Wednesday, 15 December 2021 — Melbourne, Australia

By Callum Newman Editor, The Daily Reckoning Australia

[7 min read]

• How narratives move markets
• The bigger picture

Dear Reader,

As Jim Rickards points out below, we cover a lot of different topics here at The Daily Reckoning Australia. From the pandemic and geopolitics to the state of gold or stocks, there are a lot of different features that we think are important for investors to understand.

But none of these occur in a vacuum. In the end, everything is linked in some way.

Today, Jim looks at the bigger picture and how narratives move markets. In future issues, he will take this broader view to answer some frequently asked questions about the world economy.

First, read on to see Jim connect the dots of the various topics we cover at The Daily Reckoning Australia…

Regards,

Callum Newman,
Editor, The Daily Reckoning Australia

By Jim Rickards Strategist, The Daily Reckoning Australia

We cover a lot of ground in The Daily Reckoning Australia. Specific topics vary, but over time we’ll look at economic growth, central bank policy, inflation, deflation, currencies, gold, stocks, bonds, demographics, geopolitics, and a lot more.

All of this is done with a view to helping investors make the best choices for their portfolios and achieve the best asset allocation that includes those choices.

Of course, none of the topics listed above (and others we cover) are ever completely separate. They’re all part of one large complex dynamic system under the umbrella of finance and capital markets.

If inflation takes off, gold is never far behind. When bond prices rally, it means interest rates are dropping. That can be good for stocks in the short run, but then lead to market corrections or crashes as reality sets in — lower rates mean that monetary policy is tight, and recessions become more likely.

Exchange rates are not driven by trade balances or purchasing power parity. They still teach that in universities, but those ideas are stale leftovers from an age of gold standards and fixed exchange rates. Has anyone ever exported a Big Mac or imported a haircut?

Currencies are driven by capital flows, including so-called hot money. Those capital flows are driven by interest rate differentials, which are in turn driven by inflationary expectations. The capital surpluses can support imports until either exchange rates drop, or domestic savings increase — the reverse of the textbook explanation.

To use a cliché — it’s all connected.

That said, we do tend to tackle these topics one at a time. A quick look at past issues will reveal that we spent most of 2020 covering COVID and the presidential election. We have spent 2021 moving from inflation to asset bubbles to demographics and more.

One of my favourite topics I’ve written about was narrative economics. In previous issues, I explained how narratives (basically stories, sometimes referred to as anecdotal evidence) can drive markets more powerfully than fundamentals or technicals.

How narratives move markets

Narratives form a kind of background and scenery for a play that’s being performed by actors in the foreground. Most people focus on the actors. It’s important not to forget about the scenery. That’s where the villains hide.

That’s intuitive to most observers. What was surprising was that narratives can last for years in many cases and that they can turn on a dime. The first stage of the Great Depression (1929–32) was driven by a narrative that consumption was bad because so many were in financial distress.

It was bad form to buy a fancy car or expensive clothes even if you could afford it, because you were ‘showing off’ in front of the less fortunate. Of course, that just prolonged the depression because without consumption the US economy could not find a bottom.

That narrative flipped in 1933 when FDR became president. Suddenly, spending was good precisely because it could help the economy get back on its feet. FDR’s campaign theme was ‘Happy Days are Here Again!’.

The economy grew strongly from 1933–36, although it was still digging its way out of a very deep hole. Of course, the Fed blundered again and caused a second technical recession from 1937­–38, which is why the Great Depression overall is dated from 1929–40.

Still, the narratives such as ‘consumption is bad’ and ‘consumption is good’ were more important drivers of recession and recovery than monetary and fiscal policy and the New Deal.

In addition to longevity and possible flip-flops, the other characteristic of narratives is that they can be completely false and still be powerful. We’re seeing examples of that today. The country has been in the grip of a strong inflationary narrative for the past six months.

It’s false. All signals from base effects to interest rates to velocity point to disinflation and possible deflation in the remainder of 2021 and into 2022. The stock market has been rising on the back of this inflation narrative. It will soon get a reality check.

The bigger picture

So, yes, normally we look at a range of topics that affect markets and your portfolio. But we’re going to do something different in my upcoming issues. We’re taking two steps back and looking at all of these topics from a broader perspective. We’re going to take many of the major factors that drive markets and synthesise them into a big picture. Think of it as a landscape on a large canvas instead of the individual portraits we usually paint.

Our format will be a kind of Q&A. We’ll pose questions on topics investors are most interested in and use those questions as a platform for explanations of the key factors in markets today. As we move through the questions and answers, we’ll have the opportunity to connect the dots in ways that let readers see the bigger picture. The goal is not to provide a snapshot, but more of a movie that we can follow into the future.

In intelligence analysis, we call this ‘looking over the ridgeline’. It’s important to go beyond what’s seen and to anticipate the hidden and the unseen so that we’re not taken by surprise. The idea is to take a step back from sub-topics (inflation, deflation, growth, pandemic, demographics, fiscal and monetary policy) and give readers a sense of where the global economy is 20 months after COVID hit the world in an impactful way, and 18 months after the greatest recession since 1946. We’ll also look 16 months ahead through the rest of 2021 and all of 2022.

