January 14, 2022
By Steve Blumenthal
“Inflation is always and everywhere a monetary phenomenon
in the sense that it is and can be produced only by a more rapid increase
in the quantity of money than in output.”
– Milton Friedman (July 31, 1912 – November 16, 2006),
American economist and statistician, 1976 Nobel Memorial Prize in Economic Sciences
I’ve been working on an updated report with my partner John Mauldin on what John calls “The Great Reset.” It’s about the challenges debt creates for societies late in long-term debt growth cycles and it’s about a hidden form of debt in terms of underfunded entitlement programs, such as Social Security, Medicare, and government pension systems. You can imagine if you borrow too much, the payments you need to make to pay back the debt eats into your budget and your personal economy slows.
You can think about debt individually or cumulatively as a society and globally. We all tend to focus on our own balance sheet, but it’s important for investors to have a broader view. Debt cycles occur over long periods of time and reach a point when someone gets stuck with the bill. The Great Reset is about that point in time that governments have to reset the debt and restructure the promises they have made. Inflating it away seems to be the path they are on. One way or another, we will reach that point. John’s best guess is 2028. I believe it will be sooner, though John reminds me it could be later.
At some point, we have to collectively come together, save more, pay down the debt (or some form of debt restructure/forgiveness), and agree to reduce our retirement benefits. Who will vote for the candidate pitching higher taxes and a cut in your Social Security, Medicare, and pension benefits?
Tough choices and what we choose to do will impact our economy and the general investment markets. It’s easier to gain voter support by handing out free money. It’s much harder when you tax them more and reduce their retirement benefits. Inflate our way out or buckle up and save more and spend less? We are clearly on the inflate our way QE path and some side effects in the form of 7% inflation is starting to turn some heads.
Next week, I’ll provide you with a link to The Great Reset paper. Our goal is to share what we believe is probable (but not guaranteed) and simply highlight that there is a way to navigate your wealth to prosper. We just don’t believe it will be the traditional buy-and-hold, 60/40 cookie-cutter approach.
You’ll see in the paper that the size of the debt is accelerating at a surreal pace. The U.S. has gone from $20 trillion to nearly $29+ trillion in the last five years. Blink and we’ll be at $50 trillion by 2030. When a government is spending $2 trillion more per year than it is taking in tax revenue, you can see how we might get there. Some say inflation is a temporary supply chain issue. I don’t think that is the full story. Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” While we have no way to yet know, I believe the politicians we elect in the coming years are going to promise more money from the government.
The key variable today is inflation. Financial markets are beginning to respond. When the belief that the Fed has our backs turns, investor confidence will change. The immediate question is what will the Fed do about inflation? It may be beginning to turn. Here is a clue:
71% Stocks, 15% Cash, 14% Bonds
One last note on being wrong-footed. Stocks move up in price when there are more people buying than selling. They move down in price when there are more people selling than buying. It is easier to see in a picture. The following chart plots a monthly survey of individual investors’ asset allocation dating back to 11-30-1987. Think supply and demand.
When investors are heavily allocated to cash and underweight exposure to stocks, there is a lot of money available to be used to buy stocks. When overweight stocks and underweight cash, there is less money available to buy stocks. Investors tend to be “all in” at market peaks and extremely underinvested at market bottoms. This is investor behavior (greed and fear) at work.
Here’s how to read the following chart:
- I’ve highlighted a few things for you to focus on. First, zero in on the top section. The red bar shows periods in time when individual investors had more than 70% of their money allocated to stocks. The most recent reading is 70.5%. The red zone reflects periods of extreme overweighting to stocks. The red arrows point to important market tops (2000 and 2007).
- The green zone shows periods of extreme underweighting to stocks. The green arrows point to important market bottoms (2002 and 2008/09).
- If you zero in on the middle section, the green arrows show high cash levels (investors have plenty of money to buy stocks). The red arrows point to periods of low cash and correspond to periods of high stock allocations.
Bottom line: Today’s conditions are similar to prior periods of high equity market ownership. The last time equity ownership was this high and cash allocations this low was in early 2018. That year, the Nasdaq Composite lost 3.9 percent, its worst year since 2008, when it dropped 40 percent. In the fourth quarter of 2018, the S&P 500 declined 13.97% and declined 6% in 2018. Seems to me we have a similar set-up today in terms of the concentration in Nasdaq stocks, high equity market exposure, and a Fed beginning to lean into inflation.
7% inflation is calling the Fed’s hand. I don’t think they have much room to maneuver. If they tighten too much they risk a stock market crash. I just don’t believe they will do that. If equity markets sell-off hard, expect a pivot by mid-year. Buckle up, the risk is high; hedge your bets.
There are many ways to make money. In my view, it’s just not the right time for buying-and-holding stocks unless you have a very long runway and a cast iron belly. John and I will share a few ideas in The Great Reset paper. I’ll share the link with you next week.
Grab that coffee and find your favorite chair. Trade Signals is next and I have a few photos to share with you from Colorado in the personal section. Thanks for reading… I very much appreciate the time you share with me each week.
Trade Signals – Equity Signals Remain Bullish; Fixed Income Signal Moves to Sell
January 12, 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 beat goes on… A few notable changes to our signals this week (in no particular order of importance): the Don’t Fight the Tape or the Fed indicator moved to a “0” from a “-1” reading since last week. Generally speaking, that is a slightly bullish signal for equities. The Ned Davis Research Crowd Sentiment reading declined week-over-week, which is a modestly bullish signal for equities.
With respect to fixed income signals, the Zweig Bond Model moved to a Sell signal, which is a bearish indicator for high-grade corporate debt and long-term Treasurys.
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 – Rocky Mountains
“Skiing is a dance, and the mountain always leads.”
– Author Unknown
Dad successfully moved Matthew into his new apartment. Denver is a fun city and there is a large young professional population. He lives two blocks from Coors Field, the home of the Colorado Rockies baseball team. We hit a brewery called 10 Barrel Brewing Co. and had an excellent hazy IPA called Profuse Juice.
I drove an hour-and-a-half through the mountains to Winter Park. Friend Mark and I skied Mary Jane (connected to Winter Park Ski Resort). The top of the mountain peaks at 12,000 feet, the sky was blue, the snow was soft and the views were spectacular.
On Tuesday, Matthew and I drove back up I-70 West to Copper Mountain. The drive was shorter and it was the first time for me skiing Copper. Colleague Terry Cunningham joined us and guided us around the mountain. Post skiing we met a long-time friend and former CMG’er Jack Forgosh for a beer. Yes, another good IPA. Jack bought a condo in Silverthorn, which is 10 minutes from Copper and 20 minutes from Breckenridge.
I landed in Philadelphia on Wednesday evening. Waited 90 minutes for luggage, shook my head, and whispered to myself, “Susan and I need to spend more time in the mountains.” It was a fun few days.
Wishing you a fun week,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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