Yesterday we talked about the latest hot inflation data. The increase in prices (CPI) from September to October was 0.9%. That's the second time in the past six months that the month-over-month reading has measured that high.
Again, if we extrapolate out that 0.9% monthly inflation number to an annual rate, it would project double-digit inflation.
And keep in mind, we have plenty of drivers at work, and new drivers being introduced (like more fiscal spending), that will only increase the rate at which prices are rising.
With that, let's revisit a couple of key inflation hedges, to see how these markets are responding.
First, gold …
We've looked at gold quite a bit in my daily notes. This is the historically favored inflation hedge. But despite the hottest inflation we've seen in decades, gold is down for the year (still). As you can see in the chart, when the inflation data hit yesterday morning, gold broke out of this technical downtrend.
If we look at a longer-term chart, you can see that this technical downtrend looks more like a short-term correction in a long-term bull market. For those that appreciate the value of technical analysis, this ABC pattern (from Elliott Wave theory) projects a move to $2,700.
Now, let’s look at copper …
Unlike gold, copper is up on the year, big (+25%). It’s winning on two fronts: 1) an inflation hedge, and 2) c
opper plays a key role in renewal energy (from solar, to wind, to electric vehicles). And the upside case for copper (from here) remains very strong.
As you can see in the chart, we’ve had these types of moves in the price of copper. If this recent run is on par with the history of the past two decades, copper has at least another 25% upside.
The producers of copper, who know the supply/demand dynamics better than anyone, think prices will go well beyond the projection in my chart.
Here’s how the CEO of one of the largest copper producers in the world put it, on an earnings call earlier this year:
“China has been the driver of copper demand growth over the past two decades. Now the source of new demand is expanding…. copper is essential to the transition to a global cleaner energy future. Roughly 70% of copper is used to deliver electricity. As clean energy initiatives are implemented, copper intensity in the economy expands in a major way. The outlook for copper has never been better. Significant demand growth is inevitable. Supply to meet this growth is severely challenged. It’s going to require meaningfully higher prices to support mine investment. The combination of rising demand, scarcity of new supplies point to large impending structural deficits, supporting much higher copper prices than previously anticipated.“
We own two copper producers, and one of the world’s largest gold producers in our Billionaire’s Portfolio. This gives us leveraged exposure to the price outlook in these key metals. If you’re not a member to this subscription service, you can join us today (here), and get all of the details on these stocks.
We've talked throughout the year about the likelihood of seeing double digit inflation, given how the monthly change in prices were coming in.
If we extrapolate out today's (October) number, we get a 10.8% annual rate.
Now, consider this: As of mid September, there was still $550 billion of the $1.9 trillion stimulus passed earlier this year, that has yet to be disbursed. Now we have another $1.2 trillion spend coming down the pike.
All of this, and the Fed is still buying $105 billion bonds a month (i.e. injecting $105 billion into the economy).
So the Fed is still running emergency policies, just for the wrong emergency (in the wrong direction).
This is the most dangerous inflation we've seen since the Volcker era.
On that note, remember back in August we talked about some comments Jay Powell made in a townhall meeting, about Volcker. He admiringly called him "the most distinguished public servant, in economies, in [Powell's] lifetime." And he said he admires him because of his courage to take on the unpopular, but necessary path of beating what Powell calls The Great Inflation.
Volcker beat double-digit inflation with short-term interest rates that approached 20% — and in doing so, he took the economy into recession. But he also set the stage for a long and very good period of development for the U.S. economy.
That said, if we had a sense that Powell is prepared to become an inflation fighter, we also have a sense that the Biden administration doesn't want an inflation fighter.
On Friday, Biden interviewed one of the most dovish Fed Governors, as a candidate to replace Powell.
With Brainard, you get a Fed that would fall even farther behind on inflation. She will support the move to a central-bank backed digital currency. And she will execute on the Biden social and climate agenda (which includes tougher positions on bank regulation).
This candidate only makes sense if you (the Biden administration) think this agenda of America transformation (social, energy, health care, financial) will become such a drag on the economy, that inflation will naturally fall back from demand disruption — and require Fed life support.
We talked about the mixed signals in markets on Friday.
Yields going down, despite the Fed taking the first step in a policy reversal last week.
Yields going down today, despite the house passing a $1.2 trillion spending package over the weekend.
The Vix going up, and gold going up (finally) despite stocks closing the past week on record highs. That continues this week. These are all signals of risk hedging.
So, we ended last week, asking if perhaps the official change in direction from the Fed, and an ending of the pandemic could be setting the stage of an unwind of some very bubbly growth "disrupter/stocks of the future."
And this chart came to mind …
Fast foward a few days, and we have another "turning point indicator" in that view: Congress may have fired its final fiscal bullets, passing the infrastructure spend over the weekend.
Add to that, over the weekend, after becoming the richest man in the world, thanks to the chart above, Elon Musk suggested he might be inclined to sell 10% of his stock.
Now we have this chart …
The great macro trader, Paul Tudor Jones, has describes the euphoric stage of bull markets like this: "there's typically no logic to it, and irrationality reigns supreme."
