January 8, 2021
By Steve Blumenthal

“They (investors) will behave very peculiarly.
And in terms of the reactions because they are human beings
and they get excited when others get excited,
they get greedy when others get greedy, they get fearful when other get fearful,
and they’ll continue to do so.

– Warren Buffett

You’ve no doubt heard, “It ain’t over till the fat lady sings,” a colloquialism that is often used as a proverb. You know what it means, too: that one should not presume to know the outcome of an event that’s still in progress—even when it seems the conclusion is nearing.

The quote above comes from a talk Warren Buffett gave to a group of young students. He talked about how pension funds put 100% of their new money in stocks in the early 1970s, because they were wild about stocks. Then, stocks got cheaper. When they did, the pension funds put a record low 9% of their new money in stocks. He told the students, “[If] you will look you will see things you won’t believe in your lifetime in the securities markets. And the country will do very well over time, but you will see these huge waves. And if you can stay objective throughout that, if you can detach yourself temperamentally from the crowd, you will get very rich, and you won’t have to be very bright.”

It all boiled down to this piece of advice: “Be fearful when others are greedy, be greedy when others are fearful.”

Here is a look at what is known as the Buffett Indicator, which is reported to be Warren’s favorite valuation metric. At 176.6%, the value of the U.S. stock market compared to the gross production of the U.S. economy is higher than it’s been any point since 1950. If we called the 2000 peak the Tech Bubble, what do we call today? It’s pretty evident others are greedy.

Now, don’t get me wrong. I’m thrilled. This is fun. If you missed the move or you’re in a diversified portfolio, you may be scratching your head. Now’s not the time. We are at or near the top of the wave. I suggest if you are looking for a reasonable entry point, that “buy when others are fearful” moment is it, and it will be at or near the red line in the chart above—plus or minus a little… a reasonable a target in my view.

Keep in mind that markets are volatile. Channel your inner Warren Buffett (or the great Sir John Templeton) as you view the next two charts. Be mindful that markets cycle.

Chart 1: S&P 500 Index – 1996 to December 31, 2020

Chart 2: S&P 500 Index (top section), Bond Yields (middle section) and Commodity Market (bottom section)

My friend Ben Hunt of Epsilon Theory fame put out a note titled, “The Investment Thesis That Makes You Nod Your Head.” He wrote:

Ten-year Treasury yields have spiked to 1.08% and stocks are at all-time highs, even though yesterday we saw a record number of Covid deaths in the United States and a mob storming the Capitol.

Why? Because our common knowledge—what everyone knows that everyone knows—is that enormous fiscal stimulus is coming soon (bullish!), and with that will come inflation (bullish?), and with that will come … something … that will impact our portfolios in a major way.

Every investor in the world is now trying to figure out that something. Every investor in the world is now trying to figure out what inflation means for their portfolio.

What everyone knows that everyone knows is the fat lady has yet to sing. What we old veterans know is she will sing. We just don’t know when. If you are nearing or in retirement, keep ratcheting up your stop-loss risk protection and if you are younger, listen to Warren, keep adding to your equity positions and hold on for the ride. You don’t need to be smart, just brave. You will be tested.

Stocks, measured by the S&P 500, returned 18.35% in 2020. Bonds earned 7.44% based on the U.S. Investment Grade (Bloomberg) Aggregate Index. A good year with just a handful of stocks providing the bulk of the lift. You know the names.

I wondered how Warren performed, so I plotted Berkshire Hathaway against the S&P 500 Index over the last two years. Warren is up 11.97%. That’s about 5% per year for one of the world’s greatest investors. The S&P 500 is up 30.38%.

Further, since we added Catherine Wood’s ARK Invest highest conviction stocks to our CMG Mauldin Platform a few months ago, I thought I’d add ARK’s most popular ETF (“ARKK”) to the return comparisons. It’s up 187.93%. Awesome! I’m speechless.

The 10-year Treasury yielded 1.88% on January 1, 2020 and ended the year at 0.93%. That drop by half in yields was the driver to the good year in bond performance. What’s notable is that the 10-year yield bottomed at 0.47% on June 29, 2020 and rose to 0.93% by the year’s end. Bond yields did well the first half of the year but lost value in the second half of the year when yields doubled by year-end.

My two cents: Think entirely differently about your bond exposure. Rising rates cause bond prices to decline in value, and think about it: what can 1% or even 2% yields do for you anyway? I was of the belief that we’d have one more drop in yields. With Democratic control of the House, Senate, and White House, I think the fiscal bazooka is about to be fired (print and spend on all sorts of programs like highways, bridges, etc.). Replace bond allocations with highly collateralized short-term private credit (yields in the 7% range) and blend trading strategies in a way that may achieve the return to risk reward bonds provided your portfolio in years past.

