By David Haggith for The Great Recession Blog
May 12, 2021 -- I’m not saying nothing
else can do the job before inflation fully gets here, just that the kind of
inflation I’ve been writing about certainly will do it if nothing else does.
That’s what terrifies the market and for a very good reason that may not be the
first one that comes to some investors’ minds.
Many talk about the “risk premium” of
investing in stocks. As inflation rises, bond yields rise to offset what will
be lost to inflation. As bond yields rise, stocks become less competitive.
That’s a problem, but it’s not the big
problem. Not this time.
The big problem is that we all know
where the money for stocks is coming from — the Federal reserve and the US
government by borrowing and distributing the money the Fed prints. So, the big
problem is the Fed.
The Fed is getting tangled in a mess of
its own making
Having made the case in a number of
previous articles that high inflation is now already a given, it won’t be long
before the Fed is caught in a trap where it needs to continue creating money in
order to keep the market rising and to keep stimulating the economy, but it
won’t be able to because it will be blocked by the inflation monsters it is
creating. That’s why we hear the Fed talking incessantly about how inflation is
“transitory” right now. The Fed NEEDS to have all investors believe that the
rapidly dawning period of inflation will be short so it can be ignored. The Fed
needs the market to believe it CAN and WILL keep printing money.
However, the Fed is just fooling itself.
The longer it claims inflation is temporary so that it can ignore the rapidly
rising numbers, the more inflation will move out of control because the Fed and
the federal government keep the money printing and the armored cars for
transporting it to the masses running around the clock. (Figuratively speaking,
of course.)
The Fed may fool itself to its (and our)
long-term harm, but it is not likely to fool the market much longer because the
inflationary numbers will be coming in too high for the market to ignore. We
saw that on Wednesday in how the market responded to news of the highest
inflation in years — a number annualized at 4.2% in April, which is well below
the level of inflation we’re about to see this summer. That’s just the wind-up
for the strike-out pitch.
How inflation will fight the Fed and win
The danger inflation imposes is that, if
it rises as high as I am certain it is going to rise (double digits), then the
Fed will be forced to raise its interest targets because the market will shove
interest up regardless, making the Fed look dumb for claiming an interest
target it cannot hold. The Fed won’t be able to what it takes to hold interest
down without creating massively greater inflation through its creation of new
money.
However, it is not just that the bond
vigilantes will wrest control of interest out of the Fed’s hands, it’s that the
stock market will force the Fed to deal with inflation by fearing it whether
the Fed says it should or not. Consumers will also press congress to press the
Fed to deal with inflation. The longer it delays, the more massively the Fed
will have to raise interest rates, just as Paul Volker did in the 80’s to get
inflation under control.
This conundrum is starting to
materialize now at a time when the stock market is at absurdly perilous
heights. Faint realizations of inflation are no longer so faint, which is why
the market is running out of momentum. Investors are starting to believe the Fed
will lose control of interest rates. Investors are starting to doubt the Fed’s
words of confidence.
Of course, to crash, momentum has to
turn downward, and that won’t likely happen until the market is certain the Fed
is going to lose control; but that can happen slowly at first and then quickly
as it did in 2018.
Inflation is a time bomb on the Fed’s
back. My thesis is that every month now the Fed is going to find it harder and
harder to maintain the illusion that it can keep creating money, pumping it
into mom-and-pop investor hands (retail investors, the Robinhood crowd, etc.)
through government stimulus programs (at the government’s demand) and keep
trying to maintain low interest to pump money into the stock market via
corporate stock buybacks funded on loans. Inflation will crush easy money. It
rules. The Fed can rule over it, but only by taking away money and crashing
markets that are utterly dependent on that money.
The plate spinner is starting to lose
control of all the plates it has to keep twirling on the ends of little sticks.
Today’s action in the market shows the market is starting to pay attention to
the clatter of falling plates as inflation shows up worse than investors
feared. The real fear — the deep paralyzing fear that is only
now being foreshadowed — is not competition from rising bond yields (certain as
that is to come) but that inflation will become hot enough that the Fed will be
forced to turn off all of its go juice.
Inflation has the power to suddenly turn
market sentiment on its head because, well, follow the money back to where it
is coming from.
Stocks headed sharply lower as inflation
jitters percolated again, following a report showing U.S. inflation in the year
to April rose at its fastest pace in about 13 years, amid the recovery from the
COVID pandemic.
Inflation jitters will become
inflation panic when it becomes clear that the rise to 4.2 is
not just a blip but the first step on the consumer side of many steps to come.
