CPI Manipulation

The debate about inflation being transitory or not misses the point.   It doesn't focus on the tool for measuring inflation.  The goverment has changed how the CPI measures inflation over the past 40 years, with the biggest change happening in early 1980s and the early 1990s.  Here is what Shadowstats shows if using the 1990 style CPI measurement. 

You can see that the difference between the 1990-based CPI and the official CPI has grown since 2000, from about a 2.5% average differential in the 2000s to around a 3.5% average differential in the 2010s.  Shadowstats CPI based on 1990 measurements would show an average of 5% CPI inflation over the past 30 years.

From 2001 to 2021, crude oil has gone from $23/barrel to $73/barrel, a 6% annual increase.  Corn has gone from $2.10/bushel to $6.75/bushel, also approximately 6% annual increase.  From 2000 to 2018, the median monthly apartment rent went from $841 to $1588, a 3.6% annual increase.  From 2000 to 2020, median single family home prices have gone from $119,000 to $334,000 according to the US Census, a 5.3% annual increase.  Also, these price increases don't factor in the fact that new apartments and houses are built smaller than in the past, yet are priced higher.  That would probably add 5-10% to the actual price/square foot.  So those estimates are under reporting shelter inflation.

 So if you have corn and oil prices as a proxy for food and energy, that has gone up 6%/year, and monthly apartment rents and housing prices have gone up 3.6% and 5.3% respectively, so averaging out to 4.5%/year (not considering that new homes and apartments are definitely smaller than older ones).  So food, energy, and shelter, the basic goods that people need, has gone up way more than the CPI.  This also doesn't look into service costs like healthcare and tuition, which has gone up at an even faster rate than the above.  

So how does the CPI measure inflation over the past 20 years at an average of around 2%?  Its lies, damn lies, and (government) statistics.  Substitution effects, hedonic pricing, etc.  

And this doesn't even cover asset price inflation, such as stocks and bonds, which as income producing assets, give you less income when bought at inflated valuations, as they are now.  The very definition of inflation.  Getting less while paying more.  

So the whole argument about whether inflation is transitory or not is ignoring the elephant in the room.  The measurement of inflation.  Its flawed and manipulated. Inflation has been much higher than the average reported 2%/year, which would be obvious for anyone with a half decent memory.  So letting inflation run hot above 2% is really a joke.  By that measure, they've let inflation run hot for the last 50 years!  The government has only gotten more zealous in manipulating the CPI lower over the past 20 years, thus allowing the Fed to pretend like inflation is low so they can keep rates low, and do QE, reducing funding costs for the government without sacrificing the currency, and boost the stock and bond markets. 

With this kind of government manipulation of inflation statistics, of course inflation will be transitory.  These higher inflation numbers will raise the baseline number for which the next year's inflation will be measured against, thereby making it harder to have "high" inflation due to base effects.  In the end, where inflation goes up in a stair case fashion or a straight line, there will always be an excuse by the Fed to say that high inflation is transitory, and can be ignored, and low inflation can never be ignored and is a sign of deflationary forces that need to be fought by printing massive amounts of money.  So either way, whatever inflation is printing, the Fed will keep their loose monetary policy.  

Its the only way to service $30 trillion in debt without any pain of having to pay massive amounts of interest on the debt.  Keep those interest payments low with ZIRP, and try to keep the dollar from weakening by repeating the strong dollar mantra which is all talk, no action.  

Market action is back to usual low vol, grind up market.  A good market for long investors, a bad market for traders.  Not much edge here on either side.

The Grind Continues

You think they will let you buy that easily?  Over the past 2 months, since the SPX broke 4000, the consensus view among the market "experts" is that its gone up too much, too fast, its too frothy and speculative, and the market is due for a pullback.  I've mentioned before that the usual permabull Tony Dwyer, from CNBC, has been looking for a pullback since the 3900s in March.  He's just an example.  There are tens of thousands who think exactly like him.  They are usually wrong when they get bearish, counter to their permabull tendencies.  These active market participants, who bemoan the growth of passive investing, are badly lagging the indices again this year.  They are perpetual underperformers who criticize how dumb passive investing is, and yet fail to beat the S&P 500.  

