The Answer Is Critical To Your Financial Health!
It is important to anticipate whether Stagflation is stalking because the
yield curve will start pricing it in which will place equity yields, earnings
and PE growth multiples at risk.
We believe there are clear signs of stagflation already occurring and
according to the recent Global Fund Manger Survey, many believe if we
don't already have elevated Inflation and an emerging period of
stagflation, we can soon expect it!
Yield Curve
What is particularly critical to the equities market is how the yield
curve will react differently regarding whether it anticipates increasing
Inflation through Reflation or Stagflation. If it views reflation the yield
curve will shift up but also steepen as long-term yields increase faster than
short term yields. If it sees stagflation because the drivers
for inflation also impede economic growth, then the yield curve also
shifts upward but instead can be expected to flatten. The longer-term yields
rise slower than the short term yields.
In both case yields rise which places pressures on equities but the shape
of the yield curve has the most profound impact on equity prices. In
the last 5 years 71% of equity index increases are a result of P/E
multiple expansion from 10X to 18X. This places PE multiple of the S&P
500 currently in the 90 percentile of historical valuations relative to the
last 40 years. Anticipating what may occur is presently of the utmost
importance to smart investors.
The 10 Year US Treasury Yield lifted violently on the Trump victory and
reflation policy expectations. After a brief consolidation it has again
aggressively moved up but it is important to view this as part of three
reasons bond yields increase - 1- Economic growth rate, 2- Inflation and
3-Creditworthiness. The current Treasury yield lift in my judgment is more
about the pending congressional US debt ceiling hurdles and potential Creditworthiness
factors than reflation or stagflation concerns.
Stagflation
STAGFLATION: "Is persistent high inflation combined with high
unemployment and stagnant demand in a country's economy"
Stagflation is very costly and difficult to eradicate once it starts, both
in social terms and in budget deficits. It is a situation in which the
inflation rate is high, the economic growth rate slows, and unemployment
remains steadily high. It raises a dilemma for economic policy, since actions
designed to lower inflation may exacerbate unemployment, and vice
versa. Historically, inflation and recession were regarded as mutually
exclusive, the relationship between the two being described by the Phillips curve.
Economists offer two principal explanations for why stagflation occurs:
First (Think: '70's) stagflation can result when the
productive capacity of an economy is reduced by an unfavorable supply shock
that causes an increase in the price of oil for an oil-importing country.
Such an unfavorable supply shock tends to raise prices at the same time that
it slows the economy by making production more costly and less
profitable. Milton
Friedman famously described this situation as "too much money
chasing too few goods".
Second (Think today), both stagnation and inflation can
result from inappropriate macroeconomic policies. For example, central banks
can cause inflation by allowing excessive growth of the money
supply, and the government can cause stagnation by excessive
regulation of goods markets and labor markets. Excessive growth of the money
supply, taken to such an extreme that it must be reversed abruptly, can be a
cause. Both types of explanations are offered in analyses of the global
stagflation of the 1970s: it began with a huge rise in oil prices, but
then continued as central banks used excessively stimulative monetary policy
to counteract the resulting recession, causing a runaway price/wage spiral.
Let's consider the four elements of stagflation, 1- Inflation, 2-
Unemployment, 3- Demand and 4- GDP Growth to see whether this is a real
possibility for the US.
1 - Inflation
According to The Federal Reserve, entrusted with monitoring and managing
Inflation pressures in the economy, until recently it is has been low and
well below the Fed's 2% target. But the times they are a changing!
Since this time last year inflation expectations have been increasing
steadily and rose even more dramatically with the Trump Presidential victory.
The Trump spike was a result of his proposed economic stimulus programs such
as Infrastructure and Defense.
However, it is isn't just expectations that have been increasing, but
also actual price tags.
Some price increases have been much higher than how such measures as the
CPI tabulates inflation.
From a long term historical perspective (if you believe government
statistics) the inflation rate is still relatively low.
However, taking out "special" government adjustments such as
"Substitution", "Hedonics" and "Imputation"
along with the other changes that have been made by the government since
the early 80's, we see the real picture.
ShadowStats.com which tracks inflation closely show that in fact if we
consider inflation in terms of how the government calculated it in 1980
(before interest rates started falling abruptly) you find it approximates 10%
per annum! I personally believe this much more closely matches what the
average US household would suggest they are experiencing.
CONCLUSION: We DEFINITELY have inflation and it is worse than the
Federal Reserve acknowledges or is actually aware!
2 - Unemployment
According to the government narrative we have low unemployment with
concerns about a tight labor market. This is pure fabrication or minimally
misinformation and distortion of the facts. John Williams at ShadowStats
again shows the reality.
The ShadowStats Alternate Unemployment Rate for January 2017 is 22.9%.
'
We presently have a labor force participation level at historically low
levels with nearly 100 million working age adults not in the work force and
many with jobs not able to to get sufficient hours to support a middle class
life style.
As Presidential candidate observed at a campaign rally in front of 30,000
people. "If the unemployment rate was really 5% do you think we would
really have this many people here!" Do you believe government statistics
or "your lying eyes"?
CONCLUSION: We have high a very high unemployment and
under-utilization of the American workforce.
3 - Demand
What we have in the US is "Artificial Demand" rather than
"Stagnant Demand". The difference being that the former temporarily
camouflages the later - but only temporarily as in reality we have
"Stagnant Demand" being camouflaged by massive credit expansion and
low finance rates. This only brings demand forward creating a demand void in
the future.
Consider that Consumer Credit is rising rapidly in comparison to Disposable
Income. In other words we are borrowing increasingly to make ongoing
purchases but those purchases are not increasing. Debt is surging to buy the
same amount of stuff -- not more. In reality real economic demand is
shrinking and is only presently artificially being supported.
CONCLUSION: We have Weak Demand being supported by high levels of
credit in relationship to disposable income.
4 - Growth
How can the US current GDP levels seen to be anything other than terribly
weak! Thus far this quarter 1Q17 is tracking at 1.8%
The common narrative is that the US is entering a golden age in its
economy and that this growth will drive stocks ever higher. The reality is
that GDP growth has collapsed. The third quarter of last year (3Q16) was the
quarter everyone thought signaled a new beginning with growth of 3.5%.
However, the very next quarter’s growth (4Q16) collapsed to 1.9%.
Put simply, growth is NOT coming soon if at all. Even Trump’s top economic
advisor has admitted that GDP growth of 3% is unlikely until the end of 2018.
CONCLUSION: We have historically weak economic growth
Summary
It is hard not to conclude that we are already living in a period of
STAGFLATION which the markets have yet to fully recognize (may we
suggest "Cognitive Dissonance"?).
There is little way out other than praying for the Trumponomic
Economic miracle that the markets are so clearly euphoric about! Of course I
have never found prayer as a reliable approach to investment strategy!
