Inflation and Changing Minds

By Jeff Kelly on July 1, 2022

“The party told you to reject the evidence of your eyes and ears. It was there final most essential command.”

George Orwell 

We have a lot of “parties” telling us to reject what our eyes and ears tell us to be true. There has never been a July 4^th where it’s more important to be open to what you see and hear versus what you are told. This applies to the politics of the day as well as markets. If you have supported one side and the evidence is pointing in the other direction, however painful it may be, we should reevaluate or maybe even change our minds. The entrenched nature of many positions makes this hard to accomplish. In analyzing markets, the ability to change your mind is essential. The current narrative is inflation is raging. It will never end. We need to raise rates all the time, every time. But then we see the following things happening in the markets:

• Yields on 10-year treasury bonds fall from 3.55% a couple weeks ago to 2.98% today.
• That’s a decline of 20%!
• Yields on the two-year treasury bond has gone from 3.45% to 2.81%.
• The bond market, which is much smarter than stocks or the Federal Reserve doesn’t think there are nearly so many rate increases in our future as the “dot plot” from the Fed.
• Copper is down 30% in short order.
• Oil falls 17%.
• The U.S. Dollar moves relentlessly higher.
• Wheat, Natural Gas, Gasoline, Soybeans (to mention a few commodities) all move lower.
• Shipping rates crash.
• Retailers with too much inventory cut prices.
• Remember the semiconductor shortage? Micron Tech just reported earnings and cut the outlook significantly.
• Gold prices over the last year are up1.33%. Inflation hedge?

I could go on, but you get the point. Inflation may have peaked, that’s what the markets are saying right now. It doesn’t mean its headed back to 2%. But it may be headed lower. To keep our view the same considering these facts isn’t rational.

Changing our minds in light of new facts isn’t wrong or disloyal. It’s what informs good decision making. If inflation has peaked and longer-term rates are not headed higher, we can see a better market environment as we head into the 3^rd and 4^th quarters.

Changing our minds can makes sense. We need to tune out the noise and examine the facts. Imagine if we did this with politics…

CHARTS FROM THE WEEK PAST

ISM new orders below 50 is contraction.

Ditto ISM employment.

The price of Gasoline declines below its 50-day moving average.

Gasoline prices going down is a great thing. Now about 17.3% off its highs.

Very quietly and with little fanfare the yield on the 10-year treasury has move down from 3.55% to 2.98% today.

Bonds are usually smarter than stocks. Maybe the highs in rates have been seen.

China PMI’s accelerating as Covid lockdowns end.

China looks much better than the U.S. or European Markets.

“Overall Economic Activity Appears to Have Picked Up after edging down in the first quarter” – FOMC Statement (6/15/22)

The Fed is delusional, uninformed and maybe just doesn’t care. Then we get this gem yesterday “We understand better now how little we understand about inflation”. Check out the next 5 slides below to see if they know anything about the Economy “picking up”.

Retail sales not “picking up”.

 But maybe near a low.

Services also tough but due for a bounce.

Ditto Manufacturing.

“Picking Up”! Not.

Even housing is slowing.

Sorry Mr. Fed man, it’s not “picking up”.

Source: Bloomberg, Hedgeye

The weakness in the Economy and the decline in commodity prices has pulled forward the probability of rate cuts to the 1^st half of 2023.

Natural Gas down over 40% from the highs.

Some relief from the inflation argument.

May pending home sales slightly stronger, +0.7% vs. -3.9% est. & -4% in prior month; despite slight gain, sales dipped -12% y/y vs. -11.5% in prior month; per NAR, even though we saw m/m gain, “housing market is clearly undergoing a transition” given higher mortgage rates.

May durable goods orders stronger at +0.7% vs. +0.2% est. & +0.4% in prior month (rev down from +0.5%); orders ex-trans +0.7% vs. +0.3% est. & +0.2% in prior month (rev down from +0.4%) … y/y trend for headline orders holding firm at +12%.

Manufacturing Index from the Richmond Fed collapsed in June to -19 vs. -5 estimate & -9 in prior month.

New orders fell to -38, shipments to -29 and backlogs to -19. Inventory moved to 0 from -12 while employment increased and reversed course from downtick last month.

Small Caps look cheap.

Bargains are being created.

Interesting chart showing how many employees it takes to generate 1,000,000 in sales in the retail business over time.

Tough on the department stores.

We need a supply response in energy and a move to nuclear.

Russia defaulted on some debt this week.

Not because they don’t have the money, they do. But they aren’t allowed to convert to dollars or use the payment system. So, they keep the money. Not a great plan by us.

As oil price moves higher the amount of consumer credit does as well.

Rising food prices will lead to bad outcomes.

The number of precious metals contracts held by financial institutions have risen dramatically.

Could some demand for commodities be artificial?

German Yields declined the most since 2008 last Thursday.

Lots of price drops in housing.

The most since 2015.

Two different approaches to inflation.

In the 1940’s they kept rates low. In the 1970’s they raised them over and over again.

The cost of electricity in Germany has soared.

Growth estimates for economy and most companies are still too high.

Money supply taking a major dive.

The Presidential Cycle turns positive in 2023.

Comparing 2022 to 1962.

Similar sets.

Manufacturing Sentiment bad in New York, Kansas City, Dallas, and Richmond.

Most major market lows come with the PMI (Purchasing Managers Index) in the 1^st Decile.

Unfortunately, the U.S. is still in the 7th Decile.

Only China is in the 1^st decile.

While food prices have risen significantly.

They are starting to comprise a higher total of monthly expenditures.

More stocks starting to trade for prices less than the cash on their balance sheet.

A bullish sign.

Bond yields peak prior to equity market bottoms.

Important if we have seen the peak in yields.

Conditions have become very tight very quick relative to other tightening periods.

Lots of out flows from resource stocks.

After losing all his top generals and commanders in the war with Ukraine, Putin calls General Pavel out of retirement to lead the Russian invasion.

He weighs nearly 300 pounds now; intelligence officials say Putin is “scraping the bottom of the barrel”.

WEEKEND HOMEWORK

Interesting read on where we are.

Americans are in Conflict because the Framers were Conflicted

Tracking Where the Grain Russia is Stealing from the Ukraine is going.

An astonishing, never-before-told story of the Second World War, based on newly declassified documents and exclusive interviews.

In 1944 the OSS set out to recover more than 500 airmen trapped behind enemy lines in Yugoslavia. Classified for over half a century for political reasons, the full account of this unforgettable story of loyalty, self-sacrifice, and bravery is now being told for the first time.

The Tim Ferriss Show Transcripts: Edward O. Thorp, A Man for All Markets — Beating Blackjack and Roulette, Beating the Stock Market, Spotting Bernie Madoff Early, and Knowing When Enough Is Enough (#596)

Have a wonderful July 4^th weekend. Keep those pups safe and inside with the fireworks happening.