IN-DEPTH: TRANSCRIPTION - UnderTheLens - 10-23-24 - NOVEMBER - Reigniting Inflation
SLIDE DECK
TRANSCRIPTION
SLIDE 2
Thank you for joining me. I'm Gord Long.
A REMINDER BEFORE WE BEGIN: DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are COMMENTARY for educational and discussions purposes ONLY.
Always consult a professional financial advisor before making any investment decisions.
SLIDE 3 – COVER
I currently feel comfortable that until year-end 2024 the markets will perform quite well.
Because of the massive degree of global Excess Liquidity and weakening interest rates, 2025 could also be another great year for equities!
However, sometime in 2025 the markets will begin discounting what lies ahead.
That is because the underpinnings of the booming stock market will finally crumble as Bond Market Yield volatility and other factors we will discuss will begin to wreck serious havoc on corporate profits.
When exactly that will happen is almost impossible to forecast, but the outcome is not.
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We need to discuss how things are likely to unfold, knowing that timeframes are quite speculative but the eventuality is not.
In that regard I want to discuss the areas outlined here which describes the sequence we are likely to go through in reaching the inevitability of what we call the Beta Drought Decade!
Actually, the path itself has only recently become clearer as the expected pins are increasingly being put in place.
SLIDE 5
Those pins begin with how we have placed a match much too close to the kindling for inflation to be reignited to a similar degree to the inflation waves of the 1970’s.
The match and kindling this time are that of:
- Excess Global Liquidity,
- Loss Financial Conditions of Central Banks and
- Increasing Scarcities as a result of Chokepoints!
However, I don’t want you to be confused here that because inflation will be similar to the 1970’s that either the cause or how we handle the problem regarding interest rates will be the same.
There will be no Paul Volcker solving the problem this time around!
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The US Federal Reserve initiated rate cuts in the September FOMC meeting by 50 bps while Financial Conditions were already extremely loose to an unprecedented degree!
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This is highly unusual with 50 BPS cuts normally associated with a perceived crisis situation.
There are going to be serious consequences of this triggering event which will be fully appreciated and come to light after the election.
Let me explain.
SLIDE 8
We have just experienced the second-longest period in 70 years between Fed rate increases beginning in March 2020 and the September rate cuts. The Fed move was the green light for central banks around the world to follow suit.
They have like a stampede! 71% of central banks are now in accelerated easing mode compared to 9% at the lows.
There is little doubt that longer-term inflation risk, rather than receding, is now baked-in to rising inflation!
SLIDE 9
What we have a Excess Liquidity in parallel with unprecedented loose Financial Conditions.
EXCESS LIQUIDITY = REAL MONEY GROWTH RATE vs ECONOMIC GROWTH RATE
The measure of Excess Liquidity has been found to be one of the best medium-term gauges of risk-asset performance.
SLIDE 10
The G10 excess liquidity leads global assets such as US stocks by about six months (chart right). It started turning up notably in the first quarter of 2023 and has not wavered since. It has been one of the best signs that the stock market’s path of least resistance would remain up.
We are in the midst of almost its largest two-year acceleration in 50 years. We are awash in liquidity to keep the global economy afloat and we are about to make it worse!
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To add "Fuel to the Fire" we are presently witnessing:
- Easing Global Inflation Rates
- Market Belief in Lower Near-Term Recession Risks
- Growing potential for an Increase in Global Real Rates
- Weakening US Dollar (until a weeks ago)?
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… we suspect there is a flight to perceived safety going on as US Credit Default Swaps are exploding higher with few venturing to publicly venture a reason why?
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What the market is not pricing in is that G10 real money growth, even though it is still contracting on an annual basis, is turning up strongly. It is the second derivative that matters for excess liquidity and for risk assets.
Global central banks had timidly begun to cut rates before the Fed, but with the latter now easing there is a greater potential acceleration for deeper cuts and thus steeper growth in global real money.
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Now in the last couple of weeks we have China taking broad initials measures to reflate its economy – we suspect there is still a Bazooka to be fired before the end of Q1 2025
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Liquidity conditions in the US and globally are going from strength to strength, with excess liquidity of the G10 reaching highs breached only twice before in the last 50 years. Stimulus in China and easing in the US will further bolster an already very positive backdrop for risk assets. But too much liquidity will be a problem if it leads to even more stretched valuations and frothy markets liable to correcting.
