April 22, 2022
By Steve Blumenthal
“This is not the only time in history that they’ve been behind, but they are strikingly behind. They need to catch up and do it in a systematic and understandable way.”
We are in the early rounds of an inflation fight that should have started months ago. The big guy—reigning champion Powerful Powell—has entered the ring with his head held high, but commentators say he lacks the training necessary to beat his next opponent.
Printing and handing out the money was easy. He took down Covid with a left and a right… well, a click and a click. But now, he is in the fight of his life. After the first few rounds, inflation is clearly dominating Powerful Powell, and looking strong doing it.
Resting on his stool, Fed Chairman Powell looked at his trainer and said, “No one expects that bringing about a soft landing will be straightforward in the current context—very little is straightforward in the current context.” The central bank, he said faces a “challenging task.” The bell for round three rang. “Fight” his trainer yelled, “Fight.” As Powerful Powell stood up and stepped toward his opponent, his trainer hung his head and sighed.
“Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks, and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.” Sitting ringside, the legendary hedge fund manager Stanley Druckenmiller explained.
Last summer, legendary investor Druckenmiller said the Fed’s easy money is lulling investors into a false sense of security. Market participants will continue to ignore risks “until the Fed stops canceling market signals.” Source CNBC
And here we are… From the Wall Street Journal:
Hot Economy, Rising Inflation: The Fed Has Never Successfully Fixed a Problem Like This. The Central bank says it is possible, but many factors are out of its control; ‘they are strikingly behind.’
A soft landing would mean bringing inflation back down towards 2% (currently 8.5%) and not causing unemployment to rise. During the past 80 years, the Fed has never lowered inflation as much as it is setting out to do now—by 4 percentage points—without causing recession. (Full article here.)
This resets risk assets. This resets stock prices. If you are feeling uneasy, I get it. I am too. When your neighbor is telling you how great of an investor he is, sell! When he and you are scared out of your skin, buy.
Each quarter, I look forward to reading Dr. Lacy Hunt’s Hoisington Quarterly Review and Outlook research letter. Lacy is my “go to” for all things Fed policy. His recent letter, in my view, is summed up by the great Elvis Presley:
We’re caught in a trap
I can’t walk out
Because I love you too much, baby
Why can’t you see
What you’re doing to me
When you don’t believe a word I say?
We can’t go on together
With suspicious minds (suspicious minds)
And we can’t build our dreams
On suspicious minds
Elvis Presley, Suspicious Minds
Grab that coffee and sit your suspicious mind in that favorite chair. Below I do my best to summarize Lacy’s recent letter (in bullet-point format). Lacy sees six harbingers of a coming recession and he remains invested in long-duration Treasury bonds, believing yields will fall. So far, it’s been a tough year performance-wise for Lacy.
How much above his weight is Chairman Powell willing to punch? Yesterday was a hint. He said, “A double-sized rate hike is on the table.”
Everything from mortgages, car loans, and credit cards is going to get even more costly. We’re Caught In a Trap. I can’t walk out because I love you too much, equities. I think Lacy’s day is coming. A recession before the year ends is likely. Fundamentally, I think it’s almost time to trade back into 30-year Treasury bonds. My two cents: Trade bonds. Don’t buy-and-hold bonds. The yields are negative after inflation.
The Trade Signals section follows, where I share a really cool chart comparing stock market selling volume vs. buying volume. Think supply vs. demand and what that means for stock prices. Also, note the bearish bond market signals and the sizable decline in the Vanguard Long Duration ETF. If I’m right, and I may not be, an excellent trade lies ahead. A number of Fed rate hikes are already priced into the current yield. Keep a close eye on the bond market.
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The annual Mauldin Strategic Investment Conference is just ahead. It will be held over six days—Monday, May 2; Wednesday, May 4; Friday, May 6; Monday, May 9; Wednesday, May 11; and Friday, May 13.
It’s one of my favorite investment conferences each year. The speaker lineup is outstanding and I’ll be taking notes as usual.
David Rosenberg, David Rubenstein, Todd Rich, Liz Ann Sonders, Barry Habib, Katie Stockton, Ron Baron, David Bahnsen, Sam Rines, Rene Aninao, Louis Gave and the GavKal team, George Friedman, Peter Boockvar, Jim Bianco, and Emily De La Bruyere are all part of the lineup. Ed D’Agostino interviews me on Friday, May 13. John Mauldin hosts the show. I can’t wait to listen and learn!
Felix Zulauf, Mark Yusko, Ben Hunt, Howard Marks, Cathie Wood, and yes, Henry Kissinger present on May 9 (day four).
