Inflation, really?

[7 min read]

It was a rough night over in the US last night.

Not only for stocks, but for bond investors too.

The 10-year US government bond yield fell a whopping 15 basis points to around 1.52%. Yields around the world are increasing as inflation expectations start to increase.

The stock market didn’t like it. The Dow fell 1.75%, the S&P 500 2.45% and the NASDAQ sank 3.5%.

Expensive stocks are very sensitive to higher bond yields. And tech stocks in general have been very expensive for some time. Take Tesla for example. It’s the most insane bubble I’ve seen in a long time.

And it’s now starting to pop. The stock is down sharply this week. Overnight, it broke through another level of support at US$700, down 8%. It was fun while it lasted, but I think the party is over for Tesla.

That’s not to suggest the whole market is going to collapse. It’s important at times like this not to let your inbuilt biases come out and dominate your thinking.

There are definitely pockets of overvaluation and extreme speculation in the market. These should be avoided.

But I don’t agree with the notion that the whole market is going to tank. Sure, it could correct 20% or so…but that is just standard stock market behaviour.

There are a few reasons for that.

Firstly, the concern about inflation is misplaced. Yes, bond yields are rising. But they are just heading back into what could be considered normal in a post-2008 context.

The chart below shows the 10-year US government bond yield roughly since the start of the last cyclical upswing in mid- to late-2016. Yields bottomed at 1.5% and rose to around 3.2% by late 2018.

Because of the amount of debt in the economy, it couldn’t sustain rising rates, and another downturn resulted.

This time around, how much more debt is the economy carrying?

I don’t know the answer to that, but it is in the trillions. Does anyone really think the economy can handle much higher rates before deflationary forces kick in?

Where is the point it screams ‘Uncle!’ this time?

2% on the US 10-year? 2.5%?

The point I’m making here is that it is a low probability outcome to think that yields will rise to 4–5% in an inflationary outburst and halve stock price valuations from here.

The more likely scenario is that yields rise towards 2% over the next few months and then the whole inflation euphoria fizzles out as the reality of a hugely indebted economy and a large output gap means rising price pressures won’t be sustained.

What is the ‘output gap’? The Brookings Institution explains…

‘The difference between the level of real GDP and potential GDP is known as the output gap. When the output gap is positive—when GDP is higher than potential—the economy is operating above its sustainable capacity and is likely to generate inflation. When GDP falls short of potential, the output gap is negative. Figure 2 shows that recessions such as the Great Recession of 2007-2009 and the COVID-19 recession feature GDP well below potential.’

The chart below is figure 2 referred to above. It shows a sizable output gap existing right now. I’m not sure how you get an inflationary breakout under these conditions.

Still, that doesn’t mean inflation expectations won’t increase. That is clearly what is happening now. The market is discounting the expectation of future inflation, meaning overpriced tech stocks are de-rating, bond prices are falling, and gold is also under pressure.

On a positive note for gold, it is still hanging in there. Even after the overnight sell-off, it’s trading just above important support. Whether it can hang in there in the face of rising bond yields is another question.

You might be wondering why gold is falling in an environment of rising inflation expectations. Are we told that gold should do well in such a situation?

Well, it doesn’t really work like that. Gold responds to REAL interest rates not nominal rates.

According to Treasury data, the real US 10-year bond yield was minus 1.08% at the start of the year. As at 25 February, it was minus 0.6%. Still in negative territory, mind you. But less so than before.

But in the same way that gold doesn’t like positive real rates, either does a global economy awash in debt.

It’s just a question of how long it takes for rising real rates to have a detrimental impact on economic growth. And when that happens, you’ll get a Fed and government there to ‘help’.

That moment could still be six months away, or it could happen sooner.

The point is, I don’t think you should get too carried away with the inflation narrative. It will come eventually, but not yet.

And because of this, I believe the stock market is still the best place for your money. Yes, there are some crazy parts of the market right now. But there are also a lot of good value opportunities out there that should do well in the years to come.

As this correction kicks in, don’t succumb to the fear. We haven’t had one in a while and corrections are just a part of the investing game.

On this front, you’ll see an invite from me to a special upcoming event over the next few days. It’s got to do with how I see the market unfolding over the next few years, and the best way to play it.

I hope you’ll join me!

Catch you next time,

Greg Canavan,
Editor, The Rum Rebellion

It’s All Capitalism’s Fault
By Bill Bonner

Oh my…capitalism has failed.

You hear it shouted from the rooftops. It is on every pair of lips…and in every journal, newspaper, website, opinion piece, hard fact, and scurrilous innuendo in the media.

Even the Chinese are getting in on the act. Here’s The Sun (US):

‘CHINA has taunted the United States over the Texas winter storm blackout as a “failure of capitalism” that is affecting “desperate” Americans.

‘An opinion piece in the English-language Chinese newspaper Global Times says a large number of Americans feel that the “current capitalist system” has “serious flaws’ and ‘cannot help them with their concerns.”’

Capitalism is blameless

Yes, capitalism sent a polar vortex whistling down over the plains and froze the joints, valves, pipes, pumps, and everything else it could find.

It froze up the green windmills and the gas lines. It even failed to provide mittens, long johns, cords of air-dried, split, and stacked oak…or the stoves to burn it in.