It’s been a wild ride through the post-pandemic cycle, and it might be about to get wilder. Excess liquidity — by how much real money growth outperforms economic growth — has again risen to a new recent high. It has only been greater twice over the last half-century, in 2001 and in 2020.
Excess liquidity is one of the best medium-term leading indicators for stocks and other risk assets. Only last month I discussed the increasingly favorable liquidity backdrop. But with the latest release of monthly data, G10 excess liquidity has hit levels that demand an update – even more so as Federal Reserve easing and recently announced stimulus in China is primed to take it yet higher.
SLIDE 16
There’s a lot of moving parts to the G10 Excess Liquidity Indicator. Money growth, economic growth, inflation and the currency of all constituent nations feed into it. But while several countries are contributing to the indicator’s recent rise, the biggest influence has been from the US.
Within the US, falling inflation is helping push excess liquidity higher, but the real driver is money growth. M1 in the US has started expanding again after a considerable decline following the pandemic that saw it contracting on an annual basis — a very rare occurrence — and hitting its all-time lows.
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Excess liquidity is a deviation-from-trend measure, so M1, rising from depressed levels it has been stuck at for some time, has a sizable upward impact on it.
In excess liquidity, M1 is used rather than M0, which is mainly bank reserves, as this form of money can remain locked up in the banking system and thus not affect asset prices. Broader types of money such as M2 and M3 are also no good, as they are often counter-cyclical. M1 on the other hand — composed mainly of demand deposits, which banks create when they make loans — is money typically ready to spend (unlike savings deposits, which is why I use an adapted measure of US M1 to exclude them after a definition change in 2020 that added them).
A further tailwind for excess liquidity is the weaker dollar. As the measure is in dollar terms when it declines, other countries’ M1 in USD terms rise. Leading indicators show the dollar is set to remain in a weakening trend. When M1 is growing in excess of economic growth and inflation, that is money which is “excess” to the needs of the real economy and typically finds its way into markets to make a return.
Excess liquidity’s meteoric rise would alone be noteworthy, but it comes as the Fed aggressively kicked off its easing campaign with a 50 basis-point rate cut, and China announced a potentially very significant set of stimulus measures, with more likely in the pipeline.
M1 typically grows while the Fed is cutting rates (or doing QE). Additionally, banks are likely to extend more loans in the coming quarters, boosting M1. They had already been easing lending standards even before policy was loosened. This typically leads loan growth by about a year.
SLIDE 18 – CHINA
Stimulus in China is poised to be game-changing for the global liquidity picture. Even though China does not directly feed into G10 excess liquidity, it’s likely that money there will start growing again from very depressed rates, adding yet more fuel to a very positive liquidity backdrop.
China has been a significant driver of liquidity through most of the 2010s. In the GFC it was contributing up to 70% of global money growth, yet in the last two years China has been a significant drag on global money.
SLIDE 19
In level terms, China amounts to almost a third of G10 M1, and at its peak in 2018 that was 42%. A stimulus-driven rise could therefore have big implications for global assets.
There is the chance this set of measures will fizzle out like previous ones, but this push looks as if China means it. The jury’s still out on whether they will do enough to reinvigorate sustainable growth. But it is likely they will at least generate a sugar-rush of liquidity in the coming months and quarters.
It’s true that greater barriers to trade and investment between China and the West may prevent as much capital leakage as before. But with China still a major trade partner of the US and several other Western countries, and the Chinese adept at evading capital controls, there is still plenty of scope for liquidity to leach abroad.
SLIDE 20
Extremely favorable global liquidity conditions come also as global financial conditions get easier. The Global Financial Tightness Indicator, a diffusion of global central-bank rate cuts, has been rising sharply and is approaching levels rarely exceeded before. That points to stronger US and global growth.
The GFTI has been easing as central banks stopped raising rates and then began to cut them. With the Fed now in easing mode, it will embolden other central banks to cut more if they need to. That looks to be the case with the Advanced GFTI, which gives a lead on the GFTI by about 3-4 months, showing no signs it is set turn around just yet.
SLIDE 21
The outlook for US and global stocks and other risk assets is looking very favorable. But caveat emptor! Such rapid rises in liquidity can lead to increasingly speculative behavior culminating in sharp unstable gains in stocks. That’s particularly an issue when valuations of US stocks are already very much stretched on almost all measures.
Other measures of liquidity should be watched too, specifically potential stress building in the US repo market. But these are shorter-term gauges, and are unlikely on their own to shift the medium-term picture on excess liquidity.
