- A new weekly piece focused on the most important macro themes impacting the markets and economy.
- The name of these pieces is an homage to Jeff Miller who wrote Weighing The Week Ahead on his site Dash of Insight and on Seeking Alpha.
- This week we discuss whether inflation is truly transitory and what the next year or two could bring.
- We touch on oil’s rise, impact on inflation and investors, as well as, it’s likely fall again soon.
- Finally, we revisit supply chains, which has been a recurring topic the past 5 years, and the impact on future inflation.
Macro Dashes is a weekly piece released on Thursday’s that serves as the backdrop for my Investing 2020s weekly webinars. Within the themes covered we hope to find ideas for asset allocation with ETFs and for finding stocks that offer asymmetric upside beyond the indexes.
This week I am discussing the inflation vs deflation debate. I have been suggesting deflation is the bogeyman for years and recently wrote this piece:
I will also discuss the basics of the end of the oil age as it relates to inflation and deflation.
Finally, we will cover everybody’s favorite, politics, that is, will the infrastructure and reconciliation bills help or hurt, or even pass at all.
Inflation Is Transitory! Or Is It?
It is popularly unpopular, or unpopularly popular, I don’t know which, to talk about a collapse in the U.S. Dollar and and say things like “hyperinflation” this and “Weimer Republic” that. Phooey to all of it.
The debate raging in in the politisphere about inflation has been a brain twisting exercise for at least the 30+ years I’ve been following it and probably much longer. Probably at least as far back as the stupid gold standard.
And for all the talk about the dollar collapsing, it’s just as high now relative to a basket of other currencies as it was roughly 50 years ago.
So, if the dollar is not collapsing, what is causing the inflation we have seen the past year. Well, despite some other analysts saying Fed tightening and loosening not impacting the market (they’re wrong by the way), QE (quantitative easing) has some pretty strong correlations…
…like to the stock market:
…and to GDP:
Above you can see that the Financial Crisis, 2012-13 economic recovery slowdown and Covid Crash are all met by QE and there is an upsurge in economic activity within a year. Low oil prices and tax cuts certainly also helped from 2017-19, but also probably exasperated the 2020 collapse.
QE is also probably correlated to inflation:
You can see the impact of QE on inflation pretty clearly, but there is something that keeps pulling inflation back down in the past few instances. It’s incumbent to ask what that something is.
I’ve argued that the global economy, ex-emerging markets, suffers from “slow growth forever.” I wrote about it wayyy back in 2016.
Cathy Wood recently came out and said that deflation, not inflation, was her top concern. Again, I think we need to ask why. In her case it was the impact of technology being disinflationary.
I would add that demographics, ala Harry Dent (see first linked article), is the most important factor in quelling inflation and threatening deflation, and in fact helped lead to the Financial Crisis that led to QE.
So, if a reduction in QE could lead to lower inflation, how will that hit? And, what else could bring about a deflationary wave?
Oil & Gas Prices Will Fall Eventually
During the 1970s the relationship of oil to inflation was clear in everyone’s minds, especially the politicians and economists. But in the past 30 years, that relationship has broken down with only a few exceptions, just pre-financial crisis and now.
Again, I would proffer “slow growth forever” driven primarily by demographics with an assist from technology.
On the chart, we can see the uptick in oil prices and inflation. What if oil isn’t driving inflation on its own? What if QE is driving GDP which is driving up oil prices in the face of OPEC supply constraints, i.e. manipulation by the Cartel.
Remember, just 7 years ago everyone in America thought shale would be the swing producer on oil for years. Then, Saudi Arabia sniffing the beginning of the end of the oil age coming soon due to developing technology for EVs, batteries and petrochemical alternatives decided to flood the market with oil in late 2014.
What we got was the first wave of oil bankruptcies. We’ve seen two more waves since. There were over 100 oil companies bankruptcies last year according to bankruptcy law firm Haynes Boone.
So, here we are into 7 years of Saudi oil market manipulation with less competition and a rising price of oil. What’s next.
Again, this is just my analysis, but I expect oil prices to come down for two reasons by next summer.
- to support the global economy in the face of less loose (who really expects tight) monetary policy.
- to prevent an even faster shift to EVs which would kill demand for oil even faster than is happening – I already project, like BP (BP), Equinox (EQX) and TotalEnergies (TTE), that peak oil demand happens by the end of this decade.
As I discussed recently, when I was a guest on the morning webinar at ForexAnalytix, I expect the price of oil to be range bound between around $50/barrel and $80/barrel for most of this decade.
Sure, spikes and dives can happen for a moment in time, but the price to prevent weaker demand both short and intermediate term is to not push oil too high, but keep it as high as possible to maximize profits. That price is probably in the $60s per barrel as Russia suggests. Basic economic supply and demand charting.
As it stands now, the price of oil is at the high end of the range. It won’t stay there long in my opinion.
Supply Chains Are Moving
When asked by Congress this week about inflation, Federal Reserve Chairman Powell pointed out that supply chains in disarray was a core factor. He maintained the Fed can’t do much about that, but they can.
Cheap money makes it easier for corporations to move supply chains. The major supply chain moves are happening for 2 core reasons:
- Too reduce dependence on an unpredictable China (or pick your adjective).
