Baseline Economic Realities

The hot CPI increases the probability of the Fed pushing this economy over the cliff.  This is not the same economy as 2000, or even 2008.  The population growth in the US, EU, and China, the 3 big economic zones, is near zero.  GDP growth = population growth + output per capita.  With an aging demographic in the developed world, output growth per capita will struggle to increase.  Decreasing immigration due to political reasons will also hurt population growth.  

The population growth in the US and China are barely above zero, and declining fast, and the EU has negative population growth which is also declining fast. 

Workers are the building blocks of an economy.  The labor shortages are often blamed on Covid, but its really due to a lack of population growth and an aging population.  Labor has gained a lot of bargaining power over corporations in the last 2 years.  That increases labor costs and also reduces productivity.  When you don't have to worry about getting fired, or can easily find another job if you do get canned, you don't feel as much pressure to perform on the job, and thus reducing productivity.  Work from home trends exacerbate this.  

So how does this tie into the current economic situation?  With offshoring to China maxed out and other emerging markets lacking the infrastructure to support a big offshoring boom, labor shortages will be a problem for corporations looking to grow.  And since the economy in the developed nations is 2/3 consumption, an aging demographic hurts the overall consumption levels, as you can see consumption peaks in the 40s and 50s, and declines into retirement and beyond.  

% Working Age population is stagnant or decreasing while the elderly population is exploding higher.  See 1995 and 2020 population pyramids to see the change.  It gets more extreme over the next 20 years.   In the EU and China, the trends are even stronger towards aging and increasing elderly.

In order to fill the void, just like Japan did starting from the 2000s, the US, EU, and China will have to run huge fiscal deficits to maintain positive growth rates, enough to keep the system stable, along with monetary stimulus to pay for all the spending necessary, as high interest rates are unsustainable with such huge debt/GDP ratios, as Japan has clearly shown.  

If the EU stubbornly sticks with its low budget deficit mandates for member countries, they will be stuck with permanent stagnation and zero growth, along with zero or negative rates.  Even if the EU stimulates, it has to be big deficits to make a difference,  otherwise growth will be zero.  

GDP growth in the US, EU, and China will come from inflation that is underestimated in the GDP deflator, as there is really no organic growth out there.  Everyone with half a brain knows that the US, and most countries, manipulate their inflation data to much lower levels than actual numbers.

CPI reported at 9.1%, is realistically around 15% using real pricing data.  Rents have been going up 15-20% annualized, and that's only showing up as 5.5% in owner equivalent rents, a manipulated measure that was developed by the US government to underestimate housing inflation.  Housing is 33% of the CPI.  Manipulating 33% of the CPI from 15% to 5.5% lowers the CPI reading by 3.2%.  Also throw in hedonic adjustments and substitution and CPI is probably underestimating current inflation by about 5%. 

So there is almost no population growth, output per capita is likely in decline, and you have an energy shortage, which limits growth as well.  Those are just background baseline economic fundamentals.  Add the variables that change frequently like asset prices, which affect economic activity.  With stocks down across the world, over 20% in most countries in 6 months, along with a drop in fixed income portfolios, negative wealth effect will seep into consumption.  Just a small drop in consumption is enough to take it to negative levels with such weak economic fundamentals.  Throw in higher energy prices and you have a consumer with much less discretionary income.

The bond market shocked by the Fed's hawkish tone since April, is slowly looking past the hot CPI readings and focusing on the next few months when lower commodity prices will push down inflation numbers, as well as the increasingly obvious signs that business spending, hiring, and consumer spending are all trending sharply lower.  Those looking in the rear view mirror and the high CPI number are missing the message.  Inflation has peaked.  The economy is getting closer to the breaking point and if Powell tries to put on his tough man Volcker act, he will only speed up the process of sending this bus hurtling over the cliff.  And then they'll have to panic pivot like January 2019.  Bonds are looking more and more attractive as the price action is getting more constructive after that June panic.  Lots of upside in bonds both leading into a dovish pivot and after the pivot. 

I am still a long term bull on commodities, but the bearish cyclical forces are too great to ignore in the short and intermediate term.  I will be looking to reduce energy exposure in the coming weeks and increasing bond exposure, and perhaps putting on a Nasdaq short if there is an irrational rally sometime this month.  We may have put in a short term bad news bottom yesterday, but it really is a perfect storm for stocks so rallies will be brief, if they do arrive.