What’s that smell? Is something burning? Is the world’s money on fire? Or is the world on fire?
Financial markets got a lot more interesting (and volatile) last week, with the release of inflation measures in the US and China. From raw materials to finished goods, the fires of inflation are spreading. But is this inflation ‘transitory’, as US Federal Reserve Chairman Jerome Powell has described? And either way, what does it mean for Australia and Aussie investors?
Let’s begin with the data. The first hammer to drop was the news that consumer prices in the US were burning. Here’s CNBC:
‘Inflation in April accelerated at its fastest pace in more than 12 years as the U.S. economic recovery kicked into gear and energy prices jumped higher, the Labor Department reported Wednesday.
‘The Consumer Price Index, which measures a basket of goods as well as energy and housing costs, rose 4.2% from a year earlier. A Dow Jones survey had expected a 3.6% increase. The month-to-month gain was 0.8%, against the expected 0.2%.
‘Excluding volatile food and energy prices, the core CPI increased 3% from the same period in 2020 and 0.9% on a monthly basis. The respective estimates were 2.3% and 0.3%. The increase in the annual headline CPI rate was the fastest since September 2008, while the monthly gain in core inflation was the largest since 1981.’
This tends to happen when the government is mailing out trillions of dollars’ worth of cheques. It’s perplexing that investors were surprised. Tech and growth stocks on the Nasdaq swooned on the news. Higher inflation usually means higher interest rates and slower growth. The ‘growth’ premium on expensive stocks falls (and so do their share prices).
The pundits on CNBC got busy spinning up a narrative about how inflation for the little people is actually a GOOD thing. It’s driven by the US opening up. States are abandoning mask mandates. People are spending. The end of the pandemic is near!
But then came the news that further up the supply chain, where companies make actual things, prices were rising. And how could they not be? As we’ve shown readers of The Bonner-Denning Letter, the most bullish non-tech stock price action this quarter has been in corn, soybeans, lumber, and other commodities. Here’s CNBC again:
‘The Producer Price Index rose 0.6% from March, according to the U.S. Bureau of Labor Statistics. Year over year, the PPI spiked 6.2%, the largest increase since the agency started tracking the data in 2010. Economists polled by FactSet were expecting a 0.3% monthly increase in April and 3.8% year over year. The core PPI, which excludes volatile items like foods, energy and trade services, rose 0.7% in April from the previous month and jumped 4.6% year over year. The increase from a year ago was the biggest jump since 2014 when the department first calculated the data.’
If you’re excluding costs that businesses use every day — like energy — and prices are still rising 4.6% year-over-year, then actual inflation is probably much higher than reported inflation. The same is even more true in consumer prices, which don’t factor in the red-hot US property market. Everything is running hot in the US.
And China too! Little reported in the American press was China’s 6.8% increase in PPI over the last 12 months. China’s National Bureau of Statistics reported that little gem. And it confirmed that factories are going to see profit margins squeezed by rising raw materials prices unless they raise prices to the traders that send China’s finished goods all around the world.
Which brings me to Australia. For most of the first decade of this millennium, the world’s supply chain began in Australia. It was iron ore that turned into the steel to build Chinese factories. It was Aussie coal that went to power plants in China, Korea and Japan to churn out more cars, electronics, and white goods. And it was Australian wine, wheat, beef, and mutton that filled hungry middle-class bellies in China, Japan, and the Middle East.
Take a look at the chart below. It’s the ratio between the S&P 500 (financial assets) and commodities (real assets). Of course, there are some commodity and real asset companies listed on the S&P 500. And yes, these are two US-based indices. But the comparison between the two tells you a lot about what to expect for Australia’s resource-dependent stock market. What should you expect?
The big ‘stuff’ rally is coming
Commodities prices bottomed as the Nasdaq was topping. That’s the low point in the ratio between 1999 and 2000 (the Nasdaq topped in March of 2000). The first wave of the commodities ‘supercycle’ was rising oil prices. Oil peaked at over $147 per barrel in July of 2008. Then gold took over, peaking around US$1,900/oz in August of 2011.
