Jul 1, 2021

It's Not the Seventies

I get this a lot. People say, “We are experiencing inflation, so stocks should go down! Because that’s what happened in the 1970s.”

This isn’t the 1970s. This is a different sort of inflation.

What we are experiencing now is a monetary inflation, compounded by big government interventions in the labor market. This is not stagflation.

In fact, the period of stagflation that we experienced in the 1970s was an anomaly, as far as great inflations go, and isn’t likely to be repeated.

If you’ve been shorting stocks in advance of CPI numbers, and you’re not broke already, you will be soon. Inflation benefits stocks. Stocks are inflation pass-thru vehicles, though most people realize that by now.

In fact, stocks have been a better inflation hedge (so far) than gold, which has seen a lot of outflows to cryptocurrencies. This is why I’ve been increasing my allocation to equities and real estate and decreasing it elsewhere.

What’s Coming

It’s too soon to say how this will play out. We currently have 5% inflation, which probably underestimates actual inflation by a lot.

Will it get worse? It will.

Will we get hyperinflation? Perhaps, but not anytime soon. Maybe over a period of 20 years.

Could we get double-digit inflation? It’s possible that could happen next year.

Sometimes people call me bad words, like, “inflationista,” because I am predicting (and perhaps rooting for) higher inflation.

Maybe I am rooting for it.

To me, it seems a lot easier to invest in an inflationary environment than a deflationary environment. Maybe it just comes naturally to me. I have been reading about great inflations my entire career, so I know what to do.

What did not come naturally to me was buying bonds and tech stocks. You may find this hard to believe, but I was trying to short bonds at Lehman Brothers 20 years ago with 7% yields, thinking they were too low. Funny!

I have a pretty good track record overall, but I have done some dumb stuff over the years because I wasn’t seeing the bigger picture. You manage risk, stop yourself out, and move on.

Do What Works

Some great investors are only good at one thing. Their strategy works well, but only in a particular regime. The regime changes, and their strategy breaks down.

To be a truly great investor, you need a regime-agnostic style, or just one that’s highly adaptable. I am getting closer to that over time.

There are some great investors out there who are still fighting the last war. They’re still buying bonds and tech stocks. For now, they are only experiencing underperformance, but that underperformance will turn into losses.

Shorter: do what works.

Doormats

A few weeks ago, I wrote about the $4 doormats I saw in Walmart in 2010.

A reader looked up those doormats on the Walmart website and they are now… $43.

1,000% inflation over ten years. That’s a function of a lot of things—deglobalization in particular.

International trade is suffering because of, well, politics, but also, firms are taking measures to protect supply chains. In a world of low political tensions, it made sense to produce all the world’s semiconductors in Taiwan. That doesn’t make sense anymore. So, businesses are bringing manufacturing home to places where the cost of labor is higher.

Also, the countries with low-cost labor aren’t so low-cost anymore, shipping costs are rising, etc.

A lot of people want to see the US return to its manufacturing glory days. I don’t. The arrangement we had in 2006 where emerging market countries exported goods and the US exported finance was working fine. It led to $4 doormats. Incomes were stagnant, yes, but people were getting richer in real terms because the price of goods was dropping.

When you take into account monetary policy, fiscal policy, and deglobalization, it’s the perfect storm for inflation.

But that’s not all. Environmental, social, and government factors are also an inflationary force. We’re raising the cost of capital for oil companies and coal companies (among others), making it more expensive to produce.

Regime Change

There are some thoughtless newsletter writers out there who flap their arms about inflation and yell that it is all because of the Federal Reserve. Yes, it is partly because of the Federal Reserve, but it is a lot more than that. The Fed is certainly not being vigilant about inflation, that’s for sure.

This is a long-term thesis. If we had 40 years of disinflation, it’s not hard to imagine that we might have 10–20 years of inflation, or more.

This is a regime change. The CBOE Volatility Index (VIX) is pretty low right now, but it has reached a higher equilibrium than a few years ago. Everything is different.

I don’t stay up at night worrying that this inflation thesis is wrong. I stay up at night worrying that I don’t have enough exposure to it.

Jared Dillian

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