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On My Radar: Inflation

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September 25, 2020
By Steve Blumenthal

“Anyone who looked only at the index of prices would see no reason to suspect
any material degree of inflation, whilst anyone who looked at the total volume
of bank credit and the prices of common stocks would have been convinced of the
presence of an inflation actual or impending. For my part, I took the view
at the time there was no inflation in the sense in which I used this term.

Looking back in light of fuller statistical information than was then available,
I believe that whilst there was probably no material inflation up to the end of 1927,
a genuine profit inflation had developed sometime between that date
and the summer of 1929.”

– John Maynard Keynes,
describing the 1920s asset bubble that occurred when consumer prices were flat

Today’s post is short. Several weeks ago, I wrote an OMR piece titled, “Powell Starts Hard Sell for MMT.” I think we are on the polar opposite side of what I call the Paul Volker Moment. In the early 1980s, inflation was out of control. There was little confidence in the Fed. People were angry. The cost of goods was rising higher than wages. Budgets were squeezed. Tough love showed up in the form of Paul Volker and he did what he needed to do. He whipped inflation.

In talking with an advisor client about the Fed this past week, we both agreed there is a floor under the market. The Fed has a lot of free ammo (as you’ll see next). So the narrative goes, buy the dips. I could be wrong, but I do believe that is the right narrative—at least for the time being. The Fed attempts to allow the market to find its footing and then jumps in when things get too hot. Let’s call hot -15% to -20%. The S&P 500 Index is currently down a warm 10%, give or take.

Here is a look at the available capital sitting in the Fed’s kitty. And yes, they can print and make it bigger. Point is there is a lot of firepower yet to be spent. Check out the next chart, courtesy of Camp Kotok fishing buddy, Jim Bianco, via twitter. As he explained, “The grey/blue chart shows the authorized limits that gives the Fed a ton of room to add more (plus QE).”

Grey = Treasury Funds Pledged. Blue = Actual Purchases/Loans.

This next chart shows that the Fed programs to buy loans, muni bonds, commercial paper, corporates, and ETFs have stalled in recent weeks. (Source: Bianco Research.)

So yes… that’s a lot of firepower to buy assets (support the markets). BTW, you can follow me on Twitter @SBlumenthalCMG.

I told the advisor my best guess is that it comes down to confidence. When confidence in the narrative (the Fed) is lost, then significant decline will occur. For me, what will kill that confidence is inflation.

The Fed is wearing a “Whip Deflation Now” button. The inflation genie will escape the bottle. It’s not tough love when you dish out the cookie dough. It’s tough love when you take it away. Inflation will be the trigger. Then, the seesaw will pivot back to the other side, inflation will rise. Then, confidence in the Fed will be lost and markets will reprice.

This is not going to happen in the next two months—and maybe not in the next two years—but it’s coming. Deflation now, inflation later. That’s my base case.

This week, I thought I’d share with you a few interviews featuring Ray Dalio and Howard Marks, respectively. Maybe put your ear buds in and take a walk. Each is less than ten minutes. You’ll also find some interesting stats on the S&P 500, with the FANMAG stocks and without. If you are overweight them, you are happy. If you are diversified, you are sad. The numbers may surprise you.

This week, Jim Bianco tweeted, “That scream you hear is wealth managers/customers wondering why the 60/40 portfolio is not working.” Amen to that, Jim. If you are an advisor on the front lines, you’re hearing it.

Finally, one of my go-to indicators is the “Don’t Fight the Tape or the Fed” model. It’s been in a -1 signal for a few months. It ranges from +2 to -2. The best market returns have historically come when the indicator is positive (rates or falling), and the weakest returns have come when the indicator is negative (rates are rising). In “The Trend in Interest Rates Matters” section below, I look into the trend in interest rates model, which is a sub-component in the “Don’t Fight the Tape or the Fed” model. It is driving the -1 warning signal. I think you’ll find the data interesting. Click on the orange On My Radar button below to access the full post, or if you are reading on the website just scroll down.

Coffee in hand? Let’s go… And have a wonderful week!

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:

Dalio and Marks on Inflation

Following are three recordings I think you’ll enjoy. Ray Dalio is the founder of Bridgewater Associates and one of the most successful hedge fund managers of our day. And put Howard Marks up there on the market masters list. Both touch on inflation. So, get those running shoes on, plug in, and learn. Hope you enjoy!

Ray Dalio, “Inflation WILL Start Rising Soon”

Howard Marks: “The Fed Has Bailed Out The Market From A Depression”

Howard Marks, “The Stock Market Is WRONG”

FANMAG

Six stocks: Facebook, Amazon, Netflix, Microsoft, Apple, and Google are up 36.02% YTD. The S&P 500, within which those six stocks live, is up 0.49% YTD. Remove the six from the S&P 500 Index and the remaining 494 stocks are down -6.62% through yesterday’s close (9-24-2020).

If you are an advisor, this is hard to explain to your client. “The market” is up. Yet, clients are frustrated unless they are overweight these six stocks. Diversification? Sometimes it feels painful to be diversified.

Also, take a look at the annual gains since 2014. They’re 4.98% per year for the S&P 494. 8.26% is close to the long-term norm for the S&P 500 Index; however, just six stocks provided much of the lift.

The Trend in Interest Rates Matters

I want to look deeper into why the Ned Davis Research “Don’t Fight the Tape or the Fed” signal was in a moderately bearing -1 signal. In past writings, you may recall that I noted, “Watch out for -2.” That’s as bearish as the indicator can get, and it’s generally when the markets fall apart.

