April 15, 2022
By Steve Blumenthal
“The focus on ‘peak’ headline numbers shouldn’t overlook that price increases are digging in and broadening.”
– John Arthurs, Senior Editor for Markets, Bloomberg
I’m writing you this morning from Snowbird, Utah. With around 20 inches of snow having fallen over the last three days, I must invoke the “no writing on a powder day” rule. Truthfully, the adage is “no friends on a powder day,” and it’s because they don’t happen often enough and the feeling of floating on soft, deep, fresh white stuff is hard to describe. It’s just so good. Thus, a short OMR post today.
To begin, I’d like to direct you to an excellent podcast titled “On the Margin,” where host Michael Ippolito and his guest, Mark Yusko, talk about the inverted yield curve, bitcoin, and Credit Suisse’s Global Head of Short-Term Interest Rate Strategy Zoltan Pozsar’s recent ten-page note titled, “Money, Commodities, and Bretton Woods III.” It’s end-of-debt super-cycle/Great Reset stuff. You can listen here, and you’ll find a link to Pozsar’s paper below.
The market is pricing in more than eight rate hikes, taking the Fed Funds rate to ~ 2.5%. At the same time, the Fed intends to reduce its balance sheet. Remember the trillions of dollars of government and mortgage bonds purchased to provide liquidity into the system? The Fed is to begin rolling assets off its balance sheet starting in May at a rate of $95 billion per month.
Will they be that aggressive? Don’t know.
How will prices in the bond market respond? This is the opposite of what drove rates on the 10-year to below 0.50%. The 10-year Treasury closed at a yield of 2.83% yesterday (Thursday, April 14). Ouch.
Not everyone has exposure to long-duration Treasury bonds, but today, there is $2.2 billion in EDV, Vanguard’s popular bond fund ETF. That’s down ~ 27% since December and down ~ 35% since July 2020. BTW, I post this chart each week in Trade Signals. The lower section with arrows marks turning points. More information is in the full Trade Signals post.
In the past, every time the Fed hiked rates, growth in the economy was accelerating. This time, the pace of the economy is slowing (from its peak a year ago) and the Fed is hiking. I think we should be paying close attention to the impact on both bond and stock prices when the Fed starts reducing its balance sheet in May.
The kryptonite to Fed policy, as I wrote last week, is inflation. It’s the “digging in and broadening” part that is concerning. Investors and the Fed have never had to deal with inflation for more than a generation. Sticky inflation is a game-changer. I’m really not sure, nor is anyone in my view, how sticky inflation will become. But it is a clear and present danger.
As a young broker at Merrill Lynch in 1984, I remember well that inflation was on every investor’s mind. The belief was you had to trade the markets to make money, and you had to own real estate, commodities, and gold. Buy-and-hold stocks and bonds, forget it! Everyone knew that approach wouldn’t work. But it was exactly the right time to change strategy and buy-and-hold at 60% stocks and 40% bonds: PE multiples were below 10 and interest rates were yielding in the mid-teens.
Since 1984, interest rates have been low and falling, and inflation has mostly been under control. You can click here to see historical inflation rates by month all the way back to 1914. Inflation has averaged less than 2% over the 10 years prior to the pandemic. For nearly 30 years, we’ve had a period of relative peace and expanding globalization trends. Now investors have to contend with rising interest rates, inflation, deglobalization, the largest decline in real disposable income since WWII, a hawkish Fed, and war.
As gloomy as that all sounds, from an investment perspective there are things we all can do. I’ve marked three green arrows in the middle of the following chart. They correspond with the three green arrows (we’d be better off here) in the lower clip of the chart. My point is that today, investors are “ALL IN” in terms of how much of their net worth is allocated to stocks. The three red boxes highlight other ALL IN periods.
Here’s how to read the following chart:
- The baby blue line in the bottom section plots subsequent 10-year annualized returns from any given starting point.
- In 1968, investors had roughly 55% of their net worth in stocks. The subsequent 10-year annualized return was approximately 3% per year.
- In 1999, approximately 62% of investors’ net worth was allocated to stocks. The subsequent 10-year annualized return was ~ -1.50%.