Speaking of Dr. Lacy Hunt, on May 11 (day five), Lacy is paired with the former head of the Bank of International Settlements William White. Following that discussion, Lacy presents, and after that, he’ll be interviewed by Danielle DeMartino Booth, a former Fed insider and author of the best-selling book, Fed Up. I’m really looking forward to day five. And day four, and day’s one, two, three, and six. I present ideas for the current environment on day six.
Please note that there is a cost (Mauldin Economics is unaffiliated with CMG). Separately, John serves as CMG’s Chief Economist and co-portfolio manager. Please know that neither I nor CMG earns money if you attend.
Hoisington Q1 2022 Outlook and Review Letter
The letter begins with a punch: “Disaster is a strong but appropriate word that applies perfectly to the state of U.S. monetary policy.” Consider the following:
- A) The Fed, in reaction to the COVID-19 crisis, dropped the Fed funds rate to 0.25 bps and expanded the total reserves of the depository institutions by an average of 63% in 2020 and 2021. This unprecedented growth was achieved by increasing total U.S. Treasury and other securities held outright by $4.5 trillion, equaling 70% of the $6.4 trillion increase in total Treasury securities outstanding. (bold emphasis mine)This fact reveals the massive coordination of monetary and fiscal policy as government checks were directly funded by monetary largesse. In the face of an unsurpassed breakdown in product delivery systems, this money creation caused a massive imbalance between the demand and supply of goods.
- B) The result of the coordinated monetary and fiscal actions was a 5.7% increase in real GDP last year, the best rise since 1984, and a 10.1% rise in nominal GDP, the highest since 1984. The headline CPI inflation rate jumped from 2.3% in the twelve months ending in December 2019 to 8.5% in the twelve months ending March 2022, the fastest such increase in forty years. Reversing the past monetary and fiscal excess liquidity error will take time and persistence by the Fed.
- Most Americans have suffered a substantial fall in their standard of living over the past twelve months. In the latest available twelve-month change, 116.2 million American wage and salary workers suffered a 3.7% decline in their inflation-adjusted paychecks, the largest drop since 1980 (Chart 1). This alone more than offsets the gain in income going to the 6.5 million newly employed in the latest twelve months.
- In addition, salary workers suffered a larger loss in standard of living than hourly employees (Chart 2). Inflationary damage to the 70 million retired Americans cannot be calculated in precise terms, but qualitatively the situation is not good. Those covered by Social Security received a 5.9% cost of living adjustment (COLA), however, most private pensioners do not have COLAs. Click on this LINK to the full letter to see the charts.
- Approximately 50 million or more retirees’ real income has been seriously eroded by the forty-year decade-high inflation rate.
- Summing it up, those whose income trailed price increases is approximately 170 million Americans. The sizeable adverse impact of inflation is consistent with a decline in real disposable personal income.
- Eighty-five percent of U.S. households make under $150,000 a year, with many living from paycheck to paycheck or on steady salaries.
- The imbalance between those who benefitted and those who were harmed by the monetary and fiscal policies pursued over the last two years is abundantly clear. The 8.5% inflation rate has dramatically lowered the standard of living of over 170 million individuals.
- When this circumstance is compared with the accomplishment of the objective by monetary and fiscal authorities to lower the unemployment rate from a recession high of 14.7% in April of 2020 to 3.6% today, the fallacy of twin mandates is abundantly clear. The lowering of the unemployment rate reflected the creation of 20.4 million new jobs. Is it a fair balance to help 20 million individuals at the expense of permanently harming 180 million (SB here: I think Lacy means 170 million but same point)?
Lacy goes on the some of the top economists and academic literature. He chastises their beholding to the Phillips Curve. He says,
- In short, by relying on the Phillips Curve, the Fed avoids developing a strategic view of its role and the complex world in which it operates. Volcker explained publicly and to the Fed staff that the Phillips Curve was unreliable and not useful. Alan Greenspan was less outspoken, but he also rejected Phillips Curve forecasts as unreliable.
- After Greenspan left the Fed, the staff re-established the focus on the Phillips Curve, one of the central dogmas of Keynesian economics.
He sites John Taylor (see my intro quote above) who invented a now very famous interest rate forecasting model, which was outlined in his 1993 study, “Discretion versus policy rules in practice.”
- This model, commonly referred to as the “Taylor rule,” suggests how central banks should change interest rates to account for inflation and other economic conditions. The Taylor rule indicates that the Fed should raise rates when inflation is above target or when real GDP growth is too high and above potential real GDP. The rule also suggests that the Fed should lower rates when inflation is below the target level or when real GDP growth is too slow and below potential real GDP.