So why the -1 reading when the Fed is clearly in support of the market and the overall stock market trend, until the last four weeks, has been bullish? The signal has been -1 for a few months. It turns out the signal is weak due to the 10-year Treasury yield’s deviation from its long-term trend. Let’s take a look…

The idea is simple: when interest rates are rising, the stock market returns are less. When they’re falling, returns are greatest. The next chart measures the 10-year Treasury yield vs. a 70-week moving average of the yield. Simply, are yields moving up or are they moving down relative to the long-term trend in yields?

Here’s how to read the chart:

  • The middle section plots the yield (updated weekly) in orange and compares it to the rolling 70-week dotted blue line
  • The lower section of the chart slows the percentage difference between the Treasury yield and the moving average regression line
  • The bottom data boxes plot the % gain per annum for the S&P 500 Index when the light blue line is above the upper dotted bracket (rates trending higher vs 70-week line), between the brackets (call it neutral), and when it’s below the lower dotted bracket (rates trending lower).
  • The red arrow shows the current signal and the poor returns that have occurred when rates are rising.

This is not an outright bear signal, but it should be watched. If “The Don’t Fight the Tape or The Fed” indicator goes to -2, I’ll be sure to highlight it when it occurs. Keep it on your radar.

Trade Signals – A Look at Historical Returns (1926 to Present)

September 23, 2020

S&P 500 Index — 3,315 (previous close)

Notable this week:

The equity market trend signals remain bullish. The Ned Davis Research CMG U.S. Large Cap Long/Flat model is designed to produce a summary reading of the technical health of the U.S. stock market. The model looks at trend and momentum indicators of 24 sub-industry sectors that make up the S&P 500 Index. It produces a reading of 0% to 100% reflecting the percentage of the component indicators that are currently giving bullish signals. In bear markets, a large percentage of stocks are trending down in price. The current 72.59 is a modestly bullish reading. It is down from a recent high of 85 and is trending lower. Sell signals occur when the the reading is below 50. I like to think of it in terms of the number of soldiers on a field in battle. Lose half your army and your ability to win the fight is not so good. It bull markets, most stocks are rising. It is the opposite in bear markets.

Also notable, investor pessimism is picking up. The daily investor sentiment is now in the Extreme Pessimism zone, which is short-term bullish for equities. Markets tend to find footing when investor pessimism is extreme. Keep an eye on the weekly NDR Crowd Sentiment indicator. It remains in the Neutral zone. For traders, I like the weekly sentiment to be in the extreme pessimism zone and the market at or near logical support lines.

Keep in the back of your mind that there is just no way that 0.67% yielding 10-year Treasury Notes or 2.28% AAA-rated corporate bonds can come close to the historical 5.8% returns for bonds since 1926. Nor can 0% Treasury bonds come close to the historical 3.40% Treasury Bond returns. The Fed has destroyed the return on safe money and injected far more risk into portfolios.

I thought you might find the following chart informative:

I write a great deal about valuations and coming probable returns. Flat returns for U.S. equities over the coming 10 years are expected. Add 0.67% or 2.28% bond yields into the equation and it’s hard to see how 60/40 stock/bond portfolios will deliver returns. Our current starting conditions (record high valuations and low bond yields) are not good. It’s why I believe now, perhaps more than anytime in my 36-year career, downside risk management is mandatory and why I favor diversifying trading strategies.

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.

Personal Note – RBG

“If everyone is moving forward together, then success takes care of itself.”

– Henry Ford

Ruth Bader Ginsburg, Associate Justice of the Supreme Court of the United States

I remember my mom’s meetings in the 1970s when I was young. A group of her friends would gather in our house. She was an artist and outspoken champion for women’s rights. She was firm in her convictions. And I was really proud of her.

Today, I smile with great pride as I reflect on the life of Ruth Bader Ginsburg. The first woman and the first person of Jewish faith to lie in state at the U.S. Capitol. There are many wonderful contributions RBG championed for us in her lifetime. Here are just a handful that stand out to me:

  • The right to sign a mortgage without a man.
  • The right to have a bank account without a male co-signer.
  • The right to have a job without being discriminated against based on gender.
  • The right for woman to be pregnant/have children and work.

Ginsburg was born and grew up in Brooklyn, New York. Her older sister died when she was a baby, and she lost her mother shortly before she graduated from high school. She earned her bachelor’s degree at Cornell University and married Martin D. Ginsburg, becoming a mother before starting law school at Harvard, where she was one of the few women in her class. She then transferred to Columbia Law School, where she graduated first in her class. After law school, Ginsburg entered academia. She was a professor at Rutgers Law School and Columbia Law School, teaching civil procedure and was again one of the few women in her field.

Ginsburg spent much of her legal career as an advocate for gender equality and women’s rights, winning many arguments before the Supreme Court.

Sometimes I sit back and look at earth and wonder, are we really just working our way through grade school on our way to a higher degree? Our behavior is immature. We are killing each other. I pray we stop. I hold a vision we should be kind, understanding, and compassionate with each other. I hold a vision we are better together!

If you believe there is power in collective prayer, as I do (or even if you don’t, that’s ok), please whisper with me a welcome home to the beautiful Ruth Bader Ginsburg.

Welcome home, RBG. Thank you!

Grab an IPA, a fine wine, or your favorite beverage and hold it high. Here’s a toast to a world filled with light, love, and kindness. And here’s another toast to the powerful and beautiful woman in your life. Susan, Brianna, Amy, Ashley, and Linda – grateful for you.

Wishing you a wonderful week.

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Warm regards,

Steve

Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.

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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