People argue over who’s to blame. But we know one that is as innocent as new fallen snow — capitalism.

Capitalism is blameless because it is heartless, soulless and doesn’t give a damn. It doesn’t care if the pipes freeze. It merely reacts to the pressures applied to it — laws, consumer choices, innovations, restrictions, regulations, plagues and prices.

And it delivers — not necessarily what people want…but at least what they’ve got coming.

No plan B

Apparently, in Texas, one thing they didn’t want…didn’t think they needed…and didn’t want to pay for…was a plan B.

The whole system ran with few precautions. Texas doesn’t get that cold that often. People had no stoves…and no wood.

The power companies had no backup plans.

And the Texas government had no way to offer much in the way of help.

But what should we take away from this story?

That we should abandon capitalism and let the government drill for oil and gas — as it does in Venezuela, where a gallon of gas recently sold for less than a single US penny?

Perhaps a better takeaway is that people can’t depend on good weather. Or on institutions — private or public — to function flawlessly.

Gangster capitalism

Meanwhile, who’s to blame for the US’ COVID-19 deaths?

Well…capitalism, of course!

According to a number of thinkers, given voice by Chauncey DeVega:

‘The mass death from the coronavirus pandemic reflects a broader pattern of negative outcomes, largely caused by the Republican Party and broader right-wing “conservative” movement.’

This allegedly evil ‘conservative movement’ Mr DeVega tags as ‘gangster capitalism’.

And he doesn’t stop there. He’s already in deep water. Now, his head is disappearing as he blames capitalists for everything.

‘Every part of society is to be financialized,’ he says, ‘and subjected to the forces of the market.’ The result:

‘As exhaustively documented by public health experts and other social scientists, across a range of policies such as gun violence, tax policy, the environment, access to health care, education, voting rights and the size and strength of the social safety net more generally, Republican policies over the last several decades have resulted in the deaths of many more Americans, compared to the policies advocated by Democrats.’

As for the coronavirus, Mr DeVega needs to come up for air.

Death rates are about the same or higher in Europe. Belgium is hardly a bastion of capitalism. Yet, its coronavirus deaths per 100,000 are up to 192. In the UK, the figure is 182. In Italy, it’s 159. And in France, it’s 127.

And the US? Right in the middle, at 153.

Oh, and Sweden, which famously took the laissez-faire road, with respect to the coronavirus — 124…lower than them all!

Price of government

Mr DeVega also seems unaware that Republicans are no more ‘capitalistic’ than Democrats.

Both parties — especially the Republicans under Donald Trump — favour the heavy involvement of government in every part of the economy.

‘Market forces’ still function…people still give and take and get by as best they can. But they are hobbled by programs and policies set in place by the feds.

GDP growth falls. Inequality increases (as the government tends to shift more and more wealth to the elite). People become poorer and less able to protect themselves.

Plan B costs money. And you don’t bother with it if a) you don’t have any money, and/or b) you think the feds will make sure nothing bad ever happens.

And for all their frets and moans about how much damage capitalism has done, the real damage is yet to come.

Again, capitalists — people trying to do honest, win-win deals with one another — have nothing to do with it.

Inflation is coming

Meanwhile, economist Umair Haque reports in Eudaimonia that:

‘A full third of Americans can’t afford healthcare, food, and shelter. Pause. Take it in. That’s north of a hundred million people. Astounding — maybe even shocking — isn’t it? […] The poor cannot afford the basics of decent lives, while the rich cannot find ways to spend their fortunes.’

Colleague Dan Denning reports that many of these ‘left behind’ people are ending up in ‘Nomad Land,’ living in old RVs…cut off from mortgages, utility bills, and property taxes…and this is after the feds ‘protected’ people from real interest rates — capitalism’s most important signal — and saved them from market corrections…three times this century.

How? By printing up some $7 trillion worth of fake money and handing it out — mainly to Wall Street.

And as this money printing gathers speed, there is little doubt about what lies ahead: consumer price inflation.

When prices rise, the government will have to come to the rescue with more ‘stimmy’ cheques.

And since it is already broke, it will have to print even more money…which will drive prices even higher.

No savings?

And then what? What about all the poor people with no savings? What’s their plan B?

The net national saving rate is below zero — near its lowest level in history. And yet, savings are the simplest, surest plan B in the world. A cord of wood…a few extra rolls of toilet paper…and some cash.

But who bothers to save when real interest rates are negative? Who bothers to rick up firewood when the government guarantees to keep you warm?

And who bothers to protect himself from inflation when Jerome Powell, the US’ top banker, says it’s nothing to worry about? MarketWatch reports:

‘In a speech to the Economic Club of New York, Powell said he doesn’t expect “a large nor sustained” increase in inflation right now.’

All capitalism’s fault

But higher consumer prices are coming. And there is a whole minor industry of economists, think tanks, political hacks, and opinion mongers already preparing an explanation.

They find evidence of failure as soon as they open their eyes.

Then, they close them quickly, for fear of seeing something that doesn’t fit.

In the years ahead — with so many failures to gawk at — we predict that they will do a lively trade, trying to pin it all on capitalism.

Regards,

Bill Bonner,
For The Rum Rebellion