The big wall of worry now is the Fed taper.  Its not even about when taper will start, its about when Powell will officially talk about tapering on some undisclosed time in the future.  If you are looking for a bear catalyst, the Fed will not be the ones providing it.  

Powell is so over the top dovish, even more so than that supposed owl, Lagarde of the ECB, and even more than permadove Kuroda of the BOJ.  He mealy-mouthed his way through the Congressional testimony, with more transitory inflation psychobabble, trying to placate the markets after the SPX had a 2% drawdown.  He felt the heat from a 2% drawdown.  LOL. 

Powell has officially taken the title of World's Biggest Dove.  He is just acting in his own self interest, as most people would.  Don't hate the central banker.  Hate the game that the financial markets and media have created so that doves are celebrated, hawks are criticized.  As a central banker, it never pays to be even slightly hawkish.  And if you are more dovish than expected, you are praised as a visionary, like Bernanke who some thought single handedly prevented another Great Depression.  LOL.  Remember when Greenspan was considered a maestro?  On the cover of Time and praised constantly as the dotcom bubble got bigger and bigger.  Remember when Bernanke was Time Man of the Year? 

With Powell's re-appointment coming up during the fall this year, he's painfully distorted his view of the economy, in order to nurture this bubble, to get to the finish line, re-appointed by Biden, before this bubble bursts.  He knows that if he does anything more hawkish than already very dovish expectations, the stock market will not like it, and down goes his odds of re-appointment.  

With all of that being said, I actually think its time to ride with the curve flattener for the next 9-12 months.  Not because I believe the Fed will hike rates sooner than the market expects, I see very little likelihood of that happening.  Its more about the way investors are positioned, and how Powell will likely change his tune once he gets reappointed.  Right now, the 5-30s curve steepener is still the popular trade on Wall St., even after the big move from the 140s down to the 110s in the past 2 weeks.  

I remember a mere 3 weeks ago, when, after another disappointing NFP report, all the talk was about positive carry in the 5s,  how much carry there was in being long 5s and short 30s.  I don't hear that anymore, but I still hear talk about how rate hikes are still at least 18 months away, Fed will stay dovish, blah blah blah.  Its not about the Fed staying dovish, everyone knows that.  The time to enter the curve flattener is when the Fed is dovish but transitioning to being less dovish.  Like the end of 2013.  Like the end of 2016.  Yes, there is a carry cost of about 2 bps/month for being in a 5-30s curve flattener, but expect that spread to be below 100 bps by the end of the year.  Right now, as I am writing, the spread is at 118 bps.

On bitcoin.  I usually don't even pay much attention to it most of the time, but over the past few weeks, among the non-bitcoin maximalists, there was quite a lot of pessimism, talk of $20K, if it breaks $30K, something really bad will happen, etc.  Well it broke $30K, and promptly made a panic bottom.  Things like bitcoin, which don't really have any kind of fundamentals, are an eye of the beholder asset.  Like art, or collectibles.   Its goes up and down based on the psychology of its participants.  And after that supposedly hawkish Fed meeting, and recent dollar strength, the negativity was about as much as I've ever seen.  The weak hands have mostly sold.  It appears that those holding bitcoin now, are mostly strong hands.  Looking at the chart, its looks like its basing between 30-40K before another uptrend to who knows what final bubble level it can get to.  Not sure about 100K, but a retest of the all time high looks better than a 50-50 chance.  But I would still rather ride the SPX than BTC. 

There isn't much to add about what's happening in the stock market.  Its a strong market climbing the Fed taper wall of worry, and probably explodes higher into a parabolic buying frenzy once the taper announcement is behind us.  I sold the small amount of SPX I bought on Monday and I'm back on the sidelines.  Still too much call buying for me to be comfortable buying at these levels and holding for a longer term play.  Obviously, not shorting this.  Not making things complicated, keeping it simple.  Waiting for the next dip to buy.  

The Dot Plot Dip

Ok, that didn't last for long.  The FOMC "hawkish" meeting took the SPX down from Tuesday June 15 close of 4246 to a June 18 close of 4166, an 80 point dip.  Those looking for a deeper dip, missed out.  The low happened to come in the Sunday overnight session, post opex, panicky hedgers and stop outs probably the main culprit for the overnight move.  

