw Turds."  

This rise in CPI certainly had causes based in supply chain disruptions and the Putin oil spike, but it was at least half, and I'd argue more, due to the Covid Cash.

Inflation is only a monetary phenomenon and there are several reasons. When M2 increases it improves the balance sheets of individuals and businesses for as long as the money flows. When oil rises it hurts the balance sheets of individuals and businesses like a tax by consuming disposable income and compressing margins.  CPI driven by money is potentially infinite in nature, as seen in hyperinflations where the nominal prices of everything spirals ever upwards. CPI driven by oil is finite in nature and causes an economic slowdown to restore balance when it hits the limits of balance sheets.  

You can't compare the current inflation to the 1970s, which, despite its reputation of stagflation, was one of the strongest economies ever. Is there another decade that absorbed oil rising 10x while interest rates rose to 20% with only a couple brief recessions? If you take a median oil price over the last decade of $60 that would be like oil going to $600. The pain at $130 over the summer was palpable. The reason the 70s could absorb such a tax was because the underlying economy was driven by a decade of peak baby boomer borrowing, which was the inflation that subsided as the bulge of boomers tapered off. There was also less indebtedness so balance sheets were able to absorb the expense.  Our current inflation is an unprecedented one-off Covid stimulus package with nothing in its wake. Technically, we've been in a structural inflation for 100 years, but CPI measures the rate of change. This is not to say a structural oil deficit doesn't have investing implications.  

The current inflation is not the result of the Fed repressing interest rates and doing QE for a decade, which is a symptom, not the cause. Interest rates were low because the economy was weak due to globalization stripping away our manufacturing base and overall risk aversion post GFC, so the Fed inflated asset bubbles with only a minor effect on CPI from a weak wealth effect because reserves don't end up in the hands of consumers. The US has been in a stealth depression since the turn of the century as globalization kicked into high gear. Fiscal and monetary policies have simply masked the symptoms along with unprecedented-in-size global companies that boosted the stock market and intensified the illusion. There is no such thing as a service based economy. That is called a broken economy. The whole idea is to produce goods and services and sell them to the rest of the world. To be fair, globalization has uplifted the living standards of other parts of the world by introducing them to the need to gather money instead of food directly. Globalization can also be viewed through the lens of funding the expansion of freedom and democracy, albeit deeply corrupted by self-interest and systemic flaws, but it's still better than allowing socialist dictatorships to flourish in its absence. Some set of culturally organizing ideas are going to be in charge. Do you want it to be a socialist dictatorship or the flawed expression of American ideals that can be course corrected if enough people cared?

Deglobalization implies jobs are moving back here. They're not, and they won't be.  An accurate way to describe an exodus from China would be reglobalization and it won't have the slightly impact on CPI for several reasons: 1. It would take a decade and CPI measures the rate of change.  2.  China isn't even the lowest cost labor anymore.  3. It's not just cheap imports suppressing CPI, it's the lack of (what could have been) 20+ million onshore well-paying, stable, union jobs, and the dollars circulating domestically.  That would move the needle on CPI. REglobalization won't, at all.  That doesn't mean prices won't go up.  It's the pace that matters. And the subsidies for Chips, which only mask the actual cost of the products with taxpayer funds, have to be permanent now; otherwise, when they expire and the real costs are not competitive with chips made overseas, they will fail. So we have a new permanent bill, which btw, I agree with as a geopolitical strategy, I'm just saying it's not happening organically because the global structure is changing; it's being forced by government. 

Oil is disinflation wrapped in inflation's clothes. There has never been a hyperinflation caused by the supply side. And the Treasury is limited by the Joe Manchin effect, which prevents egregious spending Acts outside a crisis. The usual annual deficits are too narrowly focused to influence CPI.  The current inflation was caused mostly by distributing money directly into people's hands (amplified by supply disruptions and Putin, of course).  Married couples with 3 kids received $24k (including the regular credit tax credits) and that doesn't include if either of them worked under the table and collected the extra $600/week in unemployment. (Details of the Acts are at the end if you never added it up). 

When that lotto money is spent it will end up in the bank accounts of businesses and be restrained by banking practices to qualify for a loan (aka creditworthiness) and the proper stewardship of money controlled by business owners, which is keeping velocity in check. If this was an expanding economic environment like the 70s, you would see businesses investing that lotto money in all kinds of Capex that could keep the inflation going, but they're not. Inflation has to be funded. In fact, inflation IS the funding. Bank of America and JP Morgan estimate there's about 1.2 Trillion of the Covid cash left, but a lot of that is in the hands of people who don't need it, so quite a bit could go unspent. The only structural inflation argument I agree with is Russell Napier's notion that the government will start guaranteeing bank loans of all kinds. 

A "wage price spiral" is the most absurd concept in finance. We want wages to go UP. That's how we would avoid recession and reduce the burden of debt by increasing the nominal prices of everything around it. Is there a single instance in any culture in history when a nation collapsed because wages were too high?  Omg, did you hear what happened in Madagascar?  Their currency collapsed because everyone was making so much money. It's silly. If this was a problem there would be instances in history called The Great Wage Price Spiral of 1867.  This is the same mistake as the "oil is inflation" idea, which is the false assumption of an infinite consumer balance sheet. Wages tend not to keep up and raises don't happen to everyone simultaneously, which acts as a spiral limiter.  

I don't get the impression everyone realizes the financial system is in stage four terminal cancer, which is probably due to a "frogs boiling in water" effect.  The evidence is staring at you in the form of the balance sheet of the Fed and the US gov't, which are enormous malignant tumors that will continue to worsen over time.  The only cure is either a new innovation like fusion that essentially creates near free energy, or a new monetary system, which is what will happen reactively like the three other times in the last century if we don't do anything proactive to stop it. 

Here's what our country would look like if it was run by responsible adults from the beginning: 

We wouldn't have a general treasury market because the politicians wouldn't be able to spend money beyond what they collect in real-time taxes.  The only treasuries that existed would have a specific purpose like The Mississippi Bridge Project etc..  They would pay whatever interest rate the buyers demanded and the debt would extinguish at maturity.  The problem of allowing unaccountable politicians to spend future taxpayer money via nonspecific treasury bonds to appease voters is so deeply ingrained that we teach the treasury market like it's a natural part of how the world works when no, it's not, it's a cultural choice, and it has inevitable consequences. Our predecessors made decisions that are nearly impossible to undo. Once you deviate from sound money, once you export your manufacturing base, once you institute a policy of the Fed put, there is no going back, and they end in a currency crisis unless we choose to course correct with innovation. 