The only occasions the G10 Excess Liquidity Indicator exceeded today’s level were in September 2001 and April 2020. In 2001, this event marked the last dead-cat bounce of the 2000-2002 US bear market before the final selloff, while in 2020 stocks had another +65% rally ahead of them in over the next year and a half.
That doesn’t give much to go on. In the interim, though, it’ll be hard for markets to not keep rising on such a deep well of liquidity. But the scope of easing in the US and China means that “irrational exuberance” is set to make an unwelcome return.
SLIDE 22
We believe in the intermediate term this is going to take the equity markets higher – possibly even much higher than I show here!
SLIDE 23
So where is this leaving the Federal Reserve AND global central banks? It is important to understand the position they are now in and what they are likely to do going forward.
SLIDE 24
Global Liquidity as shown here has now hit all-time high of $107 Trillion! I am sorry for the quality of this chart but this chart was particularly hard to come by!
SLIDE 25
US Commercial & Industry (C&I) weekly lending data continue to explode higher on available liquidity signaling higher investment + activity.
Outstanding C&I loans are already tracking +73 bps Y-o-Y, the strongest growth mark since 2023.
SLIDE 26
The Fed's modern statutory mandate, as described in the 1977 amendment to the Federal Reserve Act, is to promote maximum employment and stable prices. These goals are commonly referred to as the Dual Mandate.
DUAL MANDATE
- PRICE STABILITY => Fight Inflation
- FULL EMPLOYMENT => Stop Layoffs & Recessions
THE FED'S FIRST PRIORITY
- The reality is that Inflation reduces the government's debt burden, while full employment increases tax revenues.
- The Fed historically will lean towards sacrificing price stability, (inflation and the US dollar), to protect maximum employment, (minimize job losses which are particularly disruptive to profits, the banks, the bond market and politicians).
SLIDE 27
1- PRICE STABILITY & FIGHTING INFLATION
The Covid Supply Shock, which triggered the first wave of inflation, forced the Fed into significant increases in the Fed Funds Rate. With the lag delay associated with the Rate Cuts, we have only recently seen Inflation rates fall, but are still in the 3% range and not the 2% target.
SLIDE 28
However, we are now only beginning to experience new inflation drivers just as the Fed has begun cutting the Fed Funds Rate:
- Excess Global Liquidity as central Banks Global rush to cut rates
- The full impact of massive US Fiscal Deficits which are showing with Inflation Expectations being built into the system - Example: the US port workers settling for a 66% compensation increase, while Boeing workers and others head to the picket lines.
- Service Inflation, (as shown in Core and SuperCore measures), is currently accelerating upward and shows no signs of in fact falling.
SLIDE 29
We are now witnessing rising inflation breakevens! US 10 year breakevens have now moved quickly to early summer highs.
SLIDE 30
Market determined inflation expectations are rising significantly when determined through inflation breakevens and zero coupon inflation Swaps.
SLIDE 31
THE SECOND MANADATE IS FULL EMPLOYMENT & LABOR MARKETS
Downward revisions in global EPS raise concerns, suggesting that the global economic landscape is precarious. This is prompting central banks to adopt more aggressive strategies to stimulate growth and wholesale reductions in Interest rate.
The Federal Reserve has been the last to follow.
SLIDE 32
The U.S. ISM manufacturing index reading below 50 signals a contraction in manufacturing activity. Historically, this has correlated with falling labor numbers.
SLIDE 33
Shifting consumer perception regarding job availability suggests notable change reflecting a rise in the U.S. unemployment rate, (likely to be reflected in BLS reporting after the election)
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CONCLUSIONS
- Liquidity conditions in the US and globally are re-igniting inflation.
- Meanwhile slowing Global Economic conditions are increasingly weakening full employment.
- Stagflation is becoming a bigger problem than a Recession. A "No Landing", Stagnation environment is currently the outlook.
- Weak GDP with elevated Inflation is harder for the Fed to fight than just two quarters of negative GDP (a recession).
- The fight against Stagflation is "on Deck" waiting for its turn at bat!
Expect the Fed to lower rates to fight slowing economic conditions while Inflation worsens.
SLIDE 35
Contrary to what the media is indicating, inflation is anything but behind us!
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We are witnessing a significant surge the pricing of Inflation Swaps a s shown here …
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… and in Inflation Expectations as shown here.
The underpinnings for this are clear. The market is saying Inflation has not been beaten and the Fed rate cuts are premature!
SLIDE 38
Mainstream media is not covering this during the election period for a number of reasons.