I have been sanguine about the stock market, expecting a grind higher, but even this quick burst off the overnight low and never looking back in a one way move on Monday caught me a bit off guard.  I was waiting to load up at the Monday cash open and the bounce back move had already started during European hours.   I was able to get a few fills overnight, but not a full position.  Strong markets like this SPX don't give you much time to buy on dips.  The pullbacks are shallow and brief.  

I really only see 2 scenarios for an end to this bull market.  

1) The Fed makes a hawkish pivot and drastically changes its reaction function, focusing more on keeping inflation under control and less on goosing the economy and jobs.  Causing Treasury yields to go noticeably higher.  Unlikely. 

2) A euphoric period of risk taking among institutions, causing a parabolic rise in the equity indices, >10% increase in a month.  That would be a flashing warning sign that we've reached the terminal point of this bubble and an end to the everything bubble.  Likely, but probably later in the year, not just yet.

There was a lot of speculation in the meme stocks, a sign of an imminent turn in the market, and we got that late last week.  The dip was so shallow and brief, I don't think it was enough of a reset or washout to provide an all clear sign to jump in to the SPX.  I am still waiting for a bit better of a buy signal to go in big on the long side. 

Power Flattening

I don't remember seeing that kind of curve flattening after an FOMC meeting since Janet Yellen made a hawkish gaffe in March 2014, causing the belly of the curve to plunge, while the long end barely moved.  This was actually a bigger move than March 2014.  

The 5-30 spread went from 140 to 117 over 24 hours.  The 5-30 curve steepener just happened to be the most popular trade on Wall St.  You really only get these six sigma moves when speculators are offsides.  This looks like the end of the steepener trade has gone out with a bang.  I expect further flattening of the curve over the coming months, as traders re-assess their outlook on Fed rate hikes in 2023 and 2024.  

The June FOMC meeting didn't seem hawkish at all, it just seemed like traders were set up too bullishly ahead of the event, causing that dip in stocks and bonds.  Of course the economic outlook would be upgraded considering how hot the economy is, and those minor changes in the dot plot are just the Fed trying to micromanage their outlook, and act as if they can predict the future, which of course they are horrible at. 

You know you have a crap economy when the central bank decisions are much more important than any fundamental changes in the real economy.  

The Fed will still be too late to act, even more than during the Bernanke years, due to the added high from fiscal stimulus this time around.  This time around, they are fiddling around while asset prices are through the roof.  Its likely that when the Fed actually gets done with tapering of asset purchases, which should take about a year to complete, it will be near the end of 2022, when the Republicans will have probably won at least the House or Senate, and gridlock will be on for 2023 and 2024.  I don't say that to be presumptuous about Republicans winning seats in the midterm elections.  Its basically automatic if you look at the history of a Democrat president with a Democrat majority Congress going into midterm elections.  

So I will act like the pompous and arrogant Fed, with their dot plots and forward guidance, and put out my scenario for the next 24 months.  

For the rest of 2021, with the Fed behind the curve and moving like a turtle when tightening, the stock market bubble gets even bigger, and SPX goes parabolic, busting through 4500, 4600, 4700 like they are midget hurdles.  In 2022, at super bubble valuations for stocks, the market gets unstable.  Much like 2000 and 2018, the volatility and chop get violent, even without any rate hikes, just by the mere act of reducing bond purchases.  By the time the midterm elections come around in November 2022, the stock market has already topped out and entered into a long term downtrend, with the Fed now faced with the decision to start hiking rates as their manufactured bubble is popping before their very eyes.  

Much like December 2015, the Fed probably manages to put out one measly rate hike during the tumult, either at the end of 2022 or early part of 2023, just to maintain a tiny bit of credibility about their forward guidance, and then go into a pause, shell shocked, as the popping of the biggest bubble in our lifetime wreaks havoc.  Eventually the stock market will be down enough and the pain too great and the Fed will relent to the financial markets, as they always do, and reverse their only rate hike and then start QE Infinity Part 2 in 2023.  

Market is looking a bit toppy here, intraday volatility is increasing, put/call ratios have stayed low for a while, it looks like another 100-150 point pullback in the SPX is just around the corner.  I am waiting for it.