The inflation to be concerned about is when the dollar is collapsing. That's the one that takes away the Fed put. This is not it. And if Powell thinks he can be the tough guy to end the Fed put, he will learn the same lesson as all the armchair Austrian would-be Fed chairs who claim if they were in power they would raise rates and tame that junky stock market only to realize upon its collapse that the real problem is the structure of globalization that forces the Fed and Treasury to continually inflate the gaping holes caused by a lack of domestic production. It's not a person or the people in power to blame, it's the institutional decisions made long ago that now must be perpetuated in cycles of easing and tightening, inflating and deflating, ad infinitum.  

I've noticed a pattern of people who are value investors, or sound money advocates, or those who don't participate in the bubble expansion phase, always saying this is the time the Fed put won't be there, or this is the time we're returning to normal, but they are simply not adapting to the bind the Fed is in. They want the economy to be back like it was pre-globalization when things made more sense to them. 

Apparently, if you read the Fourth Turning, you're assigned a therapist and put on suicide watch. Pessimism and repression win battles while optimism and freedom win wars. If you want to know the future, extrapolate optimism, freedom, and technology to its logical conclusion, and you will realize the world is turning into a giant interconnected computer with a mysterious intelligence emerging within it as its innate designer.  The challenges and conflicts along the way are a feature not a bug. 

Of the current 7.1% YoY inflation rate, 6.1% happened last Feb - July (release dates). If we grant the upcoming print on January 12th a .2 or .3 and then annualize the previous six months, the current economy is running at a 2.4% - 2.6% inflation rate, so the Fed's target will be hit in July.  This easy run of CPI comps, which were caused by the freakish rate of change of peak stimmy spending, peak reopening, and peak Putin oil spike, is not repeatable outside World War 3.  

The easy CPI comps end around the same time Jamie Dimon estimates most of the remaining Covid cash will be spent. It also happens to be around the time when the lagged effects of Fed tightening will be kicking in for realz yo.  Here's an updated version of the CPI chart with the easy comps in yellow.   

I don't see why CPI won't collapse from Feb - July, which, in theory, should cause quite a bounce in stocks, gold, treasuries, the Euro, and possibly the dream killer: oil.  In other words an unwind of the Fed must-tighten-to-infinity inflation trade. 

However, I believe this bounce in stocks no matter how high it goes will be a bear market rally.  If it happens, you'll hear excited chatter about a soft landing and how the market is endorsing higher rates, etc., but what would really be happening is a freak window of easy comps before the true effects of Fed tightening emerge, powered by a FOMO that, if harnessed, could end the energy crisis, and a complete devastation of shorts and puts.

Here's some things that could go wrong: 

1.  The economic data could deteriorate so severely during the process that the "recession now" narrative poses a bigger problem for stocks than a plunging CPI can overcome.  I'm more inclined to think there's enough Covid cash, wage increases, and people in jobs that the data will hold up enough, and earnings will be weak but not catastrophic (yet).  And the dollar should help this quarter. For stocks, though, it's definitely a race between the easy run of CPI comps and recession.   

2.  As CPI collapses, oil could rally enough to ruin the last three months of it, offsetting the effect.  This would be temporary because it would consume disposable income, but it would likely keep Fed Funds high and even moving higher to stop a dreaded second wave. Powell has repeated ad nauseum he wants to be an anti-Burns mafioso tough guy so he doesn't repeat the second wave of the 70s. Once the easy comps are over it won't take but a blip in oil for CPI to rise, which could develop such a twitchy trigger finger in Powell that he starts doing pressers in a grim reaper costume.  

3.  I've never seriously considered a geopolitical threat as something to worry about, but it's worth considering what would happen to your portfolio if a nuclear weapon was detonated this spring by that cornered animal, or a China invasion of Taiwan.  Do you shrug your shoulders like you can't make investment decisions on unknowns like that anyway, or do you maintain a more defensive approach because this geopolitical environment is rife with potential disasters unborn in previous decades? 

4.   The CPI collapse could be right but the markets react in a way that is suboptimal. Or maybe CPI drops but PCE sticks and Powell shakes his fist and reminds everyone they're focused on that.  In other words, stocks have economic data risk whereas something like gold only has second wave risk. 

This is actually a three phase idea because a CPI collapse should cause rates to fall across the curve, so anyone still sitting on Covid cash looking to move will see lower mortgage rates and buy a house, which could result in a less severe second wave which could have a more severe PTSD effect.  If Fed Funds stay at 4.5 during the CPI collapse, and oil starts rising, and homes get bought up, once the easy comps are over, and CPI rises from zero base effects alone, I suspect the Fed will push even higher.  The terminal rate might end up in the 6-6.5% range, and despite all the grand theories, we live in the same 2% world we lived in before the pandemic. There's been no population boom, no free energy discovery, and no productivity innovations that would have a lasting effect on growth or inflation. The only thing that happened was a sugar rush of free money that is working its way through consumer spending to once again get stuck behind a wall of creditworthiness at banks.  This is the only reason the Fed is even capable of raising rates.  Even a mild second wave would cause a resumption of the bear market that likely breaks something as Fed overtightening ripples through the economy, THEN we get the real Fed pivot as economic data quickly deteriorates into recession while the stock market plunges. There will be no bull market until QT stops and the Fed pivots. There will be no bull market with short-term rates above 4%, or even 3%. Even a move back to the highs would be a hibernating bear. 

While I am open to the "recession now no matter what CPI does" view, which causes stocks to go down as bond prices and gold go up in the first half of 2023, I favor the delayed version of recession not coming until late 2023 or even 2024, which would result in everything going up in the first half of 2023.  In this delayed scenario, the first rate cut wouldn't happen until like October 2024, so the Fed Funds inversion will be correct, it just might be early and need to push out again.  

*I don't need to point out this is my understanding, and my speculation on the turn and river cards to come, which are always unknown.  Disagree as you please.  Here's some charts. 

SPX Daily.  I don't have an opinion for January.  It could rise to the trendline or a Fib retracement into the 3980 area, but I don't see how this could possibly breakout until after earnings, and I'm thinking it might be setting up for the big breakout on CPI day in Feb.  There's a lot of time until then.  Ideally, this chops around and fills in this triangle for a month and then either takes out the low of the January price action with a classic reversal or a double bottom.  The first week of February has the Fed meeting on the 1st (along with ISM), AMZN is the last megacap to report on Feb 2nd, and NFP is on Feb 3rd.  

Let's say the top of the triangle is 4050 and the bottom is 3650.  I expect there will be too many sellers at the top and too many buyers at the bottom for a sustainable breakout without a major change, which is likely to occur either around Fed day, or CPI on Feb 14th.  If you ask yourself what is the nastiest thing that could happen it is violent chop with a downward bias toward the bottom of this triangle through earnings, then a washout on Fed day with a massive reversal during the presser if Powell suggests a pause, then I would expect dips get bought into CPI and a big breakout.  Too perfect?  Yes.  The ideal scenario never happens, but that's an idea of what I'm thinking at the moment.  

