Taking the Temperature on Growth, Inflation and Policy

Hey There Income Hunters,

I learned a great thing following Ray Dalio throughout my career and that is this …

 If you get the growth, inflation, and policy trends right, then you’ll get the market trends right …

Today I want to “take the temperature" of the three most essential inputs to trading and share where I believe we are headed.

The growth picture has been the most difficult because of COVID. We are finally seeing good improvement on daily cases, and we’ll look at that more closely …

Inflation has been the easiest to detect, because we were correct on the Fed, the Treasury, and the Government all injecting money into the system at once.

Greater money supply is the main ingredient for inflation, and we got that right …

However, figuring the path forward on inflation will now get more difficult. The inflation we knew was coming is now forcing the Fed to turn more restrictive, which could be a major mistake …

Fed Policy going forward will also become a wild card since two Fed governors recently resigned. Rob Kaplan and Eric Rosengren were found trading large amounts of S&P 500 (Ticker: SPX) futures while they were injecting money into the system during the COVID crisis.

So, today I want to break down each one of these and share their overall impact on the markets.


Growth

As you can see, the COVID case count dropped substantially in August.

Plus, on Friday Merck (Ticker: MRK) announced that one of its experimental COVID pills has reduced hospitalizations and deaths by 50% in people recently infected with COVID. 

Chart Description automatically generated

Now, the counterbalance to that is consumer confidence. The chart below illustrates how pessimistic consumers are towards the economy. This illustrates how tightly joined growth and inflation are. Inflation hasn’t been an issue in the economy for 40 years but that is all changed now.

A screenshot of a computer Description automatically generated with low confidence

Growth will remain subdued because of the amount of debt in the system, on top of the tax on essential goods and services that consumers must absorb.


Inflation 

Inflation comes in two sizes: flexible inflation and sticky inflation.

The chart below plots each as the stand today:

Chart Description automatically generated

The initial spike was mostly flexible inflation, which includes food and industrial commodities that are plentiful, and are impacted by supply and demand forces.

The much more serious inflation, which Jerome Powell completely missed, was the supply constraints caused by the global push for zero carbon emissions … 

China and India have massive needs for electricity and renewable energy cannot fulfill their needs … This has created a “sticky” inflation, which has a long way to go.

Coal, oil, and natural gas demand is soaring at a time when supply is low due to restrictions making it difficult for producers to get funding to invest in projects that could increase capacity.

I believe we continue to be on a path of accelerating inflation, and it will force many central banks to tighten even though growth is slow. 

For this reason, I believe the inflation scenario creates a dangerous situation for financial markets.


Policy 

Government 

Current Fed and Government policy creates a very volatile underbelly for the markets. First I’ll talk about the Government …

There are two major divides in Congress now. You have the progressives/Pelosi divide, and you have a Manchin/Pelosi and Schumer divide … 

However, the Democrats want to continue spending, and they will find a way.

Fed

The taper is a very big deal because growth is subpar. If the Fed goes ahead with a QE Taper in November, I think we could see a December meltdown similar to 2018.

If they pass on tapering, we could see a spike in equities and commodities, while bond prices drop.

The big wild card is the fact that Rob Kaplan and Eric Rosengren were found trading large amounts of S&P futures during the COVID crisis.

This is a scandal that could impact Powell’s reappointment as Fed chairman, which would give the administration control over the new appointees. 

With three new dovish appointees, Janet Yellen and the Treasury could take control of monetizing the debt and sending new stimulus directly into the economy … 

That is an extreme hyperinflationary scenario which we can’t rule out at this point …

It should be an interesting fourth quarter. 


Conclusion 

The bottom line is the S&P 500 is +15% year to date, and as you can see from the chart below, global flows into equities have already reached over $1 trillion dollars this year  …

Chart, line chart Description automatically generated

The ever rising prices were supported by investor confidence that the Fed would provide stimulus whenever needed.

Well, now Fed support is ending, and confidence could be cracking just as Price to Sales ratios are sky high … 

Chart, line chart Description automatically generated

Bring It Home 

I still believe the Democrats will come to an agreement and both spending bills will pass. We will see a consistent reduction in COVID cases, and the reopening should lift growth in the fourth quarter …

The Fed is the biggest wild card, but with consumer sentiment so low and the labor market still soft, J. Pow may have enough cover to pass on tapering. 

This may seem like a best case scenario, but it is also the most likely. I’ll continue to search for clues that clarify the most likely path and will report back … 

Have a great weekend everybody and as always …


Live and Trade With Passion My Friends,

Griff

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