Fed Asleep at the Wheel

2018 wasn't automatic pilot, even though Powell said so.  This is automatic pilot.  Automatic pilot QE.  When you ignore the data, when you look in the rear view mirror, when you look for any kind of excuses to justify the $120B/month QE.  Transitory.  Inflation above 2% for a substantial amount of time.  Employment levels back to levels pre-Rona.  Lots of hurdles, very high hurdles that the economy has to overcome for the Fed to put their foot off the gas.  

In a pre 2008 world, which many still believe, especially the fixed income "experts", you assume that a hot economy will get central banks to tighten monetary policy and the federal government to keep their hands off the stimulus button, not pressed firmly on it. 

But we're probably never going back to those markets again.  There is just too much debt.  Unless you have a debt jubilee, you aren't going back to a 2.5% Fed funds rate, much less 5%.  

What you have are central banks who are unwilling to accept secular stagnation.  In developed economies, the natural rate of economic growth is low.  Populations are growing slowly, and there have been no game changer technologies for the last 20 years.  The central banks are trying to solve a secular growth problem with cyclical growth solutions.   Cutting interest rates and doing QE are short term growth drivers, not long term ones.  And with yields so low, QE benefits stocks and bonds, not the real economy. 

Its like the heroin addict who keeps injecting to stay alive, to avoid deadly withdrawal effects, rather than to get high.  

In this irrationally dovish Fed world, where the hurdles are high to tighten policy, you get massive bubbles.  The excess liquidity is also creating huge pools of money that are going to the Fed reverse repo facility in order to avoid negative yields on their cash.  

The US government has clearly overcooked it on the fiscal stimulus, and the Fed is clearly overcooking it on the monetary side.  In this kind of fundamental environment, you can't overthink things.  Trying to be contrarian is the wrong play here.  This bubble will get a lot bigger before it eventually implodes in on itself, it won't be Fed policy that does it.  

So how did we get to this place, where you have such insanely dovish monetary policy?  Its pure incentives.  How did Bernanke become Time Man of the Year?  Because he did QE.  Its a world where the central bankers are lauded for boosting stock markets and bond markets and criticized when they cause stocks and bonds to go down.  Its not about the real economy. 

Remember how much criticism Powell received in December 2018 for raising 25 bps and saying automatic pilot?  There was nothing but praise when he made the pivot the following month and started cutting rates in 2019 causing a strong rebound in the stock market.  Doves are celebrated.  Hawks are criticized.

On a shorter term time frame, anytime the stock market rallies after a Fed meeting, usually when Powell is very dovish, they say Powell did a good job with "communication".  When the stock market falls after a Fed meeting, when Powell didn't meet dovish expectations, they say Powell did a bad job with "communication".   

This is how you get these irrational doves at the Fed.  They've been trained by the markets.   They get doggie biscuits from the media when they are super dovish, pleasing the markets, and get nothing but hate when they aren't dovish, disappointing the markets.   

I read the sell side research, and apparently they are thinking that there is a chance at a hawkish surprise at the Fed meeting on Wednesday.  I agree that there are dovish expectations, but post 2018 Powell usually meets those expectations, even if he has to be mealy mouth and BS his way through the press conference.  I wouldn't bet on a hawkish surprise until Biden decides on Powell reappointment.  

SPX stuck in a boring, narrow range, and of course, kissing all time highs.  Not a time to chase longs, and not comfortable shorting in this environment, so the only thing to do is wait for a dip to buy.  Think bonds are a short if/when 10 yr gets to 1.40%.  So close to a sell point there.

Why Aren't Yields Going Higher?

The 10 year yield started the year at what now seems like an absurdly low 0.91%.  The 10 year yield is now at 1.50%.  

Depending on your time frame, you get different perspectives.  If you aren't focused on the day to day movements, but are looking at moves over several months, the yields have gone up a lot and even seem a little bit HIGH.  If you are looking at just the past 2 months, when the yields have mostly been between a super tight 1.55%-1.63% range, with fleeting moves towards 1.46% and 1.70%, 1.50% seems LOW.  

Based on how most investors feel, which is that yields are still low, you can guess what time frame most of them operate on.  Almost all of the fixed income "experts" are calling for 2.00% 10 yr yields by the end of the year, yet the yields are going lower, towards the bottom of the recent range.  Those experts are almost always calling for higher yields, like a broken record. 