- Taylor, like Friedman and Meltzer, developed this rule because of the repeated failures of discretionary monetary policy.
- “If you plug in the current inflation rate over the past four quarters (about 4%), the gap between GDP and its potential for the second quarter (about -2%), a target inflation rate of 2%, and a so-called equilibrium interest rate of 1%, you get a desired federal funds rate of 5%.”
SB here: I found this very interesting:
- In the Fed’s Monetary Policy Report sent to Congress in late February 2022, the Fed did not include the section on policy rules that had been included in its reports since July 2017, when Janet Yellen was Fed Chair. Taylor wrote, “This omission is significant. It occurred at the same time the Fed has gotten well behind the curve, and inflation has risen as a result.”
There is so much more in Lacy’s quarterly letter. Do take a look. It may be harder to read if you don’t study economics but the more you read Lacy the more you will learn. He’s brilliant.
Lacy concludes (my translation) that if the Fed does not get inflation under control rates may move higher and bonds will lose more in value. He does however remain bullish on long-duration Treasury bonds. He wrote recently,
- “Due to poor economic conditions in major overseas economies, 10- and 30-year government bond yields in Japan, Germany, France, and many other European countries are much lower than in the United States.
- Foreign investors will continue to be attracted to long-term U.S. Treasury bond yields.
- Investment in Treasury bonds should also have further appeal to domestic investors, as economic growth disappoints and inflation recedes in 2022.
- A global recession later in 2022 is likely
Trade Signals: Watch Out For Minus Two
April 20, 2022
Market Commentary – Notable this week:
Adding fuel to the fire is the following chart that looks at the trading volume of buyers vs. sellers. NDR’s Volume Supply is the smoothed total volume of declining issues. NDR’s Volume Demand is the smoothed total volume of advancing issues. The data comes from the Broad Market Equity Series All-Cap Volume – data from 1981 to the present. The orange line is Volume Demand (buyers), and the dotted black line is Volume Supply (sellers). Returns are best when there are more buyers than sellers. The red date boxes with arrows indicate periods when Volumn Demand dropped below Volumn Supply (think of it as more sellers than buyers). Note the challenges that followed for the stock market when the sellers dominated market activity. Not all demand vs. supply crosses (where the black line rose above the orange line) signaled significant declines, but the picture sure is worth a thousand words. Also, note that the 2020 Covid signal was late and flip-flopped back from quick sell indication to quick buy. Late 2018, also missed. Fed intervention was the likely culprit. While not a perfect indicator, it is good to keep an eye on. The most recent cross occurred earlier this year. Buckle up.
Also, the green line marks the period from the 2000 Volumn Demand sell indicator to approximately 14-years later when the S&P 500 Index finally recovered and retook its prior high. Not saying it is going to happen. Just saying it can happen.
Click HERE to see the Dashboard of Indicators and all the updated charts in Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon, and risk tolerances.
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Personal Note – Spring Cleaning and Golf
Susan is away this weekend coaching in Maryland. I’ll be under the house grabbing the porch furniture from winter storage. The lawn needs some love and the to-do list is big. I do enjoy porch furniture set-up day far more than putting it away in the late fall. It’s nice to enjoy more time outside.
The weather forecasts for tomorrow and Sunday are outstanding here in suburban Philadelphia. A new Callaway driver arrived yesterday, and I put it in the golf bag. I’m planning on twenty-seven holes with good friend Andy M at Stonewall tomorrow. And yes, maybe Sunday too.
If you are on Instagram, there is a Stonewall member that posts photos from various golf courses all over the world. Many of the photos include his dog, Gracie. Gracie is awesome. You can follow him: @LINKSGEMS.
Next are a few shots of Stonewall:
A bad golf day
18th Hole Stonewall Old Course
A good golf day
18th Hole Stonewall Old Course
A great golf day!
9th Hole Stonewall Old Course
And here’s Gracie sporting the Stonewall hat with logo (a dairy cow)
7th Hole Stonewall North Course
The property was bought by the founding members in the early 1990s from the Pew family. It was a dairy farm and good friend Michael Gale created the logo. Susan tells me I have way too many shirts with the cow logo on them. What can I say? If Gracie got her way, I’d be wearing a brown Lab logo. Hat tip to Jon Cavalier and his great dog Gracie! (Photo credit LinksGems. Follow Jon on Twitter @LinksGems)
I’m hoping I run into Gracie this weekend.
I see a High West Double Rye on ice in my very near future. Along with some golf with good friends. I’m checking in happy and hope you are happy too.
Wishing you and your family the very best!
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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