Gold daily.  This is a tough one.  I have the highest conviction in gold going lunar but the challenge is not screwing it up.  I have some call spreads and I bought a put spread to hedge a retracement in January, but that's only a starter position.  This is kinda the same problem as stocks.  If you get too big too early then a simple retracement that you should be waiting to buy, hurts, and what if it's wrong? And yet the really strong trends don't retrace much, so you end up waiting for Godot.  

I've learned nearly every trading decision boils down to this: what will you regret less?  I prefer to miss out then give back.  You have to pick one, and the only way to soften that is to layer in and out.  You sell some when you're the most excited, and if you don't have on your full position, which you shouldn't, you add when you're most disappointed and ready to throw in the towel.  You're supposed to use the same size on every trade and never lose more than .5 - 1%.  But some trades are just better setups than others so I don't believe in that myself.  The problem is if you're wrong on the special setups, it takes an even more special run of normal wins to make it up.  But if you're right, boom stick. The bottom line for gold is the chart pattern isn't complete.  It may not complete, but if this comes down closer to 1700 it will form a perfect inverse head and shoulders.  The left shoulder low is 1679.  Gold is a notorious heartbreaker.  I think it's setting up for a huge move.  In five years, I think gold will be double in price. 

Oil daily.  I don't care about oil except that it could ruin everything.  Incidentally, the psychopath trade is long oil, short treasuries, and short equities.  If that's your jam you might want to keep it on the low, or show up outside homes and businesses with a flamethrower and torch them directly.  At least, you'd be seeing the people you're hurting.  Do I mean that?  As a trader, no, but as a business owner, yes. Incidentally, my business continued similar results.  Q4 was approximately 60% of the Q4 in 2020 & 2021, but up 50% from 2019.  Not catastrophic, but reflective of the Covid cash spike.  Through Xmas, December is the same as 2019, but 1/3 of 2020 and 1/2 of 2021.  People are spending less on consumer discretionary, which makes sense since they ran out of lotto winnings. 

10-year yields, daily.  Fib retracements: 38% is where we're at, 50% is 3.86, and the 61% is basically 4. There's nothing magical about Fib retracements. They're just levels you'd expect the one side of the trade to defend if they're in control, and when they don't it's an insight into underlying strength.

USD weekly.  If my CPI collapse dream trade comes to be, I would expect the dollar to retrace just below 100.  That would put the EUR/USD around 1.12 which is the underside of a major trendline.  I hope January is dollar up, gold down, stocks down, yields up just to setup a big reversal. 

EUR/USD daily.  

I will note again these are just probabilities. The whole game is losing small when you're wrong, and winning big when you're right.  

BONUS (details on the Covid cash Acts)

Stimmi-flation

Cares Act: $1200 per individual, $2400 per married couple, $500 per dependent under 17 (phase out above $75k for the individual and $150k for couples)

Coronavirus Relief Act: $600 per individual, $1200 couple, $600 dependent under 17 (same phase out)

American Rescue Plan: $1400 individual, $2800 couple, $1400 dependent under 19 (24 if student) (similar phase out)

Total Stimulus Checks: $804B

Small Business PPP Grants: $1T+ 

Unemployment Extra Benefits: $567B

Plus, there was an extra $1600 child tax credit (in addition to the usual $2k) for children 6 and under, and an extra $1k for those older than 6. 

If you haven't added it up,  a married couple with 3 kids was entitled to: $6400 (for the couple) + $7500 for dependents + $6k (for normal child tax credits) + $4200 in additional child tax credits (say 2 kids below age six and 1 above). That equals $24,100 (and it's not considering if one (or both) of them collected extra unemployment money.  

Consider how many self-employed, contractors, and other businesses who found a way to operate during the shutdown and paid themselves or their employees in cash so they could collect the  extra unemployment. I know a 19-year-old who collected over $16,000 in unemployment while he worked under the table.  Pretty much anyone working a cash business could have done this, so it's not unreasonable to assume a healthy percentage of the married with kids people who collected the $24,100 also collected an additional amount like this 19-year-old in unemployment, which means it was possible for households to collect $50k as a family and work under the table on top of it, and while I'd assume most were closer to the baseline, it may have averaged out closer to $30k.  

Fancy Pants Livin'

If you live in a fancy pants town you might not realize how much more affordable real estate is in other parts of the country and therefore probably dismissed the idea that the Treasury sent down payments to everyone for houses.  In mid-size cities like mine (or smaller), a pre-Covid 1970s/80s 1800 sq ft 4-bedroom house in the 'burbs with 1/4 acre yard where you never have to lock your door was like $140k-$160k. It peaked around $225k-$250k.  One of my employees had a starter house he bought in 2015 that was 1100 sq ft for $85k.  He just sold it in October for $195k to upgrade because they had another kid. In comparison, my friend in Maui has a 1600 sq foot house with a tiny yard that was $600k pre-Covid and it's now $1.1M. 

Since the stimmies were directed at the lower 75% of the income scale (and definitely the lower half), most of the recipients were in the market for houses $150k and less, so a 10% down payment would be in the ballpark of $15k, and as prices rose maybe up to $25k. This housing bubble inflated from the lower end up as all these people suddenly had down payments, which pushed up the prices of the middle and higher end houses too, and those in more expensive areas.  A lot of people in the middle income cohort already had the down payment, so the stimulus provided the added confidence to go for it, which was often motivated by the newfound freedom of remote work. 

The bubble inflated from both a supply shortage because Blackrock is buying up America to turn the country into renters (as well as the Covid shutdown stopping construction for awhile), and from the demand side as buyers flush with stimmy cash chased offers ever higher, and I've never met a real estate agent who didn't have a hot competing offer on the other line to drive up the price.  Not to mention the moral hazard of the Fed buying up MBS so the banks don't have to worry about issuing mortgages at the top of a bubble because they'll just flip them to the Fed if there's any trouble. 

The same thing happened in the auto market.  The Covid cash was not money restrained by banking practices that require provable income, or collateral, and it wasn't a loan that needed to be repaid. It was the rocket fuel of actual inflation that was broadly distributed, and caused the prices of CPI to rise.  

A Horse Named CPI

Imagine it's the Kentucky Derby but there's only one horse named CPI and he's trotting toward the starting gate at his natural pace of 1.5, then all of a sudden he comes to an unexpected halt in the gate. The politicians and central bankers freak out and load a rocket engine on his back. The gate finally reopens and he launches forward at an unprecedented acceleration, but eventually the fuel runs out, so he can't do anything else but slow down to his natural pace all on his own - there's nothing else that can happen. But the politicians and central bankers start freaking out in the other direction because they misjudged the effect of the rocket fuel, so they start piling sandbags on the horse in ever increasing amounts, instructing the jockey to pull back the reins!  

