March 11, 2021
By Steve Blumenthal
“History has shown that we shouldn’t rely on governments to protect us financially.
On the contrary, we should expect most governments to abuse their privileged positions
as the creators and users of money and credit for the same reasons that you might
commit those abuses if you were in their shoes.”
– Ray Dalio,
Co-Chairman & Co-Chief Investment Officer, Bridgewater Associates, L.P.
In my book, On My Radar: Navigating Stock Market Cycles, I touch on the challenges at the end of long-term debt accumulation cycles. I know no one who has spent more time studying long-term debt cycles than Bridgewater’s Ray Dalio. Dalio runs the world’s largest hedge fund (~$154 billion in assets under management). He is one of the most successful macro investors of our time. Dalio believes, “The times ahead will be radically different from anything we’ve experienced in our lifetimes. Though similar to many times before.” Understanding where we are in the current cycle may be the single most important concept for us to understand.
We know when we are near the end of a long-term debt cycle. It’s measurable. It’s when government debt reaches a certain level relative to what its country produces (GDP) and when interest rates reach 0%, as has happened in the U.S. and many places. Like it or not, the following is our current state. Take a look at the debt “As a % of GDP” column (second from the right) in the following chart. Carmen Reinhart and Ken Rogoff did an extensive study of history when debt-to-GDP exceeds 90%, growth rates suffer. Inhale, hold breath, read: Japan 682.2%, Eurozone 462.2%, UK 478.2%, US 345.9%.
Source: Ned Davis Research
Exhale. One more deep breath… Select worldwide central bank rates: US 0.00% t0 0.25%, Eurozone 0.00%, UK 0.50% (up 0.25%), Canada 0.50%, Japan -0.10%, Denmark -0.35%, Sweden 0.00%, Switzerland -0.75%. We find ourselves late in the cycle. What’s next?
We didn’t start the fire
It was always burning since the world’s been turning
We didn’t start the fire
No, we didn’t light it, but we tried to fight it
– Billy Joel, “We Didn’t Start the Fire”
Governments always choose to print. And because they do, it leads to a decline in the currency’s value and an increase in inflation. Over the last 50 years of global macroeconomic investing, Dalio learned the hard way that the most important events that surprised him did so because he hadn’t experienced them in his lifetime. He said these painful surprises led him to study the last 500 years of history, looking for similar situations and seeing patterns emerge.
Dalio found, “In virtually every case, the government contributes to the accumulation of debt with its actions and by becoming a large debtor itself. When the debt bubble bursts, the government bails itself and others out by buying assets and/or printing money and devaluing it. The larger the debt crisis, the more that is true. While undesirable, it is understandable why this happens. When one can manufacture money and credit and pass them out to everyone to make them happy, it is very hard to resist the temptation to do so. It is a classic financial move. Throughout history, rulers have run up debts that won’t come due until long after their own reigns are over, leaving it to their successors to pay the bill.”
Later in the cycle, new government leaders and new central bankers have to face the challenge of paying back debts with less stimulant in the bottle. To make matters worse, governments also have to bail out debtors whose failures would hurt the system—the “too big to fail” syndrome. As a result, they tend to get themselves into cash flow jams that are much larger than individuals, companies, and most other entities.
This week, I came across a video narrated by Dalio that provides a short, easy-to-understand animated summary of “Where we are in the big cycle of money, credit, debt, and economic activity and the changing value of money.” I believe this is the most critical global macro issue of our day. You and I haven’t experienced this in our lifetimes. We need not stand idle. There is much we can do. It starts with an understanding. Click below to watch the video. I promise you it’s fantastic. So far, there have been over 4 million views.
Dalio concludes that the outcome may be dire or maybe not so bad. If we save more, spend less, and are more understanding, kind and civil with each other, we’ll be on a better path. Amen to that! Let’s put our energies there.
If you have any questions, please reach out to me. And if you feel inclined, please share it with your family, share it with your children, and share it with your friends. I’ve been reading and rereading Dalio’s book, Principles for Dealing with the Changing World Order. The animated video is a summary. Hit the book for a deeper dive. It’s excellent.
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What Inflation Means to Stock Prices
One of the learnings from Dalio’s study of long-term debt cycles is that governments choose to print currency. They debase their currencies and create inflation. As the former head of the Bank for International Settlements, William White, said to me a few years ago, “In the end, there is always inflation.” We are in the early innings of this shift today.
You’re well aware of what prices look like at the gas pump and grocery store. But it’s not just food and energy prices that have spiked higher. The following chart plots one of the Fed’s favorite inflation measures called “Trimmed Mean PCE.” PCE stands for personal consumption expenditures. Trimmed means the data excludes food and energy. Look at the spike higher in the following chart.
My point is that inflation is broad based. So, what does inflation mean to stock prices? I like how NDR presents the data relative to the historical performance in the S&P 500 Index. Take a look at the upper left-hand section in the chart. When the “Trimmed PCE” compared to its 5-year moving average is above 0.15, the gain per annum for the S&P 500 is lowest. Game plan: More defense than offense!
I share a few more thoughts in the Trade Signals section next.
