If the Federal Reserve had taken the threat of inflation more seriously a year ago, we wouldn’t have the societal shift in inflation expectations, which is compounding the vicious cycle that endless liquidity, higher energy prices and supply-chain crises started.
Heck, the Fed might have had a fighting chance of getting in front of this inflation cycle if they’d listened to me a month ago when I wrote:
“Remember how I’ve been saying ‘This is a ‘No BS Market’.’ Well, the Fed tried to BS everybody yesterday with their silly 50 bps raise. Rates are still way below where they should be if they are serious about fighting inflation. They needed to shock the system yesterday with a 75bps raise and a promise of another 75bps raise. Instead they think they could play their same ol’ jawboning game.”
I see that even Jim Cramer concurs. And he’s right that it would now take a full 100 basis points to get the market’s attention. A month ago, a 75 basis point increase or even a 50 basis point intrameeting increase from Powell and the Fed probably would have done the job.
The cycle of inflation will end as the broader economic cycles play themselves out. But what can solve inflation now? Higher rates are doing part of the job, and a recession that probably started in the last two months is also going to help crimp some demand, which will probably help abate a little of the inflation dynamic.
There are also the rising inventories at Target
and other retailers that will require them to sell much of it at slashed prices. That will help a little bit.
The stage for high inflation was set over the past 30 years, as central banks and global governments were able to avoid the consequences of very low interest rates and very high budget deficits. The giant productivity boom that the internet, apps and instant flow of global money created allowed governments and central banks to plunder wealth that would otherwise have flowed to individuals.
That system comes with its own broader cycles of bubbles and crashes that we’ve navigated successfully for decades. We are now in the crash part of the cycle and this Other Side of the Bubble is being exacerbated by a vicious cycle as the productivity and wealth creation it enabled by the bubble has stalled. The central banks have no choice but to cut liquidity in the system and to try to end the inflation cycle. That will, over time, help stop inflation.
How the supply-chain crisis will end
Before turning to energy, let’s talk about The Supply-Chain Crisis because it’s also a major inflationary input.
After years of not getting the computer chips they needed, any manufacturer of cars, computers, routers, satellites, smartphones, etc., has double- and triple-ordered the chips they’ve been waiting for. There are millions of cars and trucks that Ford
and every other car manufacturer not named Tesla
could start selling if they could just get the chips they need. When a wave of new chips finally comes into the car market in the next six months or so, those car vendors are finally going to start filling back orders.
That wave of new car inventory will then drive prices of new and used cars down over the course of the next year or two. Eventually, the shortage of cars available for sale will turn into a glut of cars, and that will force the car manufacturers to slow production. Then they will realize they have way too many chips and will cancel orders. The chip vendors’ backlogs will decline, and the prices of chips will decline. And in another year or two, the market will stabilize and the insatiable growth of demand for ever more chips that do ever more things will get back in line just as Intel’s
fabrication business in the U.S. and Europe is set up to step into a stable and secularly growing industry.
Smart phones, computers, satellites, etc., will likely face a similar shortage-to-glut-to-stabilization cycle over the next year or two.
Fuel prices are the biggest inflation input today. Do you remember, a few years ago, when Republicans and Democrats, including Donald Trump, pushed OPEC, Mexico and Russia to cut oil production by 10 to 12 million barrels of oil a day so prices would rise?
Now everybody seems to expect President Biden to push U.S. producers to make up the difference. But nobody’s talking about simply going back to OPEC+ (sans Russia this time) and begging them to simply pump as much oil as they used to before we had begged them to stop pumping so much oil.
And maybe politicians should stop pretending that they are willing to let a free market work. Meanwhile, the whole ESG and green movement has made the giant oil companies shorten their investment payback periods such that even if Biden did start giving them drilling and pipeline rights, they’d have a hard time getting past the political/societal pressure of mass drilling anyway.
For higher energy prices, I blame both Republicans and Democrats, and their energy subsidies, global supply protections through wars in the Middle East, tax loopholes and other interventions during the course of my entire lifetime.
All that said, the fact is that energy is a pure commodity — it will always be subjected to cycles where higher prices bring on more global supply over time, and lower prices cause supply to dwindle over time. From here, the supply of energy (not just oil) will increase and eventually overshoot on the production side. Then prices will crash and eventually stabilize.
Navigating the bubble’s pop
As usual, I tried to be in front of the economic cycle as I wrote a lot last year about how the markets were going through a Blow-Off Top ending to the 13-year long Bubble-Blowing Bull Market and how inflation was going to be a problem. Looking ahead and around the corner, we can see that inflation is most likely going to ebb in the next few months and then we will have a lot of deflationary forces back in the system. It’s always instructive when the markets are ugly to remember that things usually do work out for the U.S. at some point.
I think patience and caution are still key, but I am getting a little bit more bullish into this panicky, crashy, ugly action.
Here’s what I’ve been doing. In the hedge fund, I’ve sold quite a few puts I’ve had, and I’ve covered a chunk of most of my shorts, opening up some more long exposure. I nibbled a little Meta
and Intel, as well as the iShares Biotechnology ETF
and Uber Technologies
I have also started buying the SPDR S&P Biotech ETF
Easy does it. It is no fun to wait, but the cycle will turn again, good stocks will eventually bottom and fortunes will be made in the next 10 years.
Cody Willard is a columnist for MarketWatch and editor of the Revolution Investing newsletter. Willard or his investment firm may own, or plan to own, securities mentioned in this column.