July 15, 2022
By Steve Blumenthal
“From 2008 until recently the Federal Reserve and other central banks kept interest rates abnormally low. They did this because it is the time-honored central bank playbook. Make borrowing cheap and you can generate the kind of economic activity that spurs consumer spending and creates jobs. The trick is to stop the cheap borrowing before it gets out of hand, which they didn’t do (and still haven’t).”
– John F. Mauldin, Chief Economist and Co-Portfolio Manager, CMG Capital Management Group, Inc.
By now, you are well aware that the consumer price index (CPI) rose by 9.1% in a broad-based advance over the past 12 months, representing its largest gain since 1981. Further, CPI increased 1.3% from a month earlier—the most since 2005—reflecting higher gasoline, shelter, and food costs. The inflation figures reaffirm that price pressures are rampant and widespread. Data shows real wages (your income after factoring in inflation), are down the most ever back to 2007.
I’ve included a piece from Ray Dalio imparting some key principles that I hope will be helpful to you. In the Trade Signals section below, I talk about the Fed’s trap, and compare Paul Volcker to Jerome Powell.
We’re caught in a trap, I can’t walk out. Because I love you too much.
Grab that coffee and find your favorite chair. With “Suspicious Minds,” (Elvis’s hit) read on.
For discussion purposes only. Talk with your investment advisor. Not a recommendation to buy or sell any security.
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Investment Principle: Don’t Always Bet On Up
By, Ray Dalio, Founder, Co-Chief Investment Officer, and Member of the Bridgewater Board
Background: I’m at a stage in my life cycle that leads me to want to pass along principles that helped me in the hopes that they will help you. Since I have spent most of my life being a global macro investor, I want to help you invest well by giving you my investment principles, but I don’t want to become your investment advisor—i.e. I want to teach you how to “fish” rather than “fish” for you. I do that by giving you brief posts and reports. I’ve been sharing my posts about the changing paradigm that is resulting from the changing world order (which is explained in my book and video) because what is now happening in the markets is due to these things happening. For reasons described, I believe that we are in a paradigm in which the buying power of financial assets will go down because of a combination of 1) actual price declines when money is tight and 2) inflation when it’s loose.
One of my investment principles that is very relevant now is “don’t always bet on up.” Always betting on up, which is what almost everybody does, is both a mistake for investors and damaging to the economic system. It’s bad for investors because the downs are typically intolerably large and can persist for long periods of time, and it’s bad for the economic system because it produces highly disruptive and unproductive big cycles. If investments and policies were handled better, investors would be better off and the world would be a better place. In this post I hope to convey how and why.
How Does This Dynamic Work?
Most everyone wants assets and the economy to go up and most everyone feels richer when the prices of the assets they own rise, even when these assets’ intrinsic values haven’t actually gone up. For example, the prices of most investment assets rose a lot (which people liked a lot) when central banks (most importantly the Fed) created a lot of credit and money. This made debt assets have very unattractive yields for creditors and very attractive borrowing costs for debtors, which led to strong growth and high inflation, which led to central banks tightening, which led to prices falling a lot (which people disliked a lot). That happened even though the intrinsic value of most of these assets didn’t change much. People pay much more attention to prices than intrinsic measures of value like productivity which is bad for the economy because it is productivity and not prices that raises living standards. I think it would be great if we had a market in productivity and focused more on how to raise it. In any case, this dynamic is what produces the money/debt/economic cycle.
Keep in Mind What Part of the Cycle We Are in and Keep an Eye Out for What Comes Next
Because most everyone wants most everything to go up and because there is a drug called credit that produces both upswings and a byproduct depressant called debt, there is a cycle of accumulating debt liabilities and debt assets that is followed by the reducing of them that happens repeatedly and drives most everything. It is one of the biggest contributors to the “Big Cycle” that I explained much more comprehensively in my book, “Principles for Dealing With the Changing World Order,” and my YouTube video of the same title than I can explain here. Since it’s so important, I urge you to read Chapter 3, “The Big Cycle of Money, Credit, Debt, and Economic Activity,” and Chapter 4, “The Changing Value of Money,” from my book.
While credit can easily produce the ups that people want, it creates the downs when the debts have to be paid back which most people don’t want. Nobody wants the downs, so central banks typically inject a new dose of stimulus to more than offset the downward effects of the depressing debt. We see this happen all the time. For example, now in Europe there is a whole lot of debt that’s coming due that would be depressing, especially as there should be a tightening of credit to fight inflation, so policy makers are now arguing among themselves about whether to have the central bank and governments provide more credit and debt to those who are over-indebted to temporarily alleviate the problem. In other words, paying back in hard money is hard (because it causes markets and the economy to go down, which nobody likes) so when it becomes too hard, central banks ease the burdens by printing some money and slipping it to debtors which leads interest rates to be low relative to inflation so the holders of debt assets lose buying power and the debtors get debt relief.
What should an investor do in light of all this?
Diversify and/or Play the Cycle
Rather than always betting on up, every investor should look at how to diversify one’s portfolio to have some investments that go up when others go down which, if done well, reduces risks more than it reduces returns. While there are sometimes when even a well-diversified portfolio of assets will go down, it won’t go down as much as an undiversified portfolio, and it won’t stay down because a severe and extended period of bad performance is intolerable. I will get into how to do that at another time.
Also, one can play the cycle, for example, by selling short as well as going long. I want to have no bias to up or down, so that is what I do. However, I caution you against market timing because it is a zero-sum game that even the best pros find challenging.
I will delve into these and other investment principles, and into what’s happening now, in my upcoming posts.
