Money Never Sleeps | The great reset! Value for nothing and your cheques for free....

January 15, 2021 | Vito Finucci


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vito finucci money never sleeps

“Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.”

– Famed economist, Milton Friedman
 

 

This is the time of year when investment firms and analysts, market pugilists and the whole circle of the financial world publish their annual forecasts and outlooks.

I’ve always believed that these are mostly a counter-productive exercise, especially for investors. Firstly, they are barely more than guesses. And I mean that literally, since we’ve been told so much about science in the last year – there is no valid science to estimating stock prices, interest rates, inflation, bond yields, gold, bitcoin, etc. from 12 months out.


In my nearly four decades in finance, the future has usually turned out to be both unknown and unknowable. And as much as we’d like to, we can’t simply blame COVID-19 because of the human tendency of recency bias – wars, pandemics, natural disasters and other tail-risk events are always there. The unprecedented occurs with alarming regularity. In my memory, Black Monday 1987, the Latin American Debt crisis in the early 1990s, the Russian default in 1998, Hurricane Katrina 2005, the 2004 Indian Ocean tsunami, the collapse of Lehman Brothers in 2008, Fukushima in Japan in 2011, 9/11, and the Great Financial Crisis (GFC) in 2008–09 are just a few that come to mind. This is why the forecasters never stand a chance over the course of a year.

What these forecasts often really do is act as a glossy advertising campaign designed to attract new clients – not help existing clients. They provide little in the way of guidance for meeting the long-term investing goals of a properly planned / funded retirement, tax planning, inter-generational wealth / estate transfer, paying for post-secondary school, planning for travel, buying a house, etc.

A
s you read over them, it’s no wonder why so many forecasts cluster around the same points. Many forecasters simply take current price levels, extrapolate an average annual gain (e.g., 8-10% in equities) and then attach their forecast around that. This helps to explain why so many outlooks on Wall Street appear so similar – it’s simply extrapolation of the current numbers.

Speaking of “recency,” my case in point: how many strategists had “the first global pandemic in 100 years, over 1 million deaths, a 34% market crash in 16 days (followed by the best up month ever), but with huge gains in a small number of tech stocks and a 15% annual S&P500 gain” in their 2020 outlooks? You are correct if you answered: “none.”

Not a single person in the world saw "Highest unemployment since The Great Depression" as a possible headline for 2020:



Source: fred.stlouisfed.org/series/UNRATE 

And even if by chance, someone had called for the first global pandemic in 100 years to occur, they then would have had to guess that the Federal Reserve would take rates to zero, and Congress, which couldn’t agree on anything for years, would pass a $3 trillion stimulus package and do it quickly.

The year 2020 was a real “beauty.” A highly contagious coronavirus strain emerged in Wuhan, China and proceeded to spread around the globe, unleashing the biggest global black swan event in the past 100 years, triggering personal and economic pandemonium for hundreds of millions around the world who lost their jobs or loved ones as a result of the virus. At the same time, it created a market nirvana for millions of 16-year-old Robinhood and hedge funds traders who benefitted from the greatest stock market bounce-back rally in history, which I believe ultimately helped Joe Biden emerge from a slim chance of defeating Trump – thanks to a strong U.S. economy in February – to eventually win the Nov. 3 U.S. presidential election.

The arrival of the virus that would eventually be called COVID-19 by the global scientific community – and which would lead to a historic pandemic, the likes of which nobody expected but one year ago – shook the world, and would lead to a slew of historic events taking place in just a few months, including a staggering lockdown of the global economy for the first time in history, the official arrival of global “helicopter money” (which we wrote about last June), in addition to tens of trillions in fiscal and monetary stimulus, an overhaul of the global economy punctuated by an unprecedented explosion in world debt, all of which ultimately set the scene for what the World Economic Forum simply calls: "The Great Reset."