If you measure the rate of change in CPI's speed as he burst from the starting gate (both from the reopening and the stimmies) and compare that to measurements of the rate of change at 10 yards, 50 yards, 100 yards...it would show a burst followed by a leveling off followed by a descent back to his natural pace. It's impossible for the artificial rocket-fuel-tainted initial rate of change to be sustained without ever increasing amounts of fuel. 

THOUGHT EXPERIMENT

What would happen if after the Fed enabled the Treasury's Covid cash distributions, they closed the institution and left with Fed Funds at zero?  The answer is the entire point: markets would take care of the inflation. High prices would cure high prices. There would be no wage price spiral. The inflation would simply burn through the system like a drug followed by a hangover. But what if I'm right (I am) that the structure of globalization is the underlying disease that is forcing the Fed and Treasury to treat the symptoms of low growth, populism, civil unrest, balance sheet debt saturation etc. with continual stimulus in ever increasing amounts to prevent a deflationary collapse?  

There's only 3 possible cures: a new monetary system that allows the world's sovereign currencies to be devalued into it, thereby reducing the burden of debt; a new innovation that creates practically free energy, thereby reducing the burden of expenses; or a breakthrough in general artificial intelligence that launches an era of enhanced productivity, thereby improving the flow of incomes. 

I believe all three are coming - when the time is right. 

BUNCHA CHARTS

I have a solid thesis forming but I don't have time today and there's no hurry because it's a next year thing.  I plan on posting it after xmas with an updated view from my recent quarter and holiday sales (spoiler: not good).  

Here's a handful of long-term charts.  I'm thinking there will be consolidation/chopping around for a month or two.  It would be nice to see knee jerk reactions to the downside in stocks on Tuesday and Wednesday because they are usually tradable, but the real deal is gonna happen next year.  It's quite possibly the best setup I've ever seen.  

USD monthly.  Backtesting the breakout.  

EUR/USD monthly into resistance. 

Gold daily.  This is setting up to skyrocket, but it could pullback to form a right shoulder first. 

Silver weekly formed a perfect base around long-term support at $18.  I'd prefer if this consolidates or pulls back - even all the way to the moving averages. 

Oil monthly.  The 2 yellow lines are the 50% & 61.8% retracements.  

SPX daily.  There is an unfilled gap from 3818 - 3859.  The yellow line is the 50% retracement around 3800.  This area seems like the source of chop and backfilling to me.  Above the downtrend are the 50% & 61.8%.  

Rocket Launch

What if we actually got follow through up to the 200-day? 

Inflation Causes Deflation

I can't believe there are still people saying inflation isn't transitory, so instead of expressing the concepts like last time, I'll anchor them in my actual experience of owning a business through all of this to show you how inflation causes deflation, then we'll explore a time frame, and see if the market is confirming this view (spoiler: it is). 

Let's start with the customer. Whether people are aware of it or not, everyone is running a business by being alive. At the end of every month you can subtract your expenses from your income and calculate your month's profit. Pick a number, but for the bottom X% of the population that disposable income is very limited, and it gets squeezed by rising costs if their wages don't keep up. I assume we can agree on that. 

My small business used to have seven employees; now it has five. My number 1 & number 2 have been with me from the beginning. My number 3 replaced two part-time family members who graduated and moved on. At the end of each year I give everyone a raise and a bonus.  I already paid above market rates because I value loyalty over squeezing out a little extra profit, and I think of them like family.  This year I overheard them grumbling about rising living costs, so I gave them an additional raise in the summer.  I plan on another at the end of the year.  Thus far I've been able to grow revenues to compensate for this, so the bottom line has increased. In fact, in four years, I've grown the top and bottom line 3x while paying my employees nearly twice what the previous owner paid hers. Some of this was due to skill in selecting the right business and executing on it, some was luck, and some was divine intervention. 

My suppliers have all been complaining about their input costs rising, so they've been raising their prices to maintain their margins and free cash flow because obviously they too are a business.  

With the disposable income of my customers getting squeezed by higher expenses, last quarter (Q3) (ending August 31st) is the first time my revenue and net profit is significantly down (the net profit is 50% of Q3 2020 and 25% of Q3 of 2021). I also had to run a 20% and 10% discount this Q3 to move "inventory," so the net profit is down due to higher employee costs, higher supplier costs, and less demand. If I was a publicly traded company I would have to pre-announce to soften the blow and give vague guidance because I don't know for sure that some of the cause isn't people spending way more on vacations this summer, but I do know there is a significant drop in customer spending. 

One thing I did was consolidate hours. I had 2 employees who only worked one day a week (for depth of staff), but they didn't take it seriously because they kept calling in, and since my number 2 wanted more hours, I gave their shifts to him. Even though it's the same amount of hours, in theory, 2 people lost their part-time job. 

I've also negotiated with my suppliers for better prices, hinting that I may have to look elsewhere (meaning, I'm the customer not wanting to pay full price, so give me a discount). Business is a game of who needs who more? Do I need the employees more than they need the job? Do the suppliers need me more than I need them? Do I need this customer wanting a discount more than they need me? It's a balancing act of negotiation that requires constantly reading people. Fortunately, I'm good at that. So the suppliers came down a bit to share the burden, which means it eats into their margins and free cash flow too, but if this continues we are both going to get squeezed even more. 

With demand down I will be careful not to order too much, in fact, I'm ordering less, so the supplier gets the feedback to produce less, which translates into less economic activity. When customer demand softens, particularly if it's because their discretionary income is shrinking because their expenses are rising faster than their wages, then I have to lower my prices to clear "inventory," but most of my expenses are fixed, so it leads to less earnings as seen in Q3. Since I'm in year four of a six year lease, rent hasn't gone up - yet. Utilities are up, which, of course, is tied to commodities as the baseline input to everyone's business on every level.

Do you see how inflation causes deflation? It's all about the free cash flow of the customer, which is limited. If it gets squeezed by expenses being higher than wage increases they will spend less and it spirals downward back onto businesses and their supply chains, squeezing margins, and causing less production and economic activity. If it keeps going it leads to layoffs and spending cuts that perpetuates the cycle, but debts remain, so inevitably people start using credit cards to pay bills, but eventually they run out of credit, so they stop paying credit cards, then mortgages, then cars. If it keeps going, centralized credit institutions get impaired, which causes either significant write-downs, or systemic risk if it's bad enough, which forces the central bank to socialize losses by buying up toxic debt, so the downward spiral must be stopped and reversed at some point. This is why there will always be a Fed put. It's not a choice. The only bright spot is the shortage of labor could help keep wages up while we go through this, but it doesn't seem sufficient to me. 