 

So why aren't yields going higher, with all this fiscal stimulus, with the jumbo sized Treasury coupon auctions, and with all of this inflation?  The Fed buying $120B a month has a large part to do with it.  But another part of it is the sheer amount of liquidity in the system.  A lot of the Covid fiscal stimulus was just a money spew that had no real purpose.  The government panicked and picked some huge number to pump out and had the Fed monetize almost all of it.  Most of that money has not been spent on real goods.  A lot of that money is being pumped into stocks, bonds, and real estate.  

I would guess that a vast majority of that fiscal stimulus has gone into:  1. cash deposits at banks 2. stocks 3. bonds, or 4. real estate.   

So even if just a minor portion of that fiscal stimulus money is going into the bond market, it is enough to offset the large Treasury issuance and keep yields steady at these levels.  An aging population still want safe assets, despite the long equity bull market.  And Powell seems determined to stay with his dovish approach and delay tightening as long as possible, or until he gets reappointed. 

The fiscal stimulus was overkill.  It was a giant helicopter drop of money that ended up helping asset markets more than the real economy.  I know everyone says the real economy is doing great, the reopening hype, the hottest economy ever, etc.  But if you are going to compare any economy to one that was halfway shutdown in 2020, it would look great.  In reality, you are just going to eventually end up going back to trend level economic growth, even with all of the fiscal stimulus.  Real economic growth might be measured higher, because the government will do their best to underreport CPI inflation, but in reality, fiscal stimulus doesn't boost the long run growth rate unless a country is severely underinvested. 

In the long run, government spending doesn't boost economic growth.  GDP growth is mainly a function of 2 things:  population growth and productivity.  Developed world population growth is quite low, and so is productivity growth.  

In the 1980s and 1990s, you had faster CPUs.  In the 2000s, the internet.  Over the past 10 years, you haven't had any technological breakthroughs which increase productivity.  Smart phones, electric cars, green energy, AI, etc. are not game changers.  They are micro things which don't affect the macro environment.  

And these huge fiscal deficits create mountains of government debt, which puts a huge burden on the central bank.  The Fed has to keep interest rates low, the system as it is now cannot support normalized interest rates.  Financial repression is not transitory, but is permanent, because the global economy is hooked on negative real yields.  Inflation can get high and the Fed will keep saying its transitory and the US government will manipulate the CPI even more to keep the inflation "under control".    

So even with higher inflation, yields can't go much higher.  The system would implode if they ever tried to normalize.  In December 2018, Powell tried to be tough guy and a 20% drawdown in the SPX stopped him dead in his tracks.  He folded like a cheap lawn chair and started cutting rates within 6 months at the mere sign of slowing growth, with nothing close to recessionary conditions.  

The Fed cares about financial markets, not inflation.  They are scared to death of another 2008.  Even the taper tantrum of 2013, which was a nothing burger, still haunts them.  I'm sure Powell had nightmares about the market reaction to his last rate hike in 2018.  The Fed is owned by the financial markets.  They are market slaves, not market leaders.  

Their default move when in doubt is to print.  They are a one trick pony.  And they are lauded when they print a bunch of money and stocks go up, and criticized when they tighten and stocks go down.  With that kind of market feedback, of course they are going to be dovish, because that's what market participants want.

In the short term, bond yields are being kept down by all the excess liquidity in the system, which is lifting all boats.  In the long term, bond yields will be kept down by slowing population growth, too much debt, and lack of productivity.  

Stock market is stuck in a low vol, tight range.  Just like 2017.  I am a buyer of any small dips down towards SPX 4120-4130.  I expect a grind higher during the summer, with brief bouts of selling where dip buyers will jump in quickly to stop the bleeding.  With the Fed dumping pure ethanol into the punch bowl, and at a furious pace,  the party will be going on for a while.  Its already the biggest bubble ever, and it looks like it will get so big that it will shatter all bubble records, never to be beaten.  Market is setting up for a monster parabolic move higher in the last few months of the year.  

