February 11, 2021
By Steve Blumenthal
“In the end, there is always inflation.”
– Ray Dalio,
Co-Chairman and Co-Chief Investment Officer, Bridgewater Associates, LP
The hottest inflation news in 40 years hit the wires this week. The January Consumer Price Index report showed the most significant annual increase in inflation since 1982 at 7.5%, with inflation extending beyond food and energy to household furnishings and health insurance.
James Bullard, President of Federal Reserve Bank of St. Louis, referring to the federal funds interest rate, “I’d like to see 100 basis points in the bag by July 1.” The betting markets agree, signaling a full 1% increase in the fed funds rate by July.
Inflation… Transitory? “Bullard, Bullard, anyone, anyone?”
Do you remember actor Ben Stein playing the monotonous economics teacher in Ferris Bueller’s Day Off? “Bueller, Bueller, anyone, anyone?” Loved that movie.
The inflation storm is forcing the Federal Reserve to change course. The winds are strong and no longer at our backs. Understanding what happens at the end of long-term debt cycles, the impact of inflation, and what it means to asset classes couldn’t be more critical than it is right now. Let’s see what the largest asset manager in the world has to say about it.
Ray Dalio founded Bridgewater Associates from his apartment in 1975. Bridgewater is the largest hedge fund in the world, managing more than $150 billion in investor money. He and his team have put together one of the most extensive historical databases of history. They then apply mathematical processes to help them understand the global market’s dynamics. The information allows them to position their clients’ assets to profit. Investors vote with their money. Bridgewater’s asset size speaks volumes.
Ray is open with his research and much of his thinking within the pages of his new book, Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail.
In the bag by July 1? What do higher interest rates mean to the repricing of risk assets? To bond prices? To equities? The bigger picture I believe you and I need to get our arms around is to understand where we are within the long-term cycle. A 1% fed funds rate by July may or may not happen. This is a small, micro move.
The larger understanding to keep top of mind is that the system is cancered with debt, and a few aspirins aren’t going to fix the problem. Few have seen the current conditions before, but they have occurred other times throughout history. Like history past, we will likely choose to print our way out of the problem. In my opinion, I don’t think that’s what what we should do. Of course, I cannot guarantee it is what we will do. But probabilities suggest it is what we will likely do. We are in the early innings. “In the end, there is always inflation.” I fear Ray Dalio is right.
John Mauldin first wrote about what he coined “The Great Reset” in 2017. It’s about the point in time where we are up against the wall with blindfold on that we will be forced to deal with the restructuring of our debt and underfunded entitlement systems (Social Security, Medicare, and pensions). If John had to guess on timing, he believes 2028 is probable. I believe it will be sooner and we both agree it could be longer. We just don’t yet know. But we do know what has happened since 2017 and what has occurred is the predictable. We are deeper in debt and still face the challenges of entitlement promises that are too big to be able to keep.
You can sign up below to receive “The Great Reset – 2022 Update.” We share a few general ideas on how to approach the period ahead. We see opportunity. We ask you to give us some general information and you can write in a question or two if you’d like John or me to respond.
In this same direction, let’s see what Ray has to say. Private equity giant David Rubenstein hosts a show on Bloomberg called “The David Rubenstein Show.” You’ll love him. He has a great “get to the point” personality, and he’s brilliant. The first section below is a link to the Rubenstein – Dalio interview. Put your sneakers on, plug in your earbuds and go out for a walk. It’s 24 minutes long and excellent.
Also, you can follow Ray on LinkedIn and sign up to have Bridgewater’s research reports sent to your inbox. Bridgewater recently posted their “2022 Global Outlook: The Success and Excesses Resulting from MP3 Policies.” It seems particularly timely to share with you right now.
So, grab that coffee and find your favorite chair. Thanks for reading. I hope you find this weekly missive informative.
If you are not signed up to receive the free weekly On My Radar letter, you can sign up here.
The David Rubenstein Show – Ray Dalio on the American Debt Problem
Click here to watch David Rubenstein’s excellent interview of Bridgewater Associates’ founder Ray Dalio on bloomberg.com.
Trade Signals – Inflation Surges 7.5%… 10-Year Treasury Yield Tops 2%
February 9, 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:
Inflation surges 7.5%. More than expected. The 10-year Treasury yield tops 2%. The equity market trend continues to weaken, though not enough to trigger technical sell signals in all of our indicators.
Leverage is always the bad actor when markets dislocate. It is because of the unwinding of leverage that they do. The following chart provides a good visual. I’ve marked the prior peaks in margin debt as a percentage of GDP and show where we are today relative to history (1949 to present).
Do you think there’s a crazy number of gambling and sports betting commercials on TV? I do. Take a look at what is happening in the U.S. stock market. The extra buying power that margin debt provides is fantastic on the way up. It is the unwinding of margin debt that we need to keep our eyes on.