With what I just described in mind, how is it possible to have a permanent condition of inflation? The term transitory is not to predict the length of time, it's to describe the mechanism of markets limiting the effects of inflation because it causes its own demise by consuming disposable income, which starts a deflationary spiral that destroys earnings, spending, and jobs. This has nothing to do with the Fed. It's simply markets at work. Wages lag rising costs. The Fed can't print creditworthy borrowers, wage increases, or money into my customer's bank accounts. They can cause the stock and bond markets to inflate, which has some degree of wealth and psychological effect, but it doesn't put money into the hands of my customers to spend.  I don't care what the economic textbooks say - I'm living it. And I should note just because my Q3 was down so much doesn't mean the greatest businesses in the world will see the same result, but it sure is a potential warning sign for the next 6-12 months. Deflation is at work, as seen with Fedex and Walmart. 

Let's do a reality check to see if the market is confirming this view:

Treasury curve: inverted, doesn't care about CPI

Eurodollar curve: inverted, no fucks given. 

5y 5y Forward Inflation Expectation: 2.27%

5-year breakeven: 2.49%

Oil, lumber, copper, silver, wheat, corn, gold, and nearly every commodity: currently downtrending. 

Housing: coming down, but kinda sticky. With mortgage rates very high relative to recent years, and disposable income getting squeezed, this should continue to slow down.  This lags the most because it's not driven by speculators pricing in the future like the other markets, so it's not surprising it will be last to be dragged down by a contracting economy as people tighten their spending or lose their jobs. Meaning, derivative markets look ahead and price in the future while housing and OER reflects the sentiment of the present and policies of the past.   

CPI - Reverberations of the Past

The inflationists are strutting around like proud peacocks again, but they aren't making sense. And I do give the ones who aren't perma-inflationists all the credit for the correct call when inflation was happening two years ago.  The CPI data we see now is the reverberations of the inflationary policies from 2020, which have long ago ended. Why is the concept of time so disregarded? I don't get it.  It's like someone drank a bottle of whiskey and started acting intoxicated buying up everything on the internet, then the booze starts wearing off as fatigue and confusion sets in, and he's still flailing at the button for that last available foot massager, but as the pain of the impending hangover starts kicking in, the inflationists are saying he's gonna stay drunk forever, in fact, next year he'll be double digit drunk! How? The alcohol ran out. It's just working through his system. If your thesis is inflation will happen again when the Fed pivots, which will cause the dollar to descend (especially if the war ends and Europe's acute woes subside), so commodities will rally and increase input costs, that makes sense, which means you agree inflation is transitory, and so is the deflation happening now that will cause the Fed pivot.  It's all cycles.  And the next wave of inflation is going to depend on how low commodities like oil go during the deflation because don't forget the Fed doesn't put money into people's hands, so demand will be a concern.  (Let me note as well, if commodity prices were to relentlessly rally despite collapsing consumer disposable income, then I would agree CPI would resume an uptrend, or stay elevated until equilibrium occurred. I've noted before my concern about oil supply, but based on what I'm seeing in my business and what the leading indicators are pricing, it doesn't seem possible because the demand will come down just as fast as supply during a deflationary period, but should that occur, then what I'm writing would be wrong. I don't really care about my opinion. I let the markets tell me what to think and adjust when necessary. Is there any other way?) 

Unfortunately, it seems like we will have to listen to the inflationists for a few more months due to base effects.  Here's the actual CPI data of the last year.  Note the big MoM% changes in yellow that will drop off as we get to them. We also have to keep in mind that housing is slooow moving, so OER could be what I would argue as falsely elevated for awhile (in relation to what is actually happening in the surrounding economic data reflecting actual customer spending affected by squeezing disposable income). 

Also, residential rents renew yearly, so that's a rolling issue going forward, but as housing slows it will slow too.  Certainly, food was a bigger problem than it has been, both recently, and this year, and gasoline last month was down 10%, so if gas stops going down at this rate of change, other items have to go down to makeup the difference.  Probably the biggest short-term concerns are housing and food from the fertilizer disruption. Also note over the last 3 months the level of CPI (in the 296's) has stopped going up. 

Date	CPI Level	% MoM	% YoY
9/21	274.31	0.27%	5.40%
10/21	276.59	0.83%	6.20%
11/21	277.95	0.49%	6.80%
12/21	278.8	0.31%	7%
1/22	281.15	0.84%	7.50%
2/22	283.72	0.91%	7.90%
3/22	287.5	1.34%	8.50%
4/22	289.11	0.56%	8.30%
5/22	292.3	1.10%	8.60%
6/22	296.31	1.37%	9.10%
7/22	296.28	-0.01%	8.50%
8/22	296.17	0.10%	8.30%
9/22	Oct 13th
10/22	Nov 10th

Markets

I think the markets are reacting appropriately. Stocks are coming down to price in an earnings slowdown, and who knows how much is priced in so far, or how long it will last.  This week is probably the last chance the S&P has to make a move up before rolling over again.  

The bullish thesis is this: 75bps is peak hawkishness from the Fed, so if we do get a "buy the news" on Wednesday AND there's follow through on Thursday, we could see a short covering rally to the downtrend line (or the next CPI in Oct).  The bearish view would simply be emboldened shorts who win the battle because they have conviction of a coming earnings disaster, CPI which only has a .27% rolling off next month, a Fed trying to regain credibility so they will overtighten because the world only sees the lagging data they're looking at (like employment and housing) and not leading data.  It's kinda like being an amateur trader making decisions off present time data and not anticipating the headlines of the future.  If the stock market gets crushed this week, it's likely to be an ugly October.  There is hope in November with a big .83% rolling off on the 10th, a lesser Fed raise Nov 2nd, and the midterms behind us, so if oil stays chill or even goes lower, we could finally see headline CPI start to really come down.  You'll have to game out the housing and core yourself.  

Personally, I'm just waiting. I think the best trade on the board is the 2-year at 4%.  I started my position around 3% so I'm underwater on that as well as just about everything else, but I'm mostly cash still. I'm thinking the 2-year will rally before the stock market bottoms, so I might scale all of my available cash into it at 4, then 4.5%, then all-in if we get to 5%, which I doubt, but I'm surprised it's at 4, so who knows.  This is literally free money.  The worst case is just sitting on it for 2 years.  The only bad scenario would be if stocks screamed higher without the 2-year rallying ahead of it to sell first, but I think that's unlikely.  The 1-year is about the same yield but it will only get half the price appreciation return if yields collapse. As someone who doesn't have clients I have the appropriate stock exposure to be disappointed in either direction: if stocks somehow go back to the highs because this is all overblown and the war ends, I'll be disappointed I don't have more; and if they go to the lows I'll be disappointed I have too much.  That's the sweet spot of disappointment for me.  If we get down to 3150, I plan to blindly buy with limit orders up to 60% of my intended amount and wait for confirmation for the rest, but that's just a guess.  