Tesla, while ebitda has increased 3x from the pre-pandemic quarter, the value of the company has increased almost 15x. And, as you can see in the chart above, Tesla, one of the biggest companies in the world, increased in value by 39% in just nine days. Irrationality reigning supreme?
Last week, the Fed Chair told us that "maximum employment" was the condition for a liftoff in rates.
What's happened since?
> Two days later we had a booming jobs report, with an unemployment rate that dropped to 4.6%, on 5% wage growth.
> And then another effective oral covid treatment option was introduced.
> And then Biden's vaccine mandate for businesses was blocked by a federal court.
> And then the House passed the $1.2 trillion infrastructure bill.
> And today, the foreign travel ban was lifted.
This is a cocktail for employment ("maximum employment"), which adds to the inflation pressures, which should speed up interest rate liftoff.
With that, the Fed ran out a slew of speakers today (a total of six) to ensure that they maintain a grip on consumer psychology. As we've discussed, the Fed is far more concerned about inflation expectations, than they are about inflation.
With that, as we've also discussed, what they say and what they do (actions) are often very different. For us, having the benefit of on-the-ground/everyday observation, it's fair to expect higher rates will come sooner than they would like us to believe.
On that note, we've been talking about the opportunity in small cap and value stocks — which tend to outperform in rising interest rate environments.
The move is now underway …
We looked at this chart last Monday, as it was closing in on the highs of the year (of March). As you can see, we now have a breakout.
And this breakout should extend.
Remember, the S&P 500 is now eighteen percentage points higher than its March highs (formerly, record highs). And this outperformance comes as small caps should be outperforming large caps coming out of recession. Again, this performance gap may close quickly (i.e. much higher small caps into the end of the year).
The jobs numbers this morning confirmed what should be a reasonable assumption: When you stop paying people to stay at home, they will go find a job.
In this case, from July forward, more than half of the states have rejected the federal unemployment subsidy. And while the August and September job growth came in under expectations, those numbers have since been revised UP. And this morning's October numbers came in better than expected.
So, averaging the job growth over the past six months, we get 665k jobs added a month. That's big. And that's on an unemployment rate that came in this morning at 4.6%.
That's more than three times the job growth underway when the Fed started normalizing rates back in 2015. And a lower unemployment rate (currently), by 40 basis points.
Add to this, today the health czars are touting the trial success of another oral therapeutic against Covid.
This should all signal a sustained, strong economic recovery, which should be a greenlight for stocks, commodities and interest rates (yields).
Check, for stocks and commodities. But yields went the wrong way today, sharply.
As you can see in the chart, there was a lot of bond buying today (price goes up, yield goes down), despite the positive news on the economy and on the pandemic front. And the move in yields was global. European yields were down sharply on the day too.
Not only that, but gold had one of its best days of the year (only 12 days better) — finishing on two month highs.
And the vix was up 5% on the day, despite broadly positive stocks.
Bottom line: It looks like there is some hedging of risk going into the weekend.
Perhaps there is some fear of an ugly unwind, of some of the bubbly tech stocks that have done so well in the pandemic period. This one comes to mind …
The October jobs report comes in tomorrow morning.
As of yesterday, this report and the coming monthly job reports, will be a lot more important.
Why? Yesterday, Jay Powell tried to take the focus off of inflation, which he admitted was hot, by telling us that they (the Fed) aren't thinking about an interest rate liftoff, in response to inflation, because we aren't at "maximum employment."
Here are his words, exactly: "We don't think it's time yet to raise interest rates. There is still ground to cover to reach maximum employment both in terms of employment and in terms of participation."
Stating that a condition of maximum (or full) employment is necessary to clear the path for setting just a positive (i.e. not zero) interest rate for our economy, is hard to comprehend.
Keep in mind, the unemployment rate from last month's report dropped to 4.8%. That's very close to the long-term average unemployment rate. And it's very close to "NAIRU," which is what the Fed believes to be the "Non-Accelerating Inflation Rate of Unemployment. This is the level of unemployment, below which, inflation would be expected to rise. That's probably not a level you want to dance around, in an economy that's already producing hot inflation.
For perspective, when the Fed started raising rates in December 2015, following the financial crisis and three rounds of QE, the unemployment rate was higher than it is now. Economic growth was lower, and inflation was lower (much lower).
So, there is debate about whether the Fed has it wrong.
Knowing the history of the Fed, especially the history of the post-financial crisis environment (the past thirteen years), they aren't trying to be right, they are trying to manipulate public perception in a way that gives them, in their view, the best chance to execute on their objectives, without changing consumer confidence/behaviors and market stability.
With that, as we've discussed, we have to watch what they do, not what they say. In this case, they've just started tapering their emergency bond purchase program (QE). And they did it sooner, and are telegraphing a faster timeline than most would have expected just a couple of months ago. The liftoff for rates will likely be the same — sooner and faster.
The Fed announced the beginning of the end of QE today. And the plan looks very much like the plan we discussed in my Monday note. They will cut their monthly bond buying program in equal amounts, to end in June of next year.
This "tapering" plan is coming earlier and with a faster timeline than they led us to believe, up to about this summer.