This will be a kind of intellectual macro-lifeline for the confused, anxious, and uncertain (which covers just about everybody these days).

We can’t promise that markets will always be smooth sailing. We will promise that in good markets and bad we’ll keep you ahead of the curve so you can preserve wealth and prosper despite adversity.

In my next issue, we’ll jump into the first of these questions. So stay tuned if you want to start getting a better understanding of our current economic landscape.

Until next week,

Jim Rickards,
Strategist, The Daily Reckoning Australia

PS: This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

By Bill Bonner Editor, The Daily Reckoning Australia

What a wacky world!

The stock market is more overvalued than at any time since 2000. Any sane person would think twice before buying more stocks.

And then, along comes the worst possible news — that inflation is running at a near-40-year high. What kind of dope doesn’t know what that portends? 

The Federal Reserve will be forced, like it or not, to tighten credit. Businesses that are heavily in debt will have to roll over their debts at higher interest rates.

We look up. And there’s our Crash Alert flag flying sheepishly…the ol’ black ‘n blue…warning investors to watch out.

Stocks forge ahead

If the stock market were an army, it would be knee-deep in mud…overextended…and far from its supply lines. And now, its scouts are staggering back to camp, wounded and hungry.

Cathie Wood’s ARK Innovation ETF [NYSE:ARKK] is down 40% from its peak last February.

Bitcoin [BTC] is 30% off its peak.

Goldman Sachs’ index of unprofitable tech companies is off 25% over the last month.

And yet, there is still no sign of a broad retreat. Stocks rose on the latest inflation news.

And now, commentators are calling for more victories ahead. Here’s Barron’s headline: ‘Stocks’ Rough Patch Could End Soon. The Fed’s Next Move May Be Priced In’.

Daredevils and dimwits

What to make of it?

There are two possible interpretations. First, investors are very stupid. Second, they are very smart.

You have to be pretty dumb not to see that asset prices are way out of line with economic reality. By all measures, stocks are at the top of their range.

Despite all the loose talk about ‘disruptive technology’ and the ‘metaverse’, real output is still produced by people who do real work, either physical or mental. And it’s still measured by GDP.

So the simplest way of keeping track of stock prices is to add all the stocks together and compare them to GDP. This is sometimes called the ‘Buffett Indicator’, after legendary value investor Warren Buffett, who popularised it.

This measure shows you that stocks are usually worth about 80% of GDP. And between 1950 and today, they only crossed the 150%-of-GDP line twice — in 1999 and again in 2017. 

After January 2000, the dotcoms crashed, and stocks quickly fell back. But recently, they just keep going up. And now, the ratio stands at 213% — an all-time high.

How much upside is left, we don’t know…but whatever it is, it is only suited to daredevils and dimwits.

Everyone’s doing it

Stocks are only where they are because the Fed has been pumping them up for more than 10 years. And now…it is still lending money at an inflation-adjusted interest rate of about MINUS 6%.

But with inflation on the rise, the only sensible thing for the Fed to do is raise interest rates — which would bring stock prices crashing down.

And this is where the very smart investors may be outsmarting themselves.

They realise that the Fed faces an ‘Inflate-or-Die’ choice. It encouraged everyone to borrow. A recent Bloomberg article, for example, told readers that they should emulate the Argentines — borrow as much as possible…and get rid of their cash as quickly as possible.

On the pampas and the Great Plains, everyone does it. Households are once again ‘taking out equity’ by borrowing against the inflated value of their homes.

Corporations do it — almost doubling their debt since 2007.

And who does it most of all? The government! The feds have tripled their debt load since 2007.

And now, so many people have borrowed so much money that the Fed can’t normalise rates — at least, that’s our ‘Inflate or Die’ hypothesis.

Why the Fed can’t raise interest rates

Inflation hurts savers (and thus, hurts the entire economy, which relies on savings to fund expansion).

But it helps debtors. Their debts evaporate as the value of the US dollar goes down.

Who’s the biggest debtor in the whole world?

Right again. The US government.

And with inflation running at almost 7% (it is actually much more, if you calculate it honestly), and the federales paying only about 2% on their loans, it means they are gaining about 5% on their outstanding debt.

With a total debt of more than US$28 trillion, that means they are reducing their obligations by about US$1.4 trillion each year, grosso modo.

The very smart money is betting that this is too sweet a racket to give up.

The Fed suppresses interest rates by buying bonds. As long as the asset-buying goes on, presumably, stocks and bonds get a bid, even as inflation rates go up.

The value of the debt goes down.

The value of the elite’s stocks and bonds goes up.

Everybody’s happy.

Well, everybody except the 90% of the population that pays higher consumer prices.

What could go wrong? Tune in tomorrow…

Regards,

Bill Bonner,
For The Daily Reckoning Australia