Hopefully none of my readers were paying much attention to economists who were
forecasting a meager 3.6%.
“Inflation destroys wealth. Period,” said
Patrick Leary, head of trading at Incapital, in an interview with MarketWatch.
“We see inflation showing up in markets. If it’s indeed transitory, markets can
live with it. But if it’s not transitory, that’s when it is going to
become troubling for stocks.”
The destruction of wealth is one
concern, but the bigger concern, I believe, is the loss of the Amazon-scale,
easy-money stream into the market. This is why the market went up when the jobs
report was truly horrible. The report of slackening employment eased feelings
of concern about inflation causing the Fed to turn off the flow. Its why the
market plunged today on solid news to the contrary of higher inflation than
many were expecting.
The Fed’s hand may soon be forced by
reality; and if you’ve been reading here — particularly the Patron Posts that
focused intensively on inflation, you’ve had a good idea of what is coming. One
won’t have to wait until the Fed tightens to stop inflation, however; one only
has to wait until stock investors become convinced the Fed will have to
tighten, regardless of what the Fed claims to assure investors it
won’t.
As MarketWatch noted yesterday,
Tuesday is looking dicey for stocks,
notably the technology space, as inflation jitters continue to
ripple across markets. The sector has been bearing the brunt of concerns that
higher inflation may prompt an early end to the Federal Reserve’s COVID-19
pandemic-driven accommodative stance. After last week’s downside
jobs surprise, some fear Wednesday’s consumer price data could also
deliver a nasty shock.
The market is top-heavy and jittery
under its own load to such an extent that it will crash if it merely believes
the Fed will be forced to tighten. That’s why it jolted as a foreshock today,
but it wasn’t a shock at all if you’ve been reading here. It was expected.
Inflation is the “worst-case scenario”
for this ticking-time-bomb market full of complacent investors, warns
our call of the day from Thomas H. Kee Jr., president and chief executive of
Stock Traders Daily and portfolio manager at Equity Logic.
And here’s the key:
“Arguably, the ONLY reason stimulus has
even been possible is because there has been no inflation. If
inflation comes back, all of the safeguards investors have
been given (free money from stimulus) will be dissolved and won’t be able to
come back to save the day,” Kee told MarketWatch…. He said recent jobs
data indeed suggest price rises will be “more serious than previously
thought….”
“The declines can be much worse than 25%
and if the FOMC [Federal Open Market Committee] is handcuffed
because of inflation, the swift bounce back that investors have been used to will
not happen either,” said Kee. “The fair value multiple on the SPX
SPX (^GSPC) is not 30 – [to] 35x. It’s more like 15x….”
What would bring that down to earth is
the return of natural-risk perceptions among investors — severely lacking right
now. “They have been given free money by the government, stimulus programs are
in full effect, and investors don’t perceive any risk at all. That is the most
dangerous thing!” Kee said….
“When the big buyer is not there …
that is when natural perceptions of risk come back, and if that happens … watch
out below!!”
You see, rising inflation has the power
to cut the Fed off at the knees. The kind of inflation I’ve been writing about
can suck the mojo right out of the Fed, and that is why Powell is already doing
his best to convince financial markets that the Fed wants higher
inflation and convince them that the higher inflation it wants is temporary
before it even begins.
Market susceptibility
Notes Lance Roberts,
There is no way this bull market doesn’t
end very badly. We all know that is the reality of this liquidity-fueled
market, but we keep investing for “Fear Of
Missing Out.”
How much does all that stimulus money
from Fed and Feds pouring into the market create the cashflow that made the
past year’s insanity possible?
Over the past 5-MONTHS, more money has
poured into the equity markets than in the last 12-YEARS combined.
Do the math and ask yourself what
happens if the money HAS to be turned off because inflation forces the Fed to
stop creating to much new money in an environment of to few goods due to
previous COVID-shutdown shortages and the continuing problems they’ve set up.
And, if you don’t think the market is
precariously riding high on easy money, look at how much it is rising on rising
margin debt (money owed to brokers):
When the Fed is pressed hard to raise
interest rates and stop printing money, brokers aren’t going to be so free in
lending money. Right now, it’s easy money at almost free rates. More to the
point, though, when the market does start coming down because of concerns about
the Fed cutting off easy money, all that margin debt starts unwinding in a
hurry as people are forced to sell assets and reduce their margin debt.
As you can also see, huge, rapid spikes
like this in market debt tend to happen right before severe crashes:
In the short term, fundamentals do not
matter. However, in the long term, they matter a lot.