I’ve been writing more and more about coming inflation. Deflation now, inflation later. I’m moving my later timeline up from two years to maybe one year or less.

Put me in my Camp Kotok fishing friend’s camp…

Bottom line: Inflation and higher interest rates will be the royal flush that calls the Fed’s bluff.

Grab that coffee, find your favorite chair, and click on the orange On My Radar button below (or simply scroll down if you are reading on the website). You’ll find my favorite inflation indicators. Today and over the next several weeks, we’ll discuss the outlook for the dollar, commodities, bitcoin, bonds, and equities—along with some ideas on investment positioning and risk management (think Trade Signals).

If a friend forwarded this email to you and you’d like to be on the weekly list, you can sign up to receive my free On My Radar letter here.

Included in this week’s On My Radar:

• Louis Gave: “Inflation Will Come Back with a Vengeance”
  
• Favorite Inflation Indicators
• The Latest on Bitcoin – Without the Jargon
• Trade Signals – Gold, Silver, and the 10-Year Treasury Yield Surge
• Personal Note – 20 Lessons I Learned in 2020

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Louis Gave: “Inflation Will Come Back with a Vengeance”

By Mark Dittli, The Market NZZ

Louis-Vincent Gave is a master of the big picture. The co-founder of Hong Kong-based research boutique Gavekal is one of the most esteemed writers about geopolitical and macroeconomic developments and their impact on financial markets.

In this in-depth conversation with The Market NZZ, Mr. Gave shares his views on the Dollar, stock markets, and oil and gold prices—and he explains why the United States is starting to act like a sick emerging market.

Following is a bullet point summary of his recent interview with The Market.  You’ll find a link to the full piece here. From Louis:

• When I look at markets, there are three key prices in the world economy: Ten-year Treasury yields, oil, and the Dollar. One year ago, yields were going down, oil was going down, and the Dollar was going up.
• Today, Treasury yields are going up, oil is going up, and the Dollar is going down. This is a huge reversal. When I see a market where interest rates are rising and the currency is falling, alarm bells go off.
• This is what you would see in a sick emerging market. If you’re invested in, say, Indonesia, rising interest rates and a falling currency is a signal that investors are getting out, because they don’t like the policy setting there.
• Today, the US is starting to act like a sick emerging market.
• Government debt in the US has increased by more than $4 trillion this year, which adds up to $12,800 per person. This is a world record, but actually most Western governments have gone on a massive spending spree during this crisis.
• In a way, they’re using the playbook that China followed after 2008, when they allowed a massive increase in fiscal spending and monetary aggregates.
• Today, Beijing sits on its hands in terms of fiscal and monetary policy, while the West knows no limits.

When China did this in 2008, they funded massive infrastructure projects: airports, railroads, roads, ports, you name it. Some of these projects turned out to be productive and some not, but I always thought they would be definitely more productive than social transfers. But this year, the debt buildup in the US has funded zero new productive investments.

• No new roads, no airports, railroads, nothing. They were basically just sending money to people to sit at home and watch TV.
• In the end, this buildup of unproductive debt can be reflected in one of two things:

1. Either in the cost of funding for the government, i.e. in rising interest rates, or
2. in a devaluation of the currency. This is what the French economist Jacques Rueff taught us years ago. Very soon, this is going to put the Fed in a quandary.

They will have to decide whether to let bond yields rise or not. If they let them normalize to pre-Covid levels, 10-year Treasury yields would have to rise to about 2.5%.

• But if they do that, the funding of the government becomes problematic. A 50-basis point increase in interest rates is equivalent to the annual budget for the U.S. Navy. Another 30 bp is the equivalent for the U.S. Marines, and so on. The U.S. is already borrowing money to pay its interest today.
• If rates go up, they’re getting into the cycle where they have to borrow more just to be able to pay interest, which is not a good position.

Louis was asked if he expects the Fed to cap interest rates (yield curve control). His answer:

• Yes, I do. And when they do, I’d say the Dollar will take a 20% hit.
• I think they will have to cap interest rates at 2%, otherwise the drag on the government will become too big.
• That question will arise rather soon, because come this spring, the base effects for growth and for inflation will kick in.
• Growth will be very strong, and so will inflation, which means that yields will quickly try to get back up to 2%.

