Inflation, Taper Tantrum, Market Price Sustainability, & Contradictions?

Authored by Bill Blain via MorningPorridge.com,

“Where there is profit, panic isn’t far behind” 

Forget the noise from crashing crypto – the big issue for markets is cutting through the buzz of contradictions to perceive the real picture presented by the threats of: inflation, taper tantrum and price sustainability. This is going to be an “interesting” summer.. (If it ever stops raining…)

Another new week for markets – what should we worry about? The big question remains how much longer can the wider markets remain this strong?

There is little point looking through the newspapers for clues on fundamental market direction. On Sunday morning I perused the markets pages of a leading global financial paper. 8 of the 10 new weekend stories were about Cryptocurrency – ranging from the obsolescence of Bitcoin, the likely crowning of Ethereum as the new hollow god, and predictions of a new rally to come, despite the massive 18% crash in Buttcon on Sunday.

I ignored it all.

When it comes to the real markets, distractions like crypto babble, crashing SPACS or headlines about how the investments of “smart” investors like Softbank and ARKK are in a spin, are just noise. They are just small stories the much larger market narrative. The future (if any) for cryptos is angels on the head of a pin stuff, while being a “leading” fund manager doesn’t provide protection from the hubris of being basically wrong and overbought. It’s likely the losses in crypto will impact overall sentiment this week, contributing a stark and timely warning about bursting bubbles.

The big issue for market direction in this toppy-feeling market is discerning the real picture – and that’s a cornucopia of contradictions at present.

The questions boil down to the reverse-trifecta of Inflation – both in terms of material shortages and labour supply, the Taper Tantrum threat, and this Market’s Longevity.

You can’t really address these issues individually.

For instance, we know there are enormous labour shortage issues emerging around the UK and US – the Sunday Times covered them in depth yesterday – as business anticipate reopening. Yet, along-side optimistic growth expectations we also have predictions of record business and retail failures on the back of a massive post covid financial reckoning that can’t be avoided… whether its companies crashing on higher rates, debt burdens, or simply their niche being replaced in the post-pandemic economy.

Listening to businessmen in my own small village many are deeply concerned about sustainability after they’ve invested their pension pots, savings, and taken out new mortgages on top of government loans to keep their firms afloat over the past 15 months. Its pretty tragic stuff – and deeply unfair measured alongside the wealth that’s flowed into the largest firms stock-holders. Markets were never fair…

That is a worrying combination of uncertainties: an inflationary threat from rising labour costs, and a business contraction threat from debt? That word you are scrabbling for is, maybe, Stagflation…

From a fundamental markets pricing perspective, the outlook appears rosy. All the data shows the vaccines protect against the new strains of COVID 19, enabling the global economy to reopen, even as central banks continue to juice the market with ultra-low interest rates and monetary experimentation via QE. That remains a win/win for prices. Low rates, easy money, repressed consumer demand unleashed, and the only real things to worry about are the apparently “good” problems of soaring materials prices as the price of everything rises on scarcity – which the Torygraph covered: “Builders hit by brick shortage and spiralling prices”.

Despite the pandemic and the massive hit it inflicted on national GDPs, we are at close to record stock prices. Is that because we anticipate boom times? The market is a patient beast – we’ve been anticipating recovery more and more since the pandemic rally started 14 months ago! The S&P 500 is up 88% since the pandemic nadir in March 2020 – and the global economy is still effectively flatlined… Basically the market is either driven by an expectation the Global economy will just about double, or prices are distorted. I will go for overpriced – whatever the stock pickers say.

Markets have been in rally mode since 2009 – and their rise has very little to do with future economic outlook, or expectations of rising earnings. The steep rise in stock prices post the 2008 Global Financial crisis did not lead to a massive explosion in economic activity. Growth was distinctly sub-optimal – and not helped by Austerity government spending policies.

Nope, stock markets have risen largely on the back of cheap central bank money and repressed interest rates, and low rates forcing investors to take greater risks in search of returns. Which leads us today’s artificially inflated, highly distorted market valuations – which stock analysts are cheering to go higher on Pandemic recovery dramatically increase corporate earnings….. Methinks they do fool themselves.

Yes, corporate earnings are set to rise. But, stock price valuations are already excessively distorted by the effects of cheap unlimited money. I saw a graph recently showing global stocks’ PE ratios have only ever looked this bubblicious in 1987, 2000 and 2007….

What would break that cycle? It’s now 8 years since the Taper Tantrum when the Federal Reserve hinted it might ease back on QE and seek to normalise interest rates. They clearly perceived the importance of the price of money to the efficient operation of the economy. If money is too cheap, it funds sub-optimal behaviours. For instance, companies find it better to buy back their own stock (which becomes an addiction as C-Suite executives discover it’s the most effective way to boost the stock price and thence their bonus and stock option values – rather than build or finance new productive assets.)

Around the globe we’ve seen a massive corporate borrowing binge – by private companies to fund dividend payments to private equity owners, to finance stock buybacks, and occassionally to fund acquisitions. Cheap money increased leverage – and today some estimates say 20% of companies will implode on their own debt if rates rise. These same Zombie companies are also protected from the evolutionary Darwinian forces of the market while interest rates remain artificially low.

The Fed knows it has to normalise rates to meet its full employment goal in the long-term. Keeping rates low may fuel a stock-boom, but doesn’t create investments to create good high income jobs in an expanding real economy. Mac-jobs don’t count.

In Europe it’s even more difficult – the ECB has but one objective: price stability. Ultra-low rates in a sluggishly recovering economy (on the back of material costs) are finally generating inflation – and that’s a big concern for Germany. The ECB is now wrestling with how to finance fiscal-push recovery across Europe, without driving inflation or unravelling the accommodation at the heart of the ECB.

Meanwhile… whatever the pundits say, inflation is already real. We know it will impact commodities and materials and therefore the cost of everything. Central Bankers are sounding as confident as the can it will prove a short-lived supply-chain recovery effect from the pandemic. Yet, the experience of business suggests it’s going to be labour markets that fuel demands for higher wages to take jobs that is more likely to push prices higher.

What does this mean for markets…? Sheesh… don’t ask difficult questions..

Be cautious – central banks are telling us rates won’t rise immediately, but will rise in the future. Inflation is a threat and trigger for rate rises sooner, and potential instability. This market looks like the third leg of a rally since 2009 – and any chartist will tell you that’s a bad thing.