- Machine learning and lower global wage disparities are making it easier to move supply chains closer to customers and resources.
The United States of course has a lot of customers who spend. And, Canada and Mexico are no slouches. In addition, the resources for almost everything can be found on North America.
Think through that Canadian Pacific (CP) and Kansas City Southern (KSU) merger again real quick. What was Kansas City Southern’s main asset? Routes form the U.S. to Mexico. Canadian Pacific just created a train line from as far north to as far south as the new NAFTA allows.
The move of supply chains won’t be quick. Semiconductors for instance, the brains of technology, drive the world. It’s going to take about two years for Intel (INTC) and Taiwan Semiconductor (TSM) to get up fabrication up and running in America. Til then, tight prices.
A lot of industries, including food, supply chains are moving back to America. The process started almost 20 years ago after 9/11. It has only accelerated over time as President Xi in China became more domineering.
I have told my clients and subscribers to “sell your commie stocks” for about 2 years now. In fact, other than Alibaba (BABA) a few years ago, I won’t buy Chinese stocks. There’s just too much risk.
That risk is apparent to CEOs on down. At this moment in time, China is not just a competitor, but a threat. Not a threat we should confront directly mind you, because nobody wins a war (see Afghanistan), but one we should work to prevent from negatively impacting us by what they do at home and in the economy.
Makes you wonder about Taiwan though doesn’t it. What if China decides to do something akin to a “crazy Ivan” from The Hunt For Red October with the global economy to gain leverage in almost surely coming Taiwan talks?
Everything is on the table in my opinion with the potential flashpoint of Taiwan, including an economic shock. Stagflation doesn’t seem that ridiculous for a moment, but that doesn’t change the bigger implications that deflation is probably the longer term problem.
Considering Inflation & Policy
If you have followed my other articles, even back to MarketWatch, you know that I have believed deflation to be the bigger threat through about the 2040s when there is a more level demographic situation, i.e. more Boomers crossing to that market in the sky. I’ll stick to that analysis as the evidence supports it pretty clearly at this point.
Deflationary pressures are structural as Larry Summers says. Demographics are an overriding theme as Neel Kashkari points out. The list of smart people, not selling “hyper inflation” and “dollar is doomed” products, pointing to aging demographics driven deflation is pretty long.
Deflation will win out with the economy and markets unless there is a plan to combat it. I’m not saying we have the right plan now, but I think we could be on our way if we reduce monetary supports a bit and add a legitimate “build back better” infrastructure and reconciliation bill.
I’ll let you decide what legitimate is. But, I would say that $3.5 trillion or $4 trillion isn’t the problem, but, how we spend it could be. A few trillion over ten years into a $100+ trillion global economy isn’t overkill.
In the shorter term, I certainly believe that inflation can persist a year or two, and even spike higher on an event, but, again, deflation is the villain bogeyman that will have sequel movies for another decade or two.
In the very short-term, what I am really afraid of is a year of stagflation if Congress goes too small or doesn’t go at all. If that occurs, we could see an Armageddon economic and stock market scenario. I don’t think it comes to that, but I have no idea what West Virginia Senator Joe Manchin and Arizona Senator Kyrsten Sinema are really thinking.
Investment Quick Thoughts
You also know that I have been skeptical of the stock market rally for a year now. We always have to remember that:
The stock market can remain irrational longer than you can remain solvent. – John Meynard Keynes
And that’s why I very rarely short anything or even buy puts. The problem with being negative the market is that you not only have to be accurate, you have to precise to about a month before your costs get really high.
So, we generally hedge by holding extra cash. With the investments that we are long on, we we want to be long ETFs and stocks that have some insulation from a correlated stock market correction and are likely to rebound faster and harder after the correction.
To that end, we have been focusing on small caps and mid caps in recent months as many of those are already down 30%, 40%, 50% or more. The SMID caps are where you can find growth and dividends.
One spot to look is in some of the de-SPAC companies, that is, SPACs that are post merger and are now just companies. In other words, it’s time to do your research and find the babies that were thrown out with the bath water.
There are legitimate bargains in former SPAC stocks trading near book value and with big growth in front of them. Some are already profitable. I have found over a dozen that I like and am invested in 11 already.
Your old line telecoms and cable companies are also pretty beaten up if you like larger cap with dividends. They are priced like depreciating copper wireline companies. Well, some are, but some aren’t. Some have irreplaceable fiber and huge roles in 5G.
I will be writing a piece in two weeks about AT&T (T) which I rate a buy. I think it will breakout in the next year or two after the Warner Bros spin off to Discovery (DISCA) – which I also rate a buy.
If you like dividends, buy AT&T right now if you don’t already own it. In the short run, you’ll collect over a 7% dividend. Sometime next year your dividend will shrink to around 3-4%, but you’ll get an entire entertainment powerhouse in the merged Discovery and Warner Bros that has extensive international reach.
With a cleaned up balance sheet, AT&T is likely to buy back shares within 2-3 years. I have set a preliminary 3-5 year price target of $60 per share just on a rerating to similar characteristics as Verizon (VZ). I actually think there is a strong possibility AT&T rises even further for two reasons I will cover in the upcoming article.
Til next week.
Disclosure: I/we have a beneficial long position in the shares of T, DISCA either through stock ownership, options, or other derivatives.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.