- In 1984, the stock allocation was less than 32% of household net worth. Subsequent annualized returns were better than 15% per year.
- The bottom line is when investors are fully invested, there is less net worth available to buy more stocks. There are more buyers than sellers and the price goes up. It is pretty clear looking at that chart that, at 62.47% of household net worth allocated to stocks, investors are ALL IN.
- When US Household Stock Allocation drops below 52%, that’s good. Below 43% is better, and below 32% is best! I’d start buying at 52% and ramp up as it moves lower. Best to be a buyer when everyone is selling and to be a seller when everyone is buying. This chart shows “everyone is buying.” Could go higher, but the risk to me is not worth the bet.
Inflation regimes are different. Investors are all in, leverage is high, and valuations are high. Timing is impossible to know, but we can get a sense of where we sit in a cycle. We are at the opposite end of where we sat in 1984. Unless you are in your 20s or 30s, the 60/40 strategy that worked for the last 36 years is done for now. Better buying opportunities will present—keep the three green “we’d be better off here” arrows in mind.
A few random thoughts:
- The Fed will tighten until something breaks. The break could be a 30+% stock market decline. The break could be a recession. Or both.
- The headline inflation rate at 8.5% is consistent with 86% odds of a recession according to David Rosenberg.
- Rate hike cycles do not always lead to recessions, but most have.
- How aggressively the Fed deals with unwinding its balance sheet may be as important or more important than how they deal with interest rates. My friend and partner John Mauldin calls it a “Two-Variable Experiment.” Such experiments are tough to get it just right.
- Inflation and higher rates impact growth. Expect a major economic slowdown with a high likelihood of a recession. Maybe as soon as later this year.
- The Fed Put remains in play. The Fed will be tested. I think they pivot at a stock market decline of -30%. The Fed Put remains in play.
- Mark Yusko said in his podcast that 50% of all U.S. dollars ever printed were printed in the last two years. Inflation indeed!
Expect increased volatility for some period to come. From JPMorgan’s Jamie Dimon earlier in the week,
- “I cannot foresee any scenario at all where you’re not going to have a lot of volatility in markets going forward,” Dimon said on a conference call with analysts after the results were released. “Q.T., inflation, war, commodity prices. There’s almost no chance you won’t have volatile markets.”
- “I hope those things disappear and go away, we have a soft landing and the war is resolved,” he said. “I just wouldn’t bet on all of that.”
Grab that coffee and find your favorite chair. Or forget the coffee and find a stiff drink. The current state of things is a hard pill to swallow. Try to detach emotionally and take in the data. Investing is all about probabilities and risk management. Focus on holding onto your CORE wealth. Where do we sit in a cycle? High risk, low risk, etc.
Opportunity always exists. The Zoltan paper is a good read. He has an excellent grasp of the macro-economic system. It’s a bit geekish and in the weeds, so I may try to put together some high-level bullet points to summarize and translate it for the layperson. I will be rereading it on the flight home tomorrow.
I thought John Arthurs did an excellent (and balanced) job discussing inflation, and I share a bullet-point summary of his comments plus a few of my own in the Trade Signals section below. Sticky. Inflation. Ugh.
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Zoltan Pozsar: “We are witnessing the birth of a new-world monetary order.”
March 21, 2022
In a note published earlier, Zoltan Pozsar wrote that this crisis is not like anything we have seen since President Nixon took the U.S. dollar off gold in 1971—the end of the era of commodity-based money. When this crisis is over, the U.S. dollar should be much weaker. He believes the global monetary system will never be the same post the crisis. You can read more here.
Trade Signals: 8.5% Inflation, The Fed Has No Choice But To Be Aggressive
April 6, 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
Market Commentary – Notable this week:
- Is Inflation Broadening? Yes, unfortunately, it is.
- Is Inflation Getting More Entrenched? Yes, there is evidence it is. The Atlanta Fed divides the CPI index components into “Sticky” prices – which take a while to implement and are difficult to reverse – and “flexible” prices that can rise and fall fast but also fall. The fear is the sticky prices will start to rise, and this will embed higher inflation.