Here’s how to read the chart:
- In the middle section of the chart, Ned Davis Research (NDR) plots a dotted 15-month smoothed moving average line. This allows us to see when the debt is in decline (when the orange line drops below the dotted black line). We all know what happened in 2000-02, 2007-09, and in Q4 2018.
- The green arrow in the bottom section shows us that margin debt as a percent of GDP is above the 15-month moving average line. Market gains are best when above the line.
- If you think of investing in terms of relative risk vs. potential return, the message here is that the size of the leverage (margin debt) has never been greater. The conclusion is that when the markets do unwind, the unwinding of the leverage will likely be as great or greater than we experienced in 2000-2002 and 2007-2009. I could be wrong, but keep in mind that leverage is always the bad actor.
This next margin debt chart provides an early warning signal. A quicker signal than the chart above. I’ve shared it with you recently. It measures the rate of change in margin debt over the last 15 months. It fired a sell signal at the end of December 2021.
It’s getting dicey. The Fed is trapped between a “rock and a hard place,” as my dad used to love to say. Inflation is calling their hand. Bank of America expects seven rate hikes over the coming year into next year. There is more than a 30% chance the Fed hikes the Fed Funds rate by 50 bps in mid-March. The 10-year Treasury breached 2%. The Zweig Bond Model has done another excellent job nailing the current trend (not every signal is perfect, no guarantees). All of the fixed income trend indicators remain in a sell.
The NDR CMG U.S. Large Cap Long/Flat Index is below 60. It measures the overall technical health of the market across 24 sub-industry sectors. A decline below 50 will signal a move to risk-off large-cap equity market exposure. Investor sentiment remains in extreme pessimism, signaling short-term bullish support for the stock market.
My opinion of the current state is this: Near-record high valuations, extreme leverage, and unfavorable Fed. Broad deterioration in the market technicals is signaling a warning. The market has been overvalued for some time. Valuations are poor metrics in terms of calling secular bull market tops and bottoms but they do signal degrees of risk. As you see above, leverage can be both useful and dangerous.
I post Trade Signals each week because it helps me stay sane. The technical signals have kept me positioned mostly risk-on despite my larger fundamental view (low coming 10-year returns due to extreme overvaluations, investors fully invested, and leverage at record highs). Now, technicals are deteriorating and it sure feels like we are getting close to another meaningful sell-off.
My best guess is for a -30% decline into mid-year. Of course, no guarantee, as no one can know. I could be wrong. The inflation picture is far different today than the last time the Fed began its tightening cycle in 2018. It was a 20% market decline that caused the famous “Powell Pivot.” I believe inflation has Powell and his Fed trapped, that they’ll do their best to let the markets work on their own. Meaning, it will take more than a 20% decline before the Fed steps in with Powell Pivot #2. My vote is to let the market clear on its own. I don’t that it is the current state of play. In any event, my message is the same: More defense than offense. Hedge your risk exposure.
Click HERE to see the Dashboard of Indicators 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.
Personal Note – Inspiration
“If you feel inspired to do something, and the feeling feels good, do it.”
I am not sure to whom to attribute the quote above. But I like it. Each day I try to set aside 15 minutes to close my eyes and tune out the world. Often, I’ll put some music on Spotify and, with the volume low, play one of my favorite peaceful playlists called “Piano and Coffee.” My goal is to get into the gap. You know the place; it’s somewhere between being awake and asleep. Relaxed, at peace, connected. For me, it helps me slow down, relax and reboot the brain. And sometimes, there is a whisper of inspiration. I find it fun to run with it to see where it goes. I’ve recommended it to my kids over the years, mainly met with a predictable strange look. But they are grown now, and recently eldest Brianna reminded me to slow down, relax and follow the good feelings. Kind of cool.
Speaking of good feelings. I visited Penn State last weekend to watch my son Kyle’s show called “GRAFF.” It’s a play that has taken him a few years to write. When inspired, he would jot down an idea in his journal. For me, it’s been fun to watch him create. He’d given me a sense of what the play was about, but it all came together for the first time last weekend.
It’s about a teenage inner-city graffiti artist, a single mom, and his imprisoned father, whom he hasn’t seen in five years. Struggles, out late, graffiti turf wars, gangs, friends, and a surprise learning that helped the young boy grow. Much of the storyline was expressed in lyrics put to music and sung in street rap. And of course, I loved it.
Steve and Kyle
Kyle had his production team film the play and is editing his work. Dad wants a copy! And Kevin Malone, I’ll share it with you… thanks for asking!
If you feel inspired to do something, do it! Right now, I feel inspired to skip the meditation and grab a cold IPA.
Hope this note finds you well and feeling happy!
With kind regards,
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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