One final note to the guy who wrote me an angry message about oil: I never endorsed any political policy or party.  If I was in charge I'd be subsidizing oil production to make energy cheap as the cost of EV's comes down over time through scale and innovation while I built regional nuclear plants and upgraded the grid to seamlessly shift energy around. That kind of infrastructure spending would pay for itself as the increased economic activity from a widespread boost in the disposable income of all consumers and businesses via cheap energy led to more income and sales tax receipts for the government. Energy should be the number one priority of any government. It's not rocket science.  

The Natural Restraints on Inflation

Intro

I might be losing my motivation for this blog because I keep choosing to look for my golf ball on the wrong fairway than write this article. Here's my argument for why structural inflation is impossible. 

The Two Faces of CPI

Traditionally, inflation is defined as a monetary phenomenon, which is when CPI rises due to an increase in the money supply, so technically a supply shock that causes CPI to rise is not inflation, it's just CPI rising. The reason this is an important distinction is because supply shocks are anchored in the law of supply and demand and the incentives of free market participants, so they always return to equilibrium; whereas an increase in the money supply could be the result of a structural economic boom in a fractional reserve system, or the structural recklessness of excessive fiscal money. In other words, the bond market doesn't care about supply shocks because the companies involved are restrained by free market competition, so the prices can't spiral out of control permanently. If the profit becomes too large it will attract competitors to bring it back to the cost of production plus the market allowed profit, or if the price rises too high it will kill its own demand. There's no escaping this restraint, except for temporary dislocations, so the treasury market will look past it. The reason CPI was over 9 with the 10-year yield under 3 is because trillions of dollars in the treasury market is saying the bulk is CPI is not inflation; it's other temporary reasons like the labor gap, supply chain issues, and a temporary disruption in oil. 

The Fed Rides Caboose

The Fed has almost nothing to do with the current increase in CPI, and they're not even capable of causing it to rise. It's not a power they have. Here are the three biggest false assumptions many on Wall Street believe: QE is inflationary; the Fed controls interest rates; and banks loan out deposits. All three have profound downstream effects in how the economy and markets behave, so let's explore them. 

The Fed couldn't make CPI rise if they tried (and they did for 10 years), mostly because their transmission mechanism into the real economy is weak and diluted. If the money they create doesn't enter the economy it can't drive up consumer prices, so let's follow the money because there's some nuance here. 

When the Fed buys treasuries it indirectly funds the government beyond their tax receipts, which is the definition of inflation, but all government spending programs (until Covid) were narrowly focused on specific Acts that created winners and losers in certain sectors, so it was never broad enough to cause CPI to rise as a whole. 

When the Fed buys MBS it frees up room on the balance sheet of banks, which allows them to make loans they wouldn't otherwise be able to make, which creates money into circulation and is also the definition of inflation. While banks create the bulk of the money supply through loan issuance, they are not restrained by deposits or reserves - they're restrained by the creditworthiness of borrowers and the viability of the loan, which is why the Fed was unable to cause CPI to rise for a decade. They needed creditworthy borrowers with down payments in order to have a broad based effect on consumer prices. 

Light My Fire

Along comes Covid, and the MMT crowd gets to see their foolish ideas play out as a real-time experiment. Combine several rounds of stimulus checks, additional unemployment money, the PPP loans, the extra child tax credits...and all of a sudden the country was full of creditworthy borrowers with down payments, which created a housing and car boom. Clearly, there is nothing better for the economy than a strong housing market since there's abundant ancillary spending that surrounds it. What resulted is the typical "pig through a python" inflation of CPI as this free fiscal money worked through the system, but without a continual source of funding it can't be anything more than a transitory, albeit exaggerated, effect. That money will be spent and end up in the bank accounts of businesses and once again get stuck in the banking system, restrained by the need for creditworthy borrowers with down payments or collateral to keep it circulating in the economy bidding up consumer prices. 

In contrast, the 1970s inflation was driven by a relentless, persistent demand for money by a freak demographic boom all moving through peak borrowing years at the same time for a long stretch of time (amplified by the oil supply shock, of course). Since CPI is a measurement of change, in order to maintain a high and rising CPI, the borrowing and spending must persist over years, which it did in the '70s because it wasn't driven by an artificial and temporary source of funds like government stimulus. 

Spiral Squeeze 

You might argue there's a psychological effect that takes over and creates a wage/price spiral that pressures CPI higher continually unless it's stopped, but this too has natural restraints because it doesn't happen broadly all at once, so it tends to be haphazard, staggered, and narrow. In an inflationary environment businesses are faced with higher input costs and the simultaneous shrinking of a customer's discretionary income, so they can try to raise their prices to maintain their margins, but some businesses have more pricing power than others, and some customers receive quicker and better wage increases than others, so the haphazard and staggered distribution of these increases acts like a built-in mechanism that prevents a runaway upward spiral in wages and prices as both customers and businesses get squeezed, which results in spending cuts and layoffs to counteract it. 

Technically, we've been in a wage/price spiral for a century. The average salary in 1913 was $575 per year, and it's now $54,000, so while wages often lag, they do rise because that's how markets adjust. An environment of 9% CPI doesn't mean you're losing that much purchasing power if your wages went up or you own assets that countered it. It also depends on what you're spending it on. If it's sitting in a brokerage account and what you want to buy went down 30%, then not only did your purchasing power go up by that amount, but also by the 30% to get back to where it started (assuming it does).  It's not a simple calculation. 

Fed Bread

When the Fed buys treasuries, most of the money printed out of thin air ends up sitting in the bank reserves of primary dealers. Fed apologists claim this is an asset swap, but it's not because the Fed doesn't have any assets. To illustrate the difference, if the Fed ran an underground bakery and they produced the best bread you can imagine and they stole market share from other bread companies by selling their bread to consumers who paid for it with the money they earned by owning, or working for, profitable businesses, the Fed would end up accumulating savings, and if they used those savings to buy treasuries in a QE program that would be as asset swap. The Fed doesn't have any assets. It's accounting gimmickry. 

Purchasing Power Pilferage

The people who get hurt the most by inflation are the ones who need to not get hurt the most by inflation because they don't own assets or have enough cash to buy stocks that went down, or they are living on fixed income that understates their loss of purchasing power, so their fixed income doesn't keep up with their rising expenses. Inflating away the debt means stealing purchasing power from savers, the poor, and those living on fixed income, so a better alternative might be knocking on the door of poor people and punching them in face. Runaway inflation is impossible because the market forces of competition and the need for creditworthy borrowers will restrain prices even without the help of the Fed, which does not even control interest rates. 