You can see that the crashing oil price drove commodities lower relative to stocks. Gold held on. But once the gold price broke, stocks rallied hard relative to commodities. It didn’t hurt financial assets (or their owners) that global central banks were pouring money into bond markets to lower the cost of government borrowing. This drove bond yields down, and made growth stocks even more attractive on a relative basis.
The ratio itself didn’t do much last year except make a low. And now here we are. But if this is a commodity cycle, what kind of commodity cycle is it? In the 1970s, it was inflationary and largely driven by the dollar being decoupled from gold in 1971 and OPEC’s oil embargo. It was an energy crisis.
In 2000, China had just entered the World Trade Organisation. A great offshoring of manufacturing from North America to the Pearl River Delta took place. This triggered a three-stage commodity boom in Australia. First, the price shock, in which increased Chinese demand drove prices way up.
Then, as Aussie commodity producers realised there was no satisfying China’s voracious appetite for copper, bauxite, iron ore, and coal, came an investment boom. That led to hiring, new mines, and new productive capacity. Then came the third wave. All that new production came online.
By then prices had started to fall in some sectors. But what the producers had lost in pricing power, they could make up in volume. Their new investment paid off with increased production. But by the then, the ‘supercycle was over’. And now?
If this is a new commodity bull market, it will be driven purely by global monetary debasement and a flight into real assets. The US is not the only country leading this debasement with stimulus, fiscal deficits, and an expanding central bank balance sheet. But because commodities are priced in dollars, the US is by far the most important factor.
Federal Reserve Chairman Jerome Powell says inflation is transitory because Americans will spend their stimulus and then get back to work. Only that’s not happening. Over six million Americans remain unemployed. There are over seven million job vacancies. When you pay people not to work, they do a very good job of it.
Meanwhile pressure on wages is rising. Employers wanting to ‘open up’ are finding it hard to hire. Once hourly wages start to climb up, how long do you think it will be before retail and consumer prices follow? Answer: it already IS happening.
All these rising numbers add up to a question for investors: if inflation is back, do you try to ride the resulting boom in raw materials prices? Do you hang on to world-changing tech stocks and hope they don’t do another dotcom-style crash? Or do you try to escape the system altogether with gold and cryptos?
Meanwhile, at a purely psychological level, the last year has been one giant experiment in crowd psychology hasn’t it? It turns out you can pretty easily modify people’s behaviour through fear. This is good for the government because it means you can turn people against one another to distract them from your own incompetence or your thinly-disguised lust for power.
Late in the week, the US Centers for Disease Control and Prevention (CDC) announced that it was relaxing its guidance on wearing a mask inside or out. The CDC said if you’re double vaxxed, you can take off the holy rag. It didn’t say how businesses and organisations should determine who is double vaxxed and who is not.
This creates a temporary dilemma which makes for amusing social watching. People will no longer know what to think of other people based on how they look. Is someone not wearing a mask because they are double vaxxed or they never wore a mask anyway? Is someone wearing a mask because they are not double vaxxed or because they ARE double vaxxed but don’t know if everyone else without a mask is.
My prediction: the masks will fall quickly. The government would like to force businesses to develop a technology driven system for determining vaccine status. In some places in the US (and Australia) you’ll get a new version of ‘separate but equal’. Society will be segregated by identity. Only this time, it won’t be between blacks and whites but the jabbed and the unjabbed.
That’s what will happen if Joe Biden, Dan Andrews, and Jacinda Ardern get their way. But I suspect ordinary people will get back to being ordinary people quite quickly. The masks will fall and become a thing of a very strange past.
A small portion of the population — with compromised immune systems or permanently damaged brains that have turned them into perpetually fearful zombies — will continue to wear a mask. And some nutjobs will continue to politicise public health by wearing the mask as a symbol of fealty to Fauci and public health administrators (who’ve been intoxicated with power for over a year now and will probably miss all the free air time, and bossing around the plebians).
But maybe just maybe the whole mess will subside as a mania. All we have to worry about next is the panic of inflation and the coming crash in equities. Good times are here again.
Editor, The Rum Rebellion
PS: In a brand new report, market expert Vern Gowdie warns of the dangers waiting in a post-COVID-19 world. Plus, he outlines the steps you should take now to protect your wealth. Learn more.