Trade Signals: 9.1% Inflation – Paul Volcker vs. Jerome Powell
Market Commentary
July 14, 2022
S&P 500 Index — 3,771
Notable this week:
9.1% Inflation – Paul Volcker vs. Jerome Powell
Powell is facing a debt problem that Volcker didn’t face. Which explains the above tweet.
The challenge for Powell is what rising interest rates do to the outstanding interest payments on all that government debt.
This next piece of data was published by the Committee For a Responsible Federal Budget back in February 2022. You can find the full article here. The 10-year Treasury was yielding 1.9% in February 2022. It is at 2.95% today. We are now at bullet point #2.
- If interest rates are 50 basis points (0.5 percentage points) higher than projected, average annual interest costs would increase by $94 billion per year. Interest payments would total $6.4 trillion over the FY 2022 to 2031 period, and federal deficits would increase (with revenue effects) by $105 billion per year.
- If interest rates are 100 basis points (1.0 percentage point) higher, average annual interest costs would increase by $187 billion. Interest payments would total $7.3 trillion over the FY 2022 to 2031 period, and federal deficits would increase (with revenue effects) by $209 billion per year.
- If interest rates are 200 basis points (2.0 percentage points) higher, average annual interest costs would increase by $375 billion. Interest payments would total $9.2 trillion over the FY 2022 to 2031 period, and federal deficits would increase (with revenue effects) by $418 billion per year.
When we borrow money and spend it today, our spending is someone else’s income. Eventually, we must slow our spending and pay back what we owe. When interest rates are low, we can borrow more for we can cover the costs more easily. The rubber meets the road when interest rates begin to rise. More of our money goes to cover the cost of the debt – we have less to spend. Economies slow. We now sit at the end of a long-term debt accumulation cycle.
Many people believe in the “Magic Money Tree” or MMT or Modern Monetary Theory. Thursday’s print of 9.1% is largely the result of central bank policies. Don’t believe in the Magic Money Tree.
From David Einhorn:
- First came the $2.2 trillion Cares Act in March of 2020. Given the crisis, this seemed completely understandable. In October 2020, Powell confidently asserted that when it came to Congress spending more, the risks of overdoing it seemed, at the time, to be smaller. Implicitly, he promised to print whatever was needed.
- Nancy Pelosi stood proud and said Chairman Powell’s warning could not be clearer: robust action is immediately needed.
- This led to an enormous second $900 billion rescue stimulus in December 2020.
- In May 2021, Janet Yellen said, and I’m paraphrasing, historically low-interest rates mean the government can spend now; debt concern should not keep the government from spending. Even though the peak of the crisis has long since passed, we got the $1.9 trillion American rescue plan in March 2021.
There are a number of reasons we are having inflation. Non greater than printing 50% of all dollars ever printed in just the last two years.
The Global Recession Probability Model is now at 95.83% (We are here red arrow). Expect recession. Stagflation remains a high probability.
A lot of damage has been done.
The Dashboard of Indicators follows next. The intermediate-term equity signals remain bearish for U.S. equities. The Zweig Bond Model has not yet signaled buy. The 10-year Treasury Weekly MACD is signaling buy. Gold remains in a sell signal.
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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Personal Note – Arts Fest, and Denver
Last night was fun . Susan and I took our sons Kyle and Kieran to The Capital Grille to celebrate Kyle’s 23rd birthday. We had a great bottle of red Bourdeaux and a delicious steak. It is a great joy to watch our children grow. I’m sure you feel the same way. Happy 23rd Birthday Kyle!
Susan and Kieran, Steve and Kyle
Susan and I are heading to Penn State tomorrow for the annual 2022 Central Pennsylvania Arts Festival, affectionately known as Arts Fest. The streets are lined with independent artists from across the country. It will be Susan’s first and my first in many years.
Downtown State College, Arts Fest
I lost my mother 41 years ago. I send her love frequently, and I’ll be thinking about her as I walk along Allen Street, cross College Avenue, and stroll up the sidewalk to Old Main. Artists line both sides, Susan and I will be doing some shopping, and my mind will be with mom.
As a young kid, I remember my mom holding Arts Fest meetings in our living room. Mom was a passionate artist with an entrepreneurial drive. She believed in art and artists and knew it to be a tough business, even for the most talented. So, she helped found Arts Fest to make the road a little easier for local artists.
When we were little, we’d walk the streets, eat snow cones, and get our faces painted. Like most kids, we had little interest in looking at the art. As Penn State college students, my friends and I would sit on the Old Main lawn and listen to the live music while sipping a very bad but inexpensive beer. I knew mom and her friends put in a lot of work to keep Arts Fest running. I think she’s looking down, amazed by how much it has grown.
The 50th anniversary was in 2016. A warm smile and happy tear found their way to my face when I read that mom was recognized as the person that got the festival going. No more bad beers today. I’ll silently hold a glass of red wine high in the air and send love to mom.
A fun weekend is immediately ahead. Next Thursday evening, I’m flying to Denver to visit my son Matt. We’ll be golfing that following Saturday. Not sure where just yet. I need to get on that ASAP.
It’s time to send the draft letter to my editing team. I want to let you know Susan, and I totally enjoyed the Elvis movie last weekend. We highly recommend it.
It is with a suspicious mind that I see the market is up nicely today, mid-day. That’s good, but remember that the Fed is “caught in a trap…” Channel your inner Ray Dalio and “diversify and/or play the cycle.” Traditional buy-and-holding stocks and bonds do not work in all investment regimes. Stagflation is one of them.
If you haven’t checked out my book: On My Radar – Navigating Stock Market Cycles. There are just a few copies left. Send me a note, and I’ll send you a copy.
Wishing you a great week!
Steve
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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