Sentiment can cause investors to
overlook economic fundamentals for a long time, but a sudden change in
perception of fundamentals long overlooked in an environment of high margin
debt and bring a rapid correction of one’s frame of reference.
Currently, investors are overlooking
fundamentals on the expectation the economy and earnings will improve to
justify the market overvaluation.
That is not likely to happen. Even if it
does, perception of the financial landscape (the core value of of money) has
been far too optimistic in most circles, as seen by the shock today; but you
could see this coming from a year away.
The Fed talks as though it still doesn’t
see what is coming, but that’s the same Fed that talked about how easy
tightening was going to be. It appears it had no idea that it didn’t have an
exit plan that wouldn’t send sentiment sharply south and crash the market. Yet,
that, too, could be seen from years away by those who were not worshipping at
the feet of Father Fed.
When, or if, expectations of recovery
are disappointed, the market will begin to reprice itself for its intrinsic
value. Given that the market is currently trading more than twice the level of
underlying economic growth, which is where corporate profits come from, such
suggests a significant risk.
That’s why the Dow fell 682 points (2%)
today, and the S&P fell 2.14% and the NASDAQ, 368 points (2.67%). There
wasn’t much of a safe space to be found in stocks.
Don’t tell me inflation doesn’t matter
to this market. Worst day in six months. More on this in another Patron Post.
Now let me, once again, do the kind of
corrective reporting I said was going to be essential at this time. First, the
fake news:
One big reason for the acceleration
was base effects – at this time a year ago, the economy was
hit with the worst of the Covid pandemic and inflation was unusually low.
That isn’t accurate. As I said in my
last Patron Post, wherein I also laid out the statistical facts and source to
back up my statement,
Food prices and many other prices rose
like they normally do last March, in spite of the pandemic. In fact, after
March, they rose worse than normal with every month in the remainder of 2020
coming in between 3.5% and 4% on an annualized basis.
“Inflation
Tsunami Sirens Are Screaming!“
I noted in particular one economist who
said groceries and fuel were now just making up for last time:
So, like groceries, gas
is catching up to get back to where we would actually expect it to be….
What predominantly happened last year
was that fuel prices plummeted due to nothing being
transported and lack of vacationing and lack of commuting, but groceries?
Come on!
“Catching up” may be true for gas if you
look back to where prices were in 2018, but it’s total horse manure when you
embrace groceries in the comment. Groceries have no catching up to do
whatsoever. The average rate of inflation for food for all of 2020 was 3.4%,
which compares to rates that 0.3%-2.5% for every year going back until 2011
where the average for the year was. 3.6%.
And while overall inflation was less
than normal for April through June last year, what does that have to do with
this year? [Overall] prices still rose last year; so, it is NOT as if you are
comparing to an anomalous year where overall prices fell in those months,
meaning some of this year’s gain was just making up for last year’s unusual
loss. Then you could truthfully say there was a base effect.
So, inflation is coming in much hotter
than the Fed led people to believe; and, as my recent Patron Posts have laid
out, there is plenty more inflation already baked in on the producer side that
will certainly be passed through. I noted you could expect to see that starting
to show up on the consumer side now, and you just did. It’s going to be an
inflation-hot summer, which can sour sentiment, so stocks won’t take well to
that. To be sure, there is a lot of testosterone still determined to press
stocks up no matter what, but a hot and humid summer will zap that sentiment,
as it did today; and it will keep zapping it no matter what the charts readers
are prognosticating based on current sentimental trends. Trends can change
quickly in the face of facts if the
facts crash in with enough vigor. I think high inflation is the much-feared
fact that can break through by stopping the Fed’s plans from moving forward.
If the Fed does keep moving forward with
the same kind of blind ignorance and stubborn resolve to prove itself right
that led it to keep pursuing its economic tightening regime (as I claimed it
would do for too long in 2018, contrary to good judgment), it will really be
making things worse for itself and harder to tame. I think that is not
unlikely.
“There are people who think the
Fed is not just behind the curve, they’re maybe missing the point and by the
time they start to play catch up, it’s too late,” Wall Street veteran
Art Cashin said Wednesday
As one economist noted,
“We doubt this report will change the
view of officials that inflationary pressures are ‘largely transitory,‘” wrote
Michael Pearce, senior U.S. economist at Capital Economics. “It’s
just that there’s a lot more ‘transitory’ than they were
expecting.”
Indeed. A lot more. What will they do
when they run out of a fake base effect to blame it on?
https://thegreatrecession.info/blog/inflation-will-kill-this-stock-market/
No comments:
Post a Comment