SPX Chart from January 2017 to February 2018:

Grinding Higher Like 2017

The VIX is back down to the 16s.  The SPX is almost back to all time highs.  And bond yields are also grinding lower over the past several weeks.   It looks like all the dip buyers, me included, will be left behind as the bus leaves the station.  The market in 2021 is reminding me more and more of 2017, when after a volatile first half of 2016, you got a blastoff to new highs after a much feared election.  

If you remember 2017, it was the year when the Fed was hiking rates, yet the 10 year yield was going down for most of the year.  Also, it was the year when you had the much anticipated Trump tax cuts which were being negotiated.  Similar to the fiscal stimulus this year, with the $4 trillion infrastructure package waiting to get passed.  

The amazing thing about 2017 was that the SPX stayed above the 50 day moving average almost all year long, and never touched the 100 day moving average the whole year.  

So far this year, the SPX is even stronger than it was in 2017, with even less time spent under the 50 day moving average, if you extrapolate over the rest of the year.  And it hasn't even gotten close to the 100 day moving average.  

There is a huge amount of underlying demand for stocks.  I have underestimated the buying power and desire for investors to buy stocks.  It feels like this market will keep grinding higher with only very brief and shallow pullbacks and enter a parabolic phase either later in the year or in early 2022.  With the Fed staying with their over the top dovish stance, expect the bubble to keep getting bigger and bigger until they actually do something other than talking about thinking about talking about taper at a future meeting. 

Remember, the fastest gains happen at the end of the bubble, so that's probably what's going to happen before this bull market ends. 

AMC Up 3700% in 18 months

Lots of unintended consequences of bubble blowing Fed policy with QE of $120 billion per month as the SPX rockets higher along with commodities, real estate, art, cryptos, and even sports cards.  

Exhibit A:

 As of June 2, 2021, close, AMC market cap is $29 billion with approximately 460 million shares outstanding.  On December 31, 2019, before the pandemic, the AMC market cap was $750 million with approximately 104 million shares outstanding.  So a company that took on massive amounts of debt and dilution to stay alive in 2020, has gone up 3700% in less than 18 months as its business deteriorates.  All because of a bunch of internet stock pumpers.  

And then you have AMC offering 1 free large popcorn at theatres to their retail shareholders.  LOL.  You can't make this stuff up.  

And its not just AMC.  It happened to GME.  And various sketchy EV names that have since gone down a lot since January but are still much higher than year ago levels. 

And yet the Fed keeps insisting that the inflation is transitory, which is what you would expect from Powell who is scared shitless about the bubble popping before he gets re-nominated by Biden as Fed chair.  Powell is nurturing this bubble  till he gets his next 4 years confirmed and then we'll probably see some token taper talk and eventually a turtle taper announcement.  

There are just speculative waves going on here.  First it was the coronavirus stocks in the summer of 2020.  Then the EV and biotech stocks from November 2020 to February 2021.  Then the meme stocks from January 2021, dying down and then a vicious return in May/June of this year.  Of course, you had the crypto run from November 2020 to April 2020 before you saw the big drop in May.  

In the meantime, you keep getting record auctions for art, NFTs, and sports memorabilia. 

I never thought I would see a bigger bubble than the dotcom bubble from 1998 to 2000.   This tops that.  In both breadth and magnitude, as well as the insanity of the moves.  Just completely irrational prices based on the greater fool theory of investing.  

And you have Biden who is completely senile and on stimulus automatic pilot.  Regardless of rising inflation or market signals of overheating, he keeps wanting more stimulus.  That's all he knows.  Just completely off his rocker and thinking 2020 is like 2008.  

And I'm sure the CPI and PCE will continue to vastly underestimate inflation because it uses hedonic pricing, substitution effects, and owner equivalent rent which are totally irrelevant for anyone who actually spends money.  This will give room for the Fed to say that inflation is under control and to keep ZIRP policy forever.  

The millenials, looking to build wealth, buy a house, etc. now feel like they have no choice but to say screw it, the only way I'll be able to get rich is to hope there are more suckers willing to buy up grossly overvalued meme stocks so I can sell at higher prices to a bigger sucker.  In the end, the rich will get richer as they snap up real estate while the millenials will end up holding the bag in AMC, GME, BB, etc.  

It continues to be a dead market for stock indices and bonds.  Nothing to do there.