Trade Signals – Macro Outlook Update: War, Commodities, Inflation, Stocks, Bonds and the Fed
March 9, 2022
Posted each Wednesday, Trade Signals looks at several of my favorite equity markets, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Notable this week:
The overall equity market trend is bearish, and equity market breadth continues to deteriorate. The Ukraine/Russian war is upsetting. The loss of life is tragic. The global impact affects commodity prices, supply chains, inflation, markets, currencies, and humanity. Government sanctions are mounting, and international businesses have responded aggressively. Investors are focused on the Fed raising interest rates by 25 to 50 bps in March; I suspect 25 bps is more likely given the war. Less noticed is that bank “risk officers” are tightening lending standards. This reduction in liquidity will have a more immediate impact on the global economy.
Before the war, I called for a global economic slowdown into mid-2022. Recent events likely accelerate and extend the downturn into the later part of this year. Inflation, rising lending rates (mortgages, etc.), declining wealth, and the Fed and global central bankers are all headwinds for the economy and equity markets. I’m sure you are well aware of the skyrocketing prices of oil and gasoline. The commodities markets are on a tear. The planting season in Ukraine begins in less than a month. Ukraine and Russia are essential agriculture markets. Russia and Ukraine account for 25% of global wheat exports, according to @Schuldensuehner.
Depending on the severity of the slowdown, I expect the Fed to turn the liquidity machine back on sometime mid-to-late summer. My fundamental bearish view on equities remains. The risk of recession has increased. When the Fed starts printing aggressively again (the next Powell Pivot), equities should respond favorably, and it may be the end game for the long-term decline in interest rates. For now, bullish on Treasury bonds, bullish on commodities, bullish on gold, and bearish on equities. Risk remains high, more defense than offense, hedge equity market exposure.
When to get aggressive on equities again?
Following is a chart of the S&P 500 Index going back to 2008. The bottom section shows the MACD indicator, which is a trend-following momentum indicator that shows the relationship between two different moving averages. This particular chart looks at the monthly price activity of the S&P 500 Index. The black line is the 12-month moving average, and the red line is the 26-month moving average. Focus on the bottom clip (the red arrow indicates a recent sell signal).
You’ll notice in the top section of the chart (far right) a market decline of 30% takes the S&P 500 back down below 3,300. The last time the Fed attempted to end QE (late 2018), the market sold off ~20%. Then, the famous “Powell Pivot” reinjected liquidity and life back into equities. Given the inflation backdrop today, I suspect it may take -30% or more this time around before the Fed starts printing again. The 3,200 to 3,300 area is a logical guess—a technical retest of the pre-Covid January 2020 high.
The Trade Signals Dashboard of Indicators follows next. The Ned Davis Research CMG U.S. Large Cap Long/Flat Index is very close to a sell signal, as is the 13/34 Week EMA. The short-term S&P 500 Index Daily MACD Indicator is in a sell. While I show the 200-day and 50- vs. 200-day trend indicators, I don’t favor them simply because too many investors follow them, and hedge fund and quant funds know it and can force activity in a way that may trigger stop-loss sell orders or buy orders. I post to get a feel for how close we are and to watch the behavior around those triggers. I lean heavily on NDR CMG U.S. Large Cap Long/Flat (which measures board market price trend, breadth, and volatility), 13/34 Week MA (which looks at the trend in price), and Volume Demand (buyers) vs. Volume Supply (sellers). The above chart is useful as well. I’ve added it to the Equity Market indicators in the dashboard that follows.
Also notable this week, the Zweig Bond Model moved from sell to buy, signaling lower rates and higher bond prices for high-quality bonds and Treasury bonds. Gold has come back to life and is trading near $2,000 per ounce. Our gold models remain in bullish buy signals. Of course, no guarantees. No model is perfect. Investing is about probabilities and risk management. My global macro perspective may be wrong.
Click HERE to see the Dashboard of Indicators 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.
Personal Note – Brotherhood
Like you, Susan and I watch the war news and are outraged and sad. Our hearts and prayers go out to the Ukrainian people. We continue to pray for peace.
It was nice to receive the following via an email the other day, and the world slowed down as I read it. It was from one of my college fraternity brothers. I thought I’d share it with you.
A moving article in The Athletic (subscription sports item; well worth it!) on the life and death of Chris Eitzmann, age 44. He was from a town in Nebraska of about 150 people, went to Harvard, became captain of their football team, later got an MBA from Dartmouth, and gained some fame as a group of guys that were roommates with Tom Brady his rookie year with the Patriots. Eitzmann died from a combination of CTE and alcohol. The reason that I write is that the story is predominately about the bond formed by friends from college and his very brief time in the NFL, how they connected, and how they stayed in touch over the years. Unfortunately, their last “reunion” was at his funeral the week that Brady announced his retirement.
It struck a chord with me as to how hard we all work to keep in touch, why it is worth it, how these guys worked extra hard to reach out to some who had “fallen outside the circle,” to bring everyone “back home,” and to be supportive of each other through the ups and downs of life. Some days these types of stories grab on more than others; it just hit home today as the world is a rough place for many people personally, professionally, and on a more macro level. Let’s keep the chatter going, the phone lines open, and remember that if ever there is a text/email/call, it will be answered.
Love you all! It’s great to be Phi Psi!
It’s good to have friendships. Reach out to an old friend and let them know you are thinking about them… and keep the chatter going!
Thanks for reading. Wishing you a great week!
With kind regards,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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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.
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