There's a lot of people out there calling this cyclical move in rates a secular one. And if you already have an inflationary bias, these cyclical numbers will just confirm your bias and make it nearly impossible to make the right read. The much discussed secular disinflationary forces are debt, demographics, globalization, and technology. They've been applying downward pressure on interest rates for 40 years. These are deep forces that are way beyond the temporary disruptions seen today. The current inflation is being driven by several cyclical forces:
1. The government stimulus checks and added unemployment money gave millions of people down payments for houses and cars, money to fix up the house, buy goods, etc.. Some of this money just replaced lost income, but a lot of it exceeded that. When you amplify this with people relocating, and not enough supply of houses, it's no wonder house and car prices went up so much. Since there tends to be an 12-18 month lag in the numbers, it's not surprising CPI is so high. However, the source of that inflation ended long ago. This is not a secular force. This is cyclical.
2. The supply side suffered from rolling periodic shutdowns globally. Since the supply chain tends to be scattered with different components coming from all over, it's also not surprising that prices would go up as businesses are forced to pay whatever is necessary to get what they need. Some of this gets absorbed by the business, some gets passed onto the customer. However, unless you think there will be supply chain bottlenecks from now until the end of time, this is not a secular force. It is cyclical. Supply chains will self-correct as Covid dissipates.
3. The wage increases are caused by workers staying home to avoid Covid risk and the relocation shuffle. Workers also left jobs they didn't like for other jobs they won't like. This creates upward pressure on wages as businesses like mine have to pay more to keep or hire competent people. Some of this is absorbed by the business, some is passed on to customers with higher prices. Last month I questioned if boomers were going to come back when this is over, but they will have no choice simply due to fixed income not keeping up with the new level of prices. In fact, we might see even more boomers emerge to make up the difference, which will close the labor gap and stop the upward pressure on wages, which is not a secular force. It is cyclical. It will end.
4. Commodity prices are going up, but unless you think the increased demand of the consumer is permanently rising, then high prices will extinguish themselves like every other time since the beginning of Earth. The cure for high prices is higher prices. Rising oil is the only real concern due to the potential reduced supply from lack of capex, but high oil prices is what kills business cycles and causes its own demise. I'm not saying this is imminent. I own XOM too. I'm just saying this isn't enough to sustain inflation and it murders itself in time. Oil is cyclical, not secular. Backwardation is saying the oil market doesn't believe in sustained oil prices. Obviously, that's not a timing signal and can stay that way for prolonged periods, or even change, but it should be noted. To be clear, I'm not saying oil can't test its all-time highs. I am saying high oil prices will undo themselves.
We lived in a 1.5% - 2% world since the GFC due to secular disinflationary forces. Along comes Covid and throws a wrench in the economic machine. Everything goes haywire for awhile, but none of the secular forces have changed. In fact, they're all worse. There is no self-reinforcing cycle. People paid their debts or spent the stimmy money at businesses like mine and now it's in bank accounts like mine. I'm not spending any different than I was before. I'm looking to invest it when the time is right.
What we're seeing now is a potential preview of how the whole thing blows up, but it's not the real deal because these aren't sustainable causes of inflation. Real monetary inflation is caused by a demographic explosion all demanding bank loans for a sustained period of time in a pre-globalization world before an explosion of technology. Since that is no longer even possible, the only other way to get sustainable inflation is through sustained fiscal stimulus like Universal Basic Income because it bypasses the bank/loan equation and sends inflation directly to people to spend every week. There's no chance of that happening right now, and Congress is likely to turn more red than blue in November, but in the future if there's a severe recession and the Fed is buying junk bonds and equities and doing yield curve control and it's still not working, that's when the end game begins as the Treasury sends out free money permanently as they battle the deflation of this historic bubble. The Fed will be forced to raise rates to contain inflation while pinning the long-end by buying every bond, which will cause gold to skyrocket as the dollar implodes. If that was happening now, I would agree with the inflationists, but it's not. The deflationists are right that deflation is the problem, but the inflationists are right that the Fed and Treasury will not go down without deploying the full arsenal of tools to keep reinflating until their hands are tied and they must stop inflation (and/or a plunging dollar) by popping the bubble, or the bubble will pop under its own weight. I think we're years away from that. Bond bears need to understand they're actually gold bulls. Bonds have a perma put under them.
It's impossible to predict exactly when this cyclical inflation will start to rollover, but my guess is a couple more months. I'm looking for the stock market is seek out the Fed put, which it will be able to provide because inflation will start going down. In the meantime, the combination of inflation and Russia fears will likely cause a meaningful drawdown. I'm thinking we're in a Fib retracement of the Covid rally. Here's a few charts.
30-year monthly bonds. This is almost at the point where it's free money. Maybe the Russian invasion will prevent it, but if this starts breaking down through this long-term trendline, I'll be layering in. The conditions don't exist for a secular move down in bonds. I don't really care if I miss this.
10-year monthly notes. Same thing. Inflation is a train running out of fuel.
SPX daily. This double topped at exactly the 61.8% retracement of the impulse leg lower. If there's a series of bullish developments like Russia not invading combined with Fed officials admitting there's no inter-meeting move etc., it will likely rally once more but be a dead cat bounce. Bears held their ground, so you have to assume they're in control until these headwinds lift.
Here's the Fib levels of the Covid rally. Don't be surprised to see a sharp move down. Honestly, I'm looking at between the 50% and 61.8%, but that could be wishful thinking because I'm not even close to fully invested. If the market finds a way to correct sideways instead of down, I'd be willing to change my mind on a break and close above the 4600 level for a couple of days. I give that possibility a zero percent chance of happening, but the market is in control.
Fib levels for the NDX. Taking out the Biden presidency could be a thing.
The megacap tech stocks are going to crush everything else out there once this is over. This is not the dotcom crash, which was fledgling technology. These are the world's greatest businesses producing record profits and cash flow with enormous global TAM, new products and services, and incredible growth ahead. This drawdown is a gift. All that happened is the fiscal/monetary-unleashed-pent-up-demand-and-reopening thesis got ahead of itself. Now it's time to correct and backfill, shake people out, and let the Fed get off the zero bound, etc. By April/May the market will have priced in the entire hiking campaign and recession, inflation will be dropping, and the Fed will be able to slow jam their dance, eventually pause, and maybe reverse. That's my view. Disagree as you see fit.
BONUS CHART: AAPL drawdowns from 2004-2018. Over this time period one out of every 4 days you were in 20% drawdown or more, 61% of the time spent in 5% drawdown or more, but if you held through it, you made 36% annually. And that's not counting since the end of 2018 (which isn't fair because it's the bottom of a 40% drawdown, but it's up 5x since then). And they're producing record profits and cash flow. Since 2018, you can add Sept 2020 -17%, May 2019 -21%, Mar 2020 -38%. And every time there's a bunch of risk averse people who shake their fists at the sky and proclaim it's over.