The Inversion Rebellion 

If the entire Treasury curve bear-steepened in proportion as the Fed raised overnight rates, then I would agree the Fed controls interest rates. If mortgage rates followed Fed Funds in lockstep, then I would agree the Fed controls interest rates, but they don't. Interest rates are controlled by the market. This is the whole idea of why a yield curve inversion is such a powerful signal. It's the vast, diverse participants in the market disagreeing with the Fed as it responds to the same evolving economic data. Banks are going to charge as much interest as the customer will pay in the context of the bank's competitors. Mortgage rates skyrocketed as the housing market boomed, which created high prices in both housing and interest rates, and caused their own demise by cooling off demand. And if you eliminated the fiscal stimulus it wouldn't have mattered how many MBS or treasuries the Fed purchased, there would be no rise in CPI - just like the post-GFC decade - because there wouldn't be creditworthy borrowers with down payments. The Fed does not have the power to cause CPI to rise. They need the Treasury as an accomplice to send people money. 

Fed critics like to say "the Fed is causing financial repression by artificially holding down interest rates," but ZIRP and QE happen during weak economies, so interest rates are already low from a widespread willingness to buy treasuries at lower and lower yields. I'm not saying the Fed buying treasuries has zero effect, but it's not nearly as much as the "financial repressionists" proclaim. Evidence for this would be the Taper Tantrum of 2013. Yields initially raced higher, then stopped at the appropriate yield for the time, and resumed their downtrend because globalization has stripped the engine out of our economy, which is the real cause of financial repression.

Poppycock Talk

Offshoring our manufacturing base not only removed tens of millions of the most secure high paying blue collar jobs, but it also resulted in exporting trillions of dollars. This is the disinflationary black hole in our economy that forces the Fed and Treasury to continually reinflate asset bubbles. This is the reason interest rates are structurally low. This is the cause of financial repression. And the people who think we're entering an era of deglobalization are full of poppycock. 

The entire reason our CEO's moved those jobs offshore is to lower their expenses by evading our taxes, regulations, and unions. None of that has changed.  There's no way any CEO is going to reshore those jobs back to the same exact conditions that prompted the exodus in the first place, voluntarily increasing payroll expenses many times over. Pointing to a few semiconductor plants as evidence of deglobalization is disingenuous because they are being heavily subsidized as a geopolitical strategy to protect our semiconductor production. There is nothing better that can happen to this country than reshoring our manufacturing base, but it is not a choice a CEO can make. If they don't like China anymore they can move to Vietnam or Africa or Mexico, but not the US. And I'm sure every single one of them want to reshore, but I want to flap my arms and take flight, which is equally as likely, so go ahead and scratch that off your structural inflation bingo card. Deglobalization would be career suicide for whoever attempts it. No one is going to buy a $10,000 iphone. The math doesn't work.

Thug Life Currencies

And this idea that somehow Russia and China are making a power play to create a new currency that's going to displace the dollar is not appreciating the fact that no one is going to denominate their international business in the currency of lawless communist dictators who don't respect the rule of law or free markets.  The US might be flawed but we're not communist-dictator flawed. It's our rule of law, individual rights, democracy, and free markets that stand behind our dollar and override its flaws. There is no alternative. At the end of this, Putin will be dead, and Russia will be devastated for a generation as the whole world accelerates their flight away from Russian energy. 

The Great Conflation

One reason everyone thinks the Fed has more power than they do is because the stock market is so dependent on the shortest end of the yield curve, which the Fed does influence, so people conflate the stock market effects with the real economy. Any institution, corporation, or fund that is able to borrow at practically zero can leverage up risk assets, which unquestionably forces more and more people out the risk curve, and amplifies an expansionary period. Money flows into tech as a proxy for duration because the cash flows of the present are dwarfed by returns from growth stocks pricing in the cash flows of the future, so multiples expand. This has almost no effect on CPI in the real economy at all besides a very weak wealth effect that comes from people seeing their retirement accounts, or the value of their house, increasing. Additionally, if the Fed buys bonds from non-banks the cash can bid up stock prices. 

When the Fed keeps overnight rates below where the market would set them, zombie companies are kept alive that shouldn't be, but those jobs and that economic activity is not nearly enough to nudge the broad prices of CPI higher. When corporations can borrow cheap to fund buyback programs, reduce their share count, and drive up both their EPS and the stock price, the effect is also not broad enough to nudge CPI higher.  QE and ZIRP only inflate asset prices, so the Fed's bubble blowing machine is constrained to financial markets.

Financial bubbles don't need higher interest rates to pop - simple human psychology is enough. People have an intuitive sense of what the price should be, and while that gets muted by greed and irrational thinking during bubbles, eventually the buyers hesitate, and the whole thing implodes. That's literally the restraint on every speculative market in history. The Fed just quickens the end.

Dodo Bird Death 

The lack of oil capex is certainly a compelling narrative, not so much as a source of runaway CPI, but as a catalyst for recession. The way to gauge the burden of oil is to determine what percentage of discretionary income oil consumes and compare it to other eras, as opposed to thinking $80 oil is twice as bad as $40 in the 90s because wages have gone up to compensate, and debt levels are higher too. As the slow transition to EV's unfolds over the decade and oil companies are disincentivized to keep drilling, oil could find an equilibrium at a higher price, but that doesn't have to be any more disruptive than when it's moved up in the past. Until the '70s oil was well under $10 a barrel. Since then everything has moved up in price permanently, including the wages to pay for it. And why is everyone so sure that the current capex spending isn't the right amount given EV adoption will be moving from the lower left to the upper right?  That seems like an assumption which is hard to calculate and may or may not be true. 

It is certainly an interesting dynamic, and while there might be crazy spikes from temporary geopolitical dislocations, and a mismatched timing of wages catching up, the price of oil can only rise so much in such an indebted economy before it causes its own demise by killing the demand. 

(I do agree the most self-evident solution to our energy problem is to power the grid with nuclear, and power vehicles with batteries - and if you're concerned about lithium, research sodium-ion batteries and perovskite solar cells - both are not ready for primetime, but they are steadily improving their charge capacity and efficiency. Innovation will lead the way.) 

Great Temptations

The only cause of structural inflation would be a permanent Universal Basic Income program that artificially overrides the natural restraints of the banking system by sending money directly to the people without the need for collateral, down payments, or adequate income since it's not a loan. The MMT crowd refuses to acknowledge the money they want the Treasury to spend comes from someone else. There's no free lunch.  If you imagine a dollar bill made up of 100 little squares of purchasing power, inflation is taking handfuls of those squares from those who hold cash (or cash equivalents), or those who earn cash but don't own assets, and distributing them to those who own assets that adjust higher in price as the currency is diluted. 