My base case is that Treasury yields will move up to around 2%, at which point the Fed will introduce some variant of yield curve control. In this case, the Dollar would tank, real interest rates would drop and gold would thrive. But maybe I’m wrong, maybe the Fed freaks out when they see inflation rising to 4%, and maybe they decide to let yields rise. If that’s the case, then financials will rip higher, driven by a steeper yield curve. So come this spring, if the Fed caps interest rates, gold will thrive, and if it doesn’t, financials will thrive.

• It’s quite possible that in the coming weeks, the Dollar will rise while Treasury yields move up. This could provoke a sell-off in gold. If that were to happen, I’d take the other side of that trade, I would buy gold. But at the same time, you can buy out of the money call options on financials. That would be the hedge for the scenario of the Fed changing its mind and letting the yield curve steepen.
• No doubt in my mind the dollar has entered a new structural bear market.
• A year ago, the Dollar was the only major currency offering positive real rates. My view is that capital flows into positive real rates, just like water flows downhill. Today, the U.S. has one of the most negative real interest rates worldwide. Given the year-on-year rise we will see in inflation this spring, real interest rates in the U.S. will drop even further.

China today is the only major economy in the world that offers large positive real interest rates. Thus, capital flows into the Chinese bond market. The PBoC is the only major central bank publicly saying they won’t destroy their currency and they won’t proceed to the euthanasia of the rentier. The consequences of this are hugely important.

• A strong RMB is a fundamentally inflationary force for the world economy.
• Manufacturers around the world have to compete with Chinese producers. Therefore, a weak RMB drives prices down, whereas a strong RMB drives prices up.
• It means that whatever we buy from China is going up in price.
• It’s not surprising that as the RMB rerates, the U.S. yield curve steepens and oil prices go up: It’s all part of the same reflationary backdrop.

Yes, I think inflation will come back with a vengeance. One of the key deflationary forces in the past three decades was China. I wrote a book about that in 2005; I was a deflationist then, as my belief was that every company in the world would focus on what they can do best and outsource everything else to China at lower costs. But now, we’re in a new world, a world that I outlined in my last book, Clash of Empires, where supply chains are broken up along the lines of separate empires.

• Let me give you a simple example: Over the past two years, the US has done everything it could to kill Huawei. It’s done so by cutting off the semiconductor supply chain to Huawei. The consequence is that every Chinese company today is worried about being the next Huawei, not just in the tech space, but in every industry.
• Until recently, price and quality was the most important consideration in any corporate supply chain. Now we have moved to a world where safety of delivery matters most, even if the cost is higher.
• This is a dramatic paradigm shift.

Louis was asked if this paradigm shift will be a key driver for inflation. He responded:

• Yes. It adds up to a huge hit to productivity. Productivity is under attack from everywhere, from regulation, from ESG-investors, and now it’s also under attack from security considerations.
• This would only not be inflationary if on the other side central banks were acting with restraint.
• But of course we know that central banks are printing money like never before.

When asked, “What will that mean for investors?” he replied:

• First, there will be two kinds of countries going forward: countries that massively monetized the Covid shock and those that did not.
• I’d compare the picture to the late 1970s, where countries like the U.S., the U.K. or France monetized the oil price shock, while Japan, Germany and Switzerland did not.
• This led to a huge revaluation of the Yen, the Deutschmark and the Swiss Franc.

Today, the Fed and the ECB were among the central banks that massively monetized, while many central banks in Asia did not.

• So I expect a big revaluation of Asian currencies over the coming five years, which in itself is inflationary for the world.
• If you look at the U.S. today, inventories are at record lows. With the economy improving in 2021, companies will have to restock, and they will have to restock with a falling Dollar.
• The Dollar is down 20% to the Mexican Peso over the past six months, down 10% to the Korean Won, down 8% to the RMB, so whatever Americans buy from abroad will be more expensive.
• Countries with weak currencies, the U.S. first among them, will have higher inflation. 

The following is Louis’s thinking on investment positioning in this new world:

• In the old world, where interest rates were falling, the Dollar was strong and oil was weak, you bought Treasuries and U.S. growth stocks and went to the beach.
• Now, the world has changed. This means you have to stay away from bonds and U.S. growth stocks.
• In a world of Dollar weakness, you buy emerging market equities and debt, and within emerging markets, I prefer Asia.
• In a world where either the yield curve will steepen or the Dollar will collapse, either financials or the commodities sector will be doing well.
• Everything seems to point towards commodities, including energy, but as mentioned, I’d still buy financials as a hedge against a steepening yield curve.
• So, in a nutshell:
  • Buy value stocks, buy the commodities sector, and buy emerging markets. And for the antifragile part of your portfolio, buy RMB bonds and gold.

