Let the Good Times Roll!
GEORGE LUCACI
GLOBAL HEAD OF DISTRIBUTION | FOLIOBEYOND
6 minute read
Let the Good Times Roll!
Let the good times roll
Let them knock you around
Let the good times roll
Let them make you a clownThe Cars, 1978
In 1978 the 10-yr Treasury average yield was 8.4%, the GDP growth was 5.5%, and the inflation rate was 7.6%.
In 2021 the 10-yr Treasury average yield has been averaging 1.3%, GDP growth is around 6.3%, while the (annualized) CPI[1] inflation rate in the U.S. accelerated to 5.4% in June of 2021, a number that was repeated in July.
No doubt, that was a different economic climate forty-three years ago. Investors shunned equities, unemployment was on its way to double digits, the Federal Reserve Board was reasonably independent, and inflation was in full swing caused by easy monetary policies financed by massive budget deficits. By 1981, inflation was running at a 14% clip, with the 10-year approaching 14%. Still, there are similarities.
The June 2021 inflation print was the highest level since July of 2008. The most significant price increases were recorded for used cars and trucks (45.2%), gasoline (45.1%), fuel oil (44.5), utility gas service (15.6%), and transportation services (10.4%). These numbers are significant.
https://www.bls.gov/cpi/tables/supplemental-files/home.htm
Why 1978? Many economists found that GPI (Genuine Progress Indicator)[2] peaked in 1978 and has declined steadily since (Ecological Economics, doi.org/m53). This lack of progress contrasts with the steady increase in GDP per capita since then and “implies that social and environmental woes have outpaced the growth of monetary wealth - comprehensive measures of economic progress that reflect the overall state of a country.” This matters because our present administration has egalitarian policy goals like reducing inequality, green infrastructure investment guarantees, criminal justice reform, guaranteed family income, national full-day child care support, establishing a federal minimum wage for all, etc. Social justice is expensive.
https://bit.ly/3s6sESV
The Federal Open Market Committee (FOMC), in its latest meeting on July 28, forecasted that the Personal Consumption Expenditures (PCE) inflation rate in the United States would average 2.4% in 2021, then decrease to 2.1% by 2023. The FOMC missive stated: “With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well-anchored at 2 percent.” How is that possible? Or better yet, are those metrics valid anymore?
Supermarkets have noticeably higher prices (that is why I took notice when the cashier at Whole Foods remarked that she could not afford the produce anymore), both hiring increases and wage increases in retail and hospitality are continuing, M2 money stock growth rates are the highest in 30 years and running at over 10%, oil prices are approaching a six-year high, and cargo shipping costs have reached multi-decade highs.
Bank of America recently brought to light inflationary pressures with the following fun facts:
• $31 trillion: global monetary and fiscal stimulus since Q1’20 COVID-19 outbreak.
• $874 million: global central bank asset purchases every hour in the past 15 months.
• $875 million: U.S. federal government spending every hour in the past 15 months.
• $830 million: Nasdaq 100 market cap gain every hour in the past 15 months.
• $60 trillion: gain in global financial assets in the past 15 months.
• 6.4x: U.S. financial asset values (Wall St) relative to US GDP (Main St), an all-time high.
• $289 trillion: size of global debt = 3.6x world GDP
• 18%: U.S. retail sales 18% above pre-COVID levels
• 11%: U.S. inflation past three months (annualized), the fastest pace in 40 years
• 15%: house prices in US/UK/NZ/Canada up 15% YoY, fastest this century
• 3 billion: people in ’21 experiencing food costs >10% per annum (1 billion up 20%)
• 34%: commodities best-performing asset class in 2021, the first time since 2002.
Finally, in two short years, the move to a real negative return on Treasuries has been, well, astonishing. This can only get worse with Fed inaction. Keeping interest rates below the rate of inflation will not get rid of the high levels of debt. That would be a multi-decade effort, and we no longer have that luxury.
Source: Bloomberg; RSM US LLP
For the last 40 years, inflation was mostly benign, but we do not have to analyze all these numbers because Fedspeak rules and our favorite economists deify their statements of illusion. We are also assured that the mega-money center banks are “too big to fail” (equivalent to being state-owned enterprises), the government continues to guarantee private sector loans, and our central bank makes a mockery of a free market economy by forcing the decoupling of interest rates and inflation. Yet, incredibly, soft infrastructure spending is socialism? Many of the government guarantees are magically manufacturing money as they are contingent liabilities using the good faith of the USA, not actual liabilities. This is a politician’s dream.
Market observers desperately look for “clues” in the Fed’s commentary. However, the Fed does not predict the future, nor are they historians. Their job is to reassure the markets by downplaying inflationary forces in times of crisis. For decades they have mesmerized market participants with overly nuanced blurbs meant to comfort the markets and signal “transparency.” The Fed is the veritable Chauncey Gardner from the 1979 movie Being There: “Yes. In the garden, growth has its seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again.” Pure genius.
The U.S. economy grew rapidly in the second quarter and exceeded its pre-pandemic size, but has the outlook turned murky due to the fast-spreading Delta coronavirus variant?
Again, The Fed, aka Chauncey Gardner, after the conclusion of its two-day policy meeting on July 28, had the answer: “With progress on vaccinations and strong policy support, indicators of economic activity and employment have continued to strengthen.” What does that mean?
In a unanimous statement, Fed policymakers also said they were moving ahead with discussions about when to reduce the central bank’s $120 billion in monthly bond purchases, a precursor to eventually raising interest rates. However, we still are unsure about the timing of the U.S. central bank’s “steady drive” towards reducing its $120bn in monthly debt purchases. Early next year is too late. The Fed has bought well over $1 trillion of mortgage bonds since March 5, 2020. With the spread of the Delta variant across the U.S., will they have “renewed concerns” about the labor market, growth, and unemployment? Getting these numbers right is the magic elixir of elections. Powell gave minor lip service to accelerating inflation but stuck to the Fed’s view that price pressures would eventually ease. https://themonograph.net/?p=2949
Institutional Investor notes: “David Einhorn’s Greenlight Capital is the latest hedge fund firm to assert that higher inflation is not a short-term phenomenon caused by temporary supply shortages, but rather the beginning of a longer trend. The value-oriented hedge fund says its portfolio is positioned for years of rising prices.”
Looking years, or even months ahead, the odds are highly skewed that inflationary pressures will force the Fed to confront higher interest rates. Is 2021 similar to 1978? Maybe, but the Fed has to find courage, reassert its independence, and once again repair the lost connection between interest rates and inflation.
At the same time, it might be a good idea for the investor to hedge the good times and not be made the clown.
[1] Education, communication, transportation, recreation, apparel, foods and beverages, housing, and medical care are the eight groups for which the CPI is measured, food having the heaviest weighting.
[2] The Genuine Progress Indicator (GPI) adjusts expenditure in 26 ways to account for social and environmental costs, such as pollution, crime, and inequality, and for beneficial activities where no money changes hands, such as housework and volunteering.