- Is There Any Reason March Was the Peak? Yes. Perhaps most tellingly, inflation in “flexible” prices, also as measured by the Atlanta Fed, enjoyed a historically freakish increase last year. (Oil prices, War)
- What Are the Prospects for Future Increases? The greatest concern has focused on shelter inflation for a while. It accounts for roughly a third of the entire CPI and was still well below average at the beginning of last year. As house prices have risen, so shelter costs in the index have also begun to climb. Rent inflation was still the fastest in 31 years.
- What Prospects for Future Declines? Energy, and the car market, both look as they the near-term peak is in. Oil is exceptionally volatile at present, thanks to the situation in Ukraine and also to conflicting signals for demand from China as it deals with its latest Covid shutdowns.
- What to Expect Next? There’s a widespread belief that the peak for headline inflation is in. But far from a certainty.
- Will the Fed Still Have to Raise Rates? Yes, it really has to tighten. There is no choice for the central bankers in this respect. To restore or maintain credibility from this position, the Fed has no choice but to be aggressive.
That concludes my notes from John Arthur’s Bloomberg article.
Striking a slightly more optimistic tone on inflation, David Rosenberg pointed out that wages are lagging far behind inflation. No sign of a wage-price spiral.
The latest reading of produce prices jumped to the highest on record… 11.2% (data only back to 2010). One has to wonder if companies can pass this on to consumers. I’ll note that my trash bill had a fuel surcharge added to it last month. Not a small number on a relative basis.
The “Real Earnings Yield” on the S&P 500 Index dropped to a new all-time low of -4.2% according to Schwab’s Liz Ann Sonders. Real takes the earnings less inflation. A new all-time low! Kryptonite to Fed policy! Kryptonite to overpriced equity and fixed income markets!
Further, “High valuations and peak profit margins are not a recipe for great forward returns. (From @michaellebowitz with h/t to @Callum_Thomas). Click through to the Trade Signals to see the chart.
The Dashboard of Indicators follows next. One bullish indicator to note in this week’s post is, that Investor Sentiment is once again in the “Extreme Pessimism” zone. The equity indicators continue to signal caution (hedge and/or raise cash), the fixed income indicators have done a good job avoiding the spike in interest rates and gold remains in a bullish uptrend.
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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SIC2022 – Strategic Investment Conference
The annual Mauldin SIC is just ahead. It’s one of my favorite investment conferences each year, hosted by John and his team at Mauldin Economics. The Speaker lineup is outstanding and I’ll be taking notes as usual. I speak on Friday, May 13.
Felix Zulauf, Dr. Lacy Hunt, William White, David Rosenberg, Daniele DeMartino Booth, Howard Marks, Mark Yusko, Grant Williams, Ben Hunt, Charles and Luis Gave, George Friedman, Barry Habib, David Rubenstein, Peter Boockvar, Jim Bianco, Emily De La Bruyere, and more.
Here is the link to the agenda.
Here is the link to register. Note, 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 I nor CMG make money should you subscribe. I do recommend attending. Especially this year. I’ll be taking notes.
Here is the link to register.
Personal Note – Happy Passover and Happy Easter!
Chag Pesach Sameach (Happy Passover) to my Jewish friends, and Happy Easter to my Christian friends. I hope your life’s journey is filled with love and joy. The world could sure use a lot more of both.
Son Matthew and I just finished three excellent ski days. We mostly skied Snowbird but met up with a new friend, Thaxter, and we skied Alta today. Here is a quick shot from the lift Supreme lift at Alta and a photo from the chair lift (beautiful place).
Steve, Matt, and Thaxter
I fly home from Salt Lake City on Saturday and see a nice red wine in my near future with a glass held high (maybe two), celebrating with my family and praying for peace. I’m going to keep on praying for the people in Ukraine and for a brighter, kinder world. Neil Howe’s book, The Fourth Turning, seems all too prescient, as does Ray Dalio’s work on “The Changing World Order.” We are in a tough spot, we can do better… We must do better.
Grateful for the time you give me each week.
Wishing you and your family a wonderful holiday weekend!
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.
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