There’s more to the article. You can find the full post here.

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Favorite Inflation Indicators

Two quick charts: The first is my favorite Inflation indicator. The index includes a variety of goods such as food, clothing, automobiles, homes, household furnishings, household supplies, fuel, drugs, recreational goods, doctor fees, lawyer fees, rent, repair costs, transportation fares, public utility rates, and federal, state, and local taxes. The second is a look at “Dr. Copper” (ticker: CPER) — many people’s favorite go-to inflation gauge.

Bottom line: Inflation is picking up.

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The Latest on Bitcoin – Without the Jargon

By Jan van Eck

Bitcoin is confusing to many. My good friend, Jan van Eck, wrote an excellent piece that explains it in a way that I think most of us can understand.

If you are interested, you can find the article here.

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Trade Signals – Gold, Silver, and the 10-Year Treasury Yield Surge

January 6, 2021
S&P 500 Index — 3,748 (close)

Notable this week:

Gold has been in a bullish trend signal all year. While gold is selling off today (which makes little sense to me), the recent break higher is short bullish for gold.

Here is a look at silver:

It appears the Democratic party will have control of both houses of Congress and the White House, following the inauguration of President-Elect Joe Biden on January 20. The US 10-year Treasury yield jumped above 1% for first time since March with Democrats set to secure the Senate with results following voting in Georgia. Finally, while the FOMC changed nothing today, the FOMC minutes were slightly negative, signaling significant downside risks to the US economy. The Fed said the economy is slowing due to the pandemic and that there is downside risk to ending loan facilities. The only policy option discussed was extending the maturity of purchases (longer-dated Treasury bond maturities) while not increasing the size of purchases.

Key to me is the dollar, inflation, and interest rates. Inflation is likely the outcome that calls the Fed’s hand. Not a current risk, but clearly a coming risk. More on this in future notes.

The 10-year Treasury yield spiked and is currently at 1.04%. This is up from a low yield of 0.38% in March 2000 and a retest of that low at 0.50% mid summer. While lower than at the start of 2020, we are well off the lows and rates are moving higher. Bonds helped portfolios the first half of 2020 and have lost money since. The solid red line shows overhead resistance at approximately 1.40%. When yields rise, bonds lose value (i.e., prices decline). We recommend absolute return-focused trading strategies replace traditional bond investing and, if you qualify, consider short-term private credit where you can find well collateralized yields in the 6% to 7% range.

Mostly green on the Dashboard of Indicators that follows below.

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. 

Click here for this week’s Trade Signals.

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Personal Note – 20 Lessons I Learned in 2020 

“Do not use your energy to worry.
Use your energy to believe, to create, to learn, to think and to grow.”

– Professor Richard Feynman, American Theoretical Physicist

The year is off to a great start, and I’m checking in with you full of optimism. I know that is hard when we are all learning of more and more friends with COVID. I’m speaking to a growing number of people who are feeling stress and anxiety. For those at high risk, isolation from children and grandchildren is just awful. The challenges range, of course, yet the light at the end of this tunnel is in view.

Sometimes, maybe most times, the greatest gifts are sitting right next to us. Over the holiday and feeling stressed myself, I sought some refuge in reading. Then, on a walk with my kids, daughter Brianna turned me on to a podcast titled “On Purpose with Jay Shetty.” Jay Shetty is an Indian British author, former investment banker, former monk, and purpose coach. He began his career with Accenture, working on digital strategy and social media consulting for company executives.

Shetty’s podcast, “On Purpose,” became the number-one health podcast in the world according to Forbes. The topics he covers include relationships, wellness, mental health, and purpose. Shetty has interviewed many, including Russell Simmons, Deepak Chopra, and Kobe Bryant.

I’ve listened to two so far: “20 Lessons I Learned in 2020” and “How to Let Go of the Pain.” I really liked them.  And I’m halfway through the Kobe Bryant interview. Consider me now among the millions of Jay Shetty followers now.

Most times our greatest growth is born out of great challenge. Perhaps the vaccine is one of them. I’m hopeful we reap many rewards from this new approach to attacking viruses. Let’s hope.

Anyway, I hope you enjoy the “20 Lessons” episode, which will be posted soon on my personal website.

I’ll be sharing more of my thoughts about the market over the coming few weeks. Inflation is top of mind, as is Asia, commodities, the Fed, the dollar and good old downside risk management.

Hope your year is off to a great start.

Best to you and your family,

Steve

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.

Click here to receive his free weekly e-letter.

Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.  

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