One of those reasons may be as simple as they don't understand that the nature of the Inflation problems has changed!
If we break down inflation into its four main components, we find that it’s substantially all about services at this point. That’s been true for a while.
Goods prices are deflating, but helped cause some of the disappointment because that’s happening less quickly than earlier in the year.
We seem to forget that the US isn’t the Industrial giant it used to be – We are a Service Economy.
A Service Economy built on Consumption.
Services and Consumer Expectations are centrally important!!
SLIDE 39
This chart shows core services’ contribution to overall inflation compares to the entire index’s other components.
The great spike in price rises that came the year after the pandemic was almost comprehensive, and it has run its course. What remains is grinding down the services inflation that followed the rest, and tends to be driven by wages.
SLIDE 40
The Fed’s favored “Supercore” measure of inflation, of services excluding shelter prices, has some bad news. It’s ticking up again, and the annual rate remains above 4%. That would make continued jumbo interest rate cuts very difficult.
SLIDE 41
If there’s reason for concern, it’s that the period of steep decline seems to be over (and goods prices have even ticked up again), with headline inflation still above 2%.
TS Lombard’s Stephen Blitz produces a diffusion index of the proportion of Consumer Price Index components whose three-month average is higher than their 12-month rolling average — a measure of whether the trend is increasing or decreasing.
SLIDE 42
On that basis, it looks like inflation has come to rest at a level that is still too high for comfort.
THE SCARCITY WAVE 2 HAS LIKELY STARTED WITH SKILLED SERVICES.
(or soon will be)
SLIDE 43
Here is where it gets a little confusing about what is going to happen – as if it isn’t always when looking at the future.
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There is little double that elevated inflation is going to be with us for awhile.
Like the 70’s showed us it can come in waves. We have all the ingredients for the next wave well in place.
It is going to be about increasing levels of shortages and scarcities.
With both US political parties taunting Tariffs if elected that almost assures it!
SLIDE 45
But unlike the 70’s Inflation won’t be fought by increasing rates!
It won’t be about oil prices shooting higher! Don’t for a moment confuse oil prices with being the same as your energy prices.
Oil though volatile lately won’t be the driver it has been as global economies increasingly slowdown.
SLIDE 46
Long duration Yields will head higher and likely stay elevated – but again not like the 70’s where we fought inflation with high rates.
SLIDE 47
High Inflation and Slow Growth is Stagflation. We have talked about this road map many times before including in our 2023 Thesis Paper “Great Stagflation”!
SLIDE 48
This time we can expect the Fed will opt as we discussed earlier to taking rates down to fight slowing economic conditions and weaken employment. Remember, central banks only control short term rates.
As conditions weaken further central banks will resort to Yield Curve Control (YCC), new forms of QE and Twist to manage long duration rates. Even the Treasury will be involved with their new Buyback Program which I have discussed in our weekly newsletter.
SLIDE 49
The biggest problem the US faces is continuing to finance its debt during this period. However, in an environment of a slowing global economy we are highly likely to see a weakening Yen, Euro, Pound and Yuan against the US Dollar which will make elevated US Yields highly attractive for the Carry Trade.
SLIDE 50
With:
- Low US rates,
- A stable dollar,
- Unprecedented levels of excess liquidity and
- A global flight to safety
Potentially, it is going to be a very good time for US equities.
2025 could turn out to be a big year for the US markets.
SLIDE 51
However, it won’t last!
The global markets are likely to face dramatically lower annualized returns over the next decade.
This is why we call it the Beta Drought Decade in out Thesis papers.
It is going to be a fascinating ride!!
SLIDE 52
As I always remind you in these videos, remember politicians and Central Banks will print the money to solve any and all problems, until such time as no one will take the money or it is of no value.
That day is still in the future so take advantage of the opportunities as they currently exist.
Investing is always easier when you know with relative certainty how the powers to be will react. Your chances of success go up dramatically.
The powers to be are now effectively trapped by policies of fiat currencies, unsound money, political polarization and global policy paralysis.
SLIDE 53
I would like take a moment as a reminder
DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are for educational and discussions purposes ONLY.
As negative as these comments often are, there has seldom been a better time for investing. However, it requires careful analysis and not following what have traditionally been the true and tried approaches.
Do your reading and make sure you have a knowledgeable and well informed financial advisor.
So until we talk again, may 2024 turn out to be an outstanding investment year for you and your family?
I sincerely thank you for listening!