And this timeline opens the door for the possibility of a mid-year rate hike.
But in his press conference this afternoon, Jay Powell wouldn't go anywhere near a discussion on the liftoff of interest rates.
His subdued tone on inflation and the rate outlook was/is fuel for stocks. As such, stocks traded to another new record high.
In his press conference, Powell danced around the scrutiny over the interest rate outlook, justifying the Fed's position by pointing to the labor situation, and the uncertainty surrounding the forces that are driving inflation (will they abate?).
On that note, he had more uncertainty introduced overnight. The gubernatorial elections in Virginia and New Jersey may have changed the policy winds on Capitol Hill. These proxy votes on the radical and disruptive policies of the democrats, should only embolden the intraparty resistance to the "big spend" agenda.
As we've discussed in past notes, at this stage, a smaller deal, or (even better) a no deal, would be among the best outcomes for markets and the economy. It would be a relief valve on inflation pressure. And it would remove the obstruction of uncertainty on a recovering economy that already has $5 trillion of excess money floating around.
Stocks close on yet another new record high today. Yields traded lower. And commodities were mostly lower.
This, as the big Fed decision will come tomorrow.
And this, as global government and corporate leaders are meeting in Scotland on the global climate action agenda.
So we have two competing forces at work here.
The Fed, and other global central banks are ending emergency policies, which will then lead to a normalization of global interest rates, at best. At worst, it will turn into an aggressive rising interest rate environment (i.e. an inflation fighting campaign).
Simultaneously, global governments are pledging to fund the green energy transformation. In the face of record global indebtedness, they will be doing more deficit spending, just as funding debt and deficits is likely to become more and more expensive (with rising interest rates).
Is it a collision course for sovereign debt defaults?
Not if they (global governments and central banks) are all coordinating/ cooperating. And they are (for the moment).
To be sure, they will borrow and spend. But we may find that central banks do not aggressively raise rates to combat inflation. As we've discussed in prior notes, they may let higher prices resolve the "higher prices problem." That means we will be left to deal with a very hot period of inflation, until the consumer finally capitulates and stops consuming.
In the meantime, the global reset of prices (higher) will continue to reset the value of economic output, higher (i.e. higher nominal GDP). And that will start shrinking global debt/gdp. This was the strategy all along, from the outset of the pandemic policy response: inflate away debt, and the value of the money in your pocket.
We’ll hear from the Fed on Wednesday. They are expected to start dialing down their monthly bond buying program (QE).
And the market is now pricing in about a coin-flips chance that they will start the lift-off of interest ratesinJune. That’s a more aggressive timeline on the first rate hike than the Fed projected in their last meeting.
We should get clues on if, and how many, rate hikes might come next year, by the way they telegraph the cuts to their bond buying program on Wednesday.
If the history of the post-financial crisis era is a guide, they will probably map out equal cuts to their current $120 billion purchases each month (currently $80 billion of Treasuries and $40 billion of Mortgage-Backed Securities). A cut of $15 billion a month could get them to the end of QE by June of 2022 — and ready to begin raising rates.
The market would, of course, consider that timeline hawkish.
Hawkish, in normal times, would be bad for stocks (and the risk environment). But given the likelihood that the Fed is already behind on managing an inflation problem, hawkish should be translated as a positive for markets.
With the potential for visibility on rate hikes coming this week, the stocks that tend to move with rising rates (tracking an economic recovery) finally started moving today. The Russell 2000 (small caps) led the day, up 2.6%.
As you can see in this chart, small caps are just now closing in on the highs of the year (which was a record high), set back in March.
Conversely, the S&P 500 is now sixteen percentage points higher than its March (record) highs.
Remember, historically, small caps outperform large caps coming out of recession — as they tend to track interest rates higher in the economic recovery. With that, we should expect small caps to close this recent performance gap with the S&P 500 — and maybe quickly.
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We close the week, and month, with stocks trading to new record highs.
But it's not the risk-on, feel good market that a record high in the S&P 500 might suggest. Especially ten months into a year, where stocks are up over 20%.
For perspective, six of the eleven S&P 500 sector tracking ETFs finished down today. The small cap index (Russell 2000) closed down on the day.
Yields were unchanged on the day. Moreover, for a stock market that was up 6.9% for October and closed on new record highs, the 10-year yield traded, at one point today, unchanged for the month!
These are market interest rates, and should be rising with a recovering economy, especially given that the Fed is due to begin reversing emergency policies next week. The intermarket behavior seems out of synch with the economic and geopolitical picture.
With the above in mind, we have a lot of events over the next few days, that will influence markets. The G20 meeting is over the weekend, which will blend into a global climate summit. I would expect this to be an opportunity for the top countries in the world, which have already committed to the climate action cause, to make the "climate crisis" case to the world.
The U.S. is positioned to lead the way with a big fiscal spend in the name of energy transformation. And in the face of record global sovereign indebtedness, I wouldn't be surprised to see the top countries in the world vow to follow the U.S., with massive deficit spending plans to fund the climate agenda.
The big question is, how will it all be paid for? Will it ultimately (and maybe soon) come in some form of a global currency devaluation?
