Guest Haymaker
Insightful content from the "Kal" half of GaveKal!
“When all the experts and forecasts agree, something else is going to happen.” -acclaimed stock market technician, Bob Farrell
Charts of the Week
A persistent driver of inflation has, of course, been medical costs. Similar to higher education, a key factor behind why health care expenses have far outpaced the CPI is almost certainly the exponential growth in administrators. The contrast versus the modest increase in the number of physicians is truly stunning… and appalling. Unfortunately, this isn’t a trend that appears to be reversing or even moderating. It begs the question: Has America become a nation of bureaucrats?
This newsletter frequently extols the benefits of tracking multi-year breakouts and breakdowns. (My experience is that three years is the minimum timeframe to be significant.) As previously conveyed, these are not only informative with stocks and commodities, they also work well with economic trends. For example, the inflation eruption back in 2021 decisively broke through the CPI’s upper band that had been in place for over a decade. This should have alerted the Fed and other central banks that they had a serious inflation problem on their hands. Unfortunately, most didn’t start tightening until 2022. By that time, inflation was out of control. Regarding commodities, one of the best breakout signals seen in recent years was with uranium. It generated buy signals in 2020, 2021 and again last year.
CPI, from 2007 to 2024 - (Click chart to expand)
Uranium - (Click chart to expand)
Hello, Readers!
Anatole Kaletsky (the “Kal” in Gavekal) is writing on last week’s complacency-rocking CPI report. He’s spot-on that many are dismissing it on technical grounds.
Inflation, like so many major economic trends, is very confusing right now. There are numerous countervailing forces impacting it but I do think a key reason that Anatole is right the Fed will have a hard time keeping inflation down around 2% is due to pay increases.
Strikes have become far more numerous and big compensation increases over multi-years have already occurred. This tends to spread out to even non-union workers.
However, unlike Anatole, I don’t think the economy is doing that great, especially adjusting for $1.5 to $2 trillion of U.S. govt deficits. Thus, we could see a 1970s-like scenario of sticky inflation and weakening economic growth. Accordingly, it could be a situation of “going stag”, as in stagflation.
Regards,
David “The Haymaker” Hay
Investors Are Hedging The Wrong Risk
Anatole Kaletsky
Tuesday’s higher-than-expected US inflation print for January and the subsequent bond market rout should have dispelled any lingering doubts about two of the main convictions I have espoused since last year. First, the risks to the perfect disinflationary boom investors have been enjoying since Goldilocks returned to the US last autumn are skewed overwhelmingly to the upside. If anything happens in the year ahead to disrupt the perfect conditions now priced in by the markets, the trouble will take the form of an inflationary boom, not a deflationary bust.
Inflation hedges have underperformed...
Secondly, the long end of the US bond market is mispriced for current US economic conditions—and is wildly mispriced for even the smallest chance of the recent disinflation stalling in the 3% range, instead of falling monotonically to 2% and then well below. Unfortunately (at least for me), one of the main investment conclusions I drew from these observations has turned out to be completely wrong so far. I expected vanishing recession risks and upside inflation surprises to drive outperformance by industrial equities, emerging markets, commodities and other inflation hedges. Instead these apparently cheap assets have continued to underperform in comparison with apparently overvalued technology stocks.
...with investor portfolios still positioned
for “immaculate disinflation”
On Monday Louis, who broadly shares my economic outlook, suggested several ingenious theories about the disappointing behavior of cyclical and inflation-hedge assets in response to the recent upside surprises. But he did not mention one simple explanation which Occam’s Razor makes very appealing. Maybe investors simply refuse to believe the recent economic data. Most portfolios today are positioned for a painless “immaculate disinflation,” and to the extent investors own assets for protection these are bonds that hedge against recession, not gold or commodities that hedge against inflation.
With this kind of portfolio structure, contemplating the possibility of an inflationary boom may be simply too painful. As Upton Sinclair said “it is difficult to get a man to understand something when his salary depends on not understanding it.” Accordingly, many investors prefer to look for reasons to disbelieve the data instead of recognizing that their portfolios are wrongly structured. And given the distortions created by reflexivity in financial markets—and exacerbated by indexation, algorithmic trading and other forms of herding—denying reality can continue to be a viable investment strategy for a surprisingly long time.
Wall Street analysts quickly dismissed the
significance of January’s inflation surprise
The responses of Wall Street analysts to Tuesday’s inflation data—and the contrasting performance of bonds and equities over the subsequent session— offered a good illustration of this behavior. Most analysts initially poured scorn on the shocking CPI data, especially the 0.4% month-on-month rise in core CPI. Analysts pointed out that roughly half the core increase was due to shelter. They argued that proprietary housing gauges suggest the shelter component will soon start falling (although this same prediction has been made since last summer and some proprietary housing indicators have now resumed rising), that many goods prices are still falling, and that healthcare costs were the biggest source of new inflationary pressure and can be measured in many conflicting ways.