The increase in house prices is a transfer of purchasing power from existing debt instruments like cash and bonds, and it disproportionately hurts the poor because they don't own assets, so their lagging wages squeezes their spending. If the Treasury determined the magic number was $10,000 to send to everyone making less than $30,000 a year, it would offset the pain on the poor, but it still comes from someone else. UBI would be a persistent, structural inflation the treasury market would have to account for, so purchasing power would be transferred from bondholders to UBI recipients to the stockholders of the businesses with the products and services they spend it on. Any inflationary impulse short of this lacks the persistent source of funds to maintain it, so it will be restrained by the natural forces of the markets, even if it takes longer for the money to work through the system than anyone believes. Underlying economic principles don't change just because things take time.

Summary

Without creditworthy borrowers with down payments or collateral there is a natural restraint on the inflation created by banks, and the only other source of inflation is the Treasury since the Fed by itself has a weak and dilutive transmission mechanism, and they don't really control interest rates, except the shortest of durations, which is contained to financial markets. Treasury spending programs are not broad enough to create lasting inflation with the exception of UBI, and since rising oil kills its own demand, especially in an environment of heavy debt, any and all CPI spikes have built-in natural restraints that will make them transitory. And since Congress is likely to become even more divided this November, the conditions for structural inflation do not currently exist, and don't appear to be on the horizon. 

If this view is correct, what you would expect to see is the YoY% change in M2 go straight up and straight back down, commodity prices go straight up and straight back down, earnings go straight up in the Covid beneficiary businesses then revert to normal, inversions of the Treasury and Eurodollar curves, the rising price of oil hurting spending at businesses like Walmart, and if recession happens from here just about all businesses and their stocks will suffer. 

Possible CPI Delays

Since nothing goes in a straight line, here's two main concerns: 

1. I don't see why Putin wouldn't use his power over natural gas flows to accomplish what he wants this winter when Europe is the most vulnerable. If he does (and to his credit he did allow wheat exports, which is somewhat surprising for a sociopath), it will likely cause another temporary geopolitical spike in the front months of oil that could cause CPI to stick even longer, but all geopolitical dislocations of price eventually revert to the cost of production plus the market allowed profit. Personally, I'm not into trading the irrational behavior of sociopaths, so I'll stick to my long-term investing allocations. If this does occur, it will be recessionary. Maybe this is what the inverted curves are anticipating, unless it's just a growth slowdown from a Fed overshoot. 

2.  Another concern is the 2-for-1 job openings-to-unemployed ratio of the labor gap. Covid caused upwards of a million domestic deaths, baby boomers scrambled into retirement, and the flow of immigrants slowed to a halt, putting upward pressure on wages, so if this labor gap doesn't close it could continue to squeeze employers and profit margins. There seems to be an enormous discrepancy between the Establishment and Household methodologies, so I don't know what data to believe anymore, but the people making a stagflation argument have a valid point if oil becomes a problem again at the same time labor keeps putting upward pressure on wages. 

However, stagflation is supposed to be driven by a weak dollar, which is how commodity prices keep input costs high regardless of weakening demand. Otherwise, the burden of existing debt leaves no room in discretionary income to weather a period of rising oil, so demand is quickly cooled. While the Fed has no power to cause CPI to rise, they can certainly cause it to fall by inverting the yield curve for as long as it takes to kill any remaining bank lending, which would hurt the consumer and cause the layoffs needed to induce a recession. Combine that with an oil supply shock and you get temporary stagflation, but because there isn't underlying growth caused by a high demand for money like the 70s, and the dollar isn't falling, it's more likely to be a disinflationary recession instead of stagflation.  Meaning, in a period of weak economic demand the only thing that can maintain high prices is a supply shock or a weak dollar. 

3.  There's three things working against stocks: Putin tightening the screws; the labor gap squeezing margins; and, most importantly, QT. The Fed wants to wind down its balance sheet, which is impossible, but I don't see why they would stop unless a plunging stock market forces them like in 2018.  That's my belief.  If you disagree, it's on you to explain why QE excites stock prices up, but QT doesn't depress them down. 

In fact, if you'd like to disagree with this article, here's ten questions to answer:

1. How does money sitting in bank reserves make broad consumer prices go up? 

2.  How can the consumer afford oil at $150 without devastating their other spending and then dragging down oil? 

3.  Without a strong demand for bank loans in ever increasing amounts for many years, where is the source of funds coming from to continually pressure consumer prices in ever increasing amounts since CPI is a measurement of change? 

4.  With CPI over 9, why did treasury yields stop between 3-3.50%?  

5.  If inflation was a concern why is the yield curve inverted?  Shouldn't it be bear-steepening aggressively?  

6.  If the Fed controls interest rates, how is it possible for the yield curve to invert?  Why don't mortgage rates track Fed Funds in lock step? 

7.  How is a CEO going to reshore any jobs that aren't subsidized if it increases input costs many times over?  How will the consumer afford those prices? 

8.  Why would international businesses choose to transact in Thug Life currencies? 

9.  If growth slows and commodity prices drop to reflect it, what's the mechanism to drive consumer prices higher?  

10.  How can a wage/price spiral maintain upward pressure if it doesn't happen broadly all at once? And why would now be different than the last 100 years of rising prices and wages?  

The bottom line is nothing has changed. There is a deflationary fire in the black hole of missing manufacturing at the heart of the developed world that is pulling interest rates and growth lower as central banks and governments attempt to fight it with hoses of liquidity. 

One chart - SPX daily.  Note it's between the 200-day EMA and 200-day SMA.  A backtest of the 4168 area would be normal, then we'll see if it can assault the downtrend line.  Also, note the positioning on the COT chart that follows. Dealers are extremely net long.  They almost never lose.  All they need to do is bid the market into Sept OPEX and they will make out like bandits as a huge percentage of those contracts expire and all that money transfers to their accounts.  That's not a prediction, it's just a highly unusual situation, and with oil still languishing it's not likely CPI is going to be a huge upside miss.  I suppose Powell or NFP could be downside catalysts, but if you ask yourself what is the nastiest thing that could happen it would be a breakout of this triangle into OPEX.  The short yellow line is the 61.8% retracement. Look at all the shorts who are currently trapped.  Don't you think they have to puke up their position before the market goes lower?  Just food for thought.  Personally, I don't think the bear market will be over until we revisit the lows or likely make new ones, but that doesn't mean we can't double top, or reverse off the 61.8 retracement.  From a trading perspective, these are the key levels setting up for Sept.  I'm mostly an investor now, so I don't really care.  Apple's going to $350, so if it makes new lows first, isn't that a good thing?  

COT chart

Bonus Song - if this doesn't blow your hair back, we can be cordial acquaintances, but we will never really know each other. 

RHCP - Don't Forget Me