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Inflated Fears of “Rigged” Markets and Hyperinflation
[By Rick Kahler CFP®]
BIO: Rick Kahler resides in Rapid City, South Dakota and is a fee-only financial planner.
Your thoughts are appreciated.
EDITOR’S NOTE: It has been a few years since I spoke with my colleague Rick. But, I read his newsletters and blog regularly and suggest all ME-P readers do the same.
Dr. David E. Marcinko; MBA
[Editor-in-Chief]
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Filed under: Experts Invited, Financial Planning, Videos | Tagged: Financial Planning, inflation, Rick Kahler CFP® |
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INFLATION
Considering the increase in commodity prices, including lumber, gasoline and others the true inflation rate is higher than officially stated. Yes, there are reasons for price increases in those sectors but the increases affect other sectors.
For example, costs to repair homes and new home construction are affected by lumber costs.
Eddie Davis
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Deflation NOT Inflation
Outside of perhaps cryptocurrencies, there may not be a more popular topic in the financial markets today than inflation. It’s something that we really haven’t seen to any significant degree in years and years, but the massive government stimulus packages along with borrowing and liquidity programs designed to restart the economy are raising concerns that inflation risk could be back on the table again.
Just look at how often the word “inflation” is showing up in corporate earnings calls.
Whether or not it ends up being a real market risk remains to be seen. The headline U.S. annualized inflation rate came in at 2.6% in March, well above the Fed’s previous 2% target, but still not enough for Jerome Powell to be concerned. He largely blames the figure on low base effects from the COVID recession and has repeatedly referred to inflationary pressures as “transitory”. Regardless, inflation has become a major source of concern for many market watchers.
One piece of evidence used by many making the inflation argument is interest rates. Since the beginning of August 2020, the 10-year Treasury rate has risen from just above 0.5% to more than 1.7% by the end of March 2021.
If interest rates tend to follow inflation expectations higher, it would stand to reason, some would say, that investors are beginning to price in this risk. Interest rates were rising. Commodities prices were rising, which is a source of cost-push inflation. TIPS were outperforming relative to other Treasuries. All of the signals were pointing in that pro-inflation direction.
But then this happened.
Instead of rising further, 10-year Treasury rates first stabilized and then dropped 15 basis points as the fixed income markets calmed and short-term volatility dropped. As I studied this a little more and looked at this in conjunction with the way other asset classes are performing, I think it’s actually becoming easier to make the case that maybe it’s not inflation that’s the big risk here. Maybe it’s actually deflation.
There are a few different factors that play into this narrative. The anti-inflation crowd might argue that the recent rise in interest rates was due not because of inflation, but because of the rebound in economic growth helping to normalize the rate curve. There could be some credence to this idea when lined up with current gold prices. One might think that gold, which is often considered an inflation hedge, would also be rising here. Yet, it’s been falling steadily for the past 9 months. Some of these inflation signals might not be actually signalling inflation at all.
A lot of folks might point to rapidly rising commodity costs as clear evidence that inflation is here. While that may be true in the short-term, the long-term implications of soaring input prices could actually be deflationary. With such a sharp and sudden increase in prices, companies haven’t had the opportunity to react in the same way they would under slowly and steadily rising price conditions. Most companies haven’t had the opportunity to pass on higher prices to customers, so their margins are getting squeezed, while consumers are now dealing with significantly higher food, gas and healthcare costs. Higher costs in these items could result in lower demand for other goods and services.
The biggest factor might be the current national debt situation. The idea of higher taxes on the wealthy and a higher capital gains rate is a step in the right direction, but only if it isn’t met with a corresponding increase in spending. With infrastructure, climate change and universal child care proposals already on the table, it seems unlikely that increased tax collections will be going to pay down existing debt. That leaves the country in a potential debt spiral that probably ends badly.
Studies have already demonstrated that additional debt has diminishing marginal returns.
Debt spending may provide a short-term economic boost, but that tends to fade eventually. The government is then faced with a higher debt load and the prospect of raising more debt in order to provide the next economic boost. The sheer degree of leverage and over-indebtedness that is starting to plague our economy could ultimately lead to a deflationary, not inflationary, spiral. The Treasury market could be telling us that the market’s thinking is starting to turn in that direction.
If this plays out, it could result in more risk-on, risk-off scenarios. The ATAC US Rotation ETF (RORO) is an exchange traded fund designed to identify the conditions which suggest investors should add or remove risk from their portfolios and position the fund accordingly. By using the prices of lumber and gold as indicators for cyclical strength and weakness, the fund aim to get ahead of any potential pivots in market sentiment.
With the financial markets facing increasing pressures and the risk of long-term deflation looking more possible, investors may want to consider planning now for a potentially higher level of market volatility down the road. The strategies of both ATACX and RORO to limit downside exposure in these types of environments could be an ideal addition to portfolios.
Sincerely,
Michael A. Gayed, CFA
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