Needless to say, it would be impossible to describe everything that happened in 2020, or all the black swans that the pandemic and its associated lockdowns let loose upon the world, in one writing. But here are some of the highlights (in no particular order):
 

  • A Black swan health event leads to a historic equity market crash, and funding strains

  • In the U.S., the Federal Reserve takes U.S. policy rates to near 0% and institutes QE at a magnitude that puts the post GFC period to shame (almost 3-to-1 comparison)

  • Huge fires engulf Australia and a swath of California, wiping out parts of the Napa Valley

  • The U.S. Treasury institutes trillions of dollars of fiscal stimulus

  • Unprecedented lockdowns are instituted all around the globe

  • Netflix’s “Tiger King” became the most-watched program, with so many people at home

  • The U.S. kills Iran’s top general in a drone strike, sparking WWIII fears

  • Working from home becomes a key shift for many companies

  • Virtual classes, meetings, charity events, etc. explode in popularity

  • The word “Zoom” becomes a verb

  • Oil prices actually had the front month contract trade with a huge negative price

  • Sports – if they are played at all – happen in empty arenas and stadiums

  • U.S. social unrest sparks protests and riots against system racism in major U.S. cities

  • “Murder hornets” appear

  • Justice Ruth Bader Ginsberg dies

  • A highly contested U.S. election leads to a volatility collapse and a year-end market rally

  • The subsequent epic equity bull market recovery rally closes the year at all-time highs

  • Masks, hand sanitizer, social distancing and Tik Tok become household words

Yet for all the chaos and panic unleashed by COVID-19, the powers that be must have learned their lesson from the GFC in 2008, because as virus fears grew, markets crashed, lockdowns expanded, talk of an economic depression spread and jobs losses exploded, it provoked an unprecedented monetary and fiscal policy panic that sparked a record $22 trillion of stimulus in just nine months around the world. In our tiny nation of Canada, the amount was over $500 million alone. As a result, central banks spent over $1 trillion a month on financial assets via QE, crushing yields, volatility and spreads, and pushing stocks to all-time highs at the end of 2020, even as earnings (and the economy) continued to slide.

It was truly “value for nothing” in a liquidity-driven asset surge.

Looking at how the net worth of the world’s richest asset owners exploded, it's almost as if they had requested the economic effects of the pandemic. It wasn't just them, however. Politicians the world over would benefit from the transition from QE to outright helicopter money and Modern Monetary Theory (MMT), which made the over-monetization of deficits widely accepted in the blink of an eye. And in the span of just a few months, $14 trillion in fiscal stimulus was announced, with central banks monetizing most of it, pushing the quantity of global debt to a record $277 trillion, a number which the Institute for International Finance expects to hit a record $360 trillion by 2030.

While in the meantime, thanks to central bank intervention, the price of all that world debt dropped to a record low, with global negative yielding debt finishing 2020 at an all-time high of over $18 trillion.

Some will say the debt financed the economy. As this Fed chart shows, between 2007 and 2020, U.S. gross domestic product (GDP) has grown from $14.5 trillion to $21.5 trillion, however, the debt obligations have grown from $52.5 trillion to an astounding $82 trillion.


 

Source: fred.stlouisfed.org

The common recuring theme in that time span seemed to be a simple one: that no matter what happens, capital markets can never again be allowed to drop, regardless of the cost or how much more debt has to be incurred. Indeed, as one looks back at the news barrage over the past year (or the past decade, for that matter), the one thing that has been a constant in the markets, of politics, of social upheaval and geopolitical strife – and now pandemics – is the fact that the world is now so flooded with constant conflicting news and changing storylines. It has become virtually impossible to even try to predict the future, and that despite people's desire for change, the world's established forces will fight to preserve the status quo at any price. Which is perhaps why it always boils down to one thing: capital markets, the bedrock of Western capitalism and the "modern way of life," are preserved at all costs, as the alternative is a global, socio-economic collapse that no one wants to witness or have to deal with.

Indeed, in 2020, the financial markets turned from a deep despair to hope, all in the span of three months.

Stocks posted their best quarter in more than 20 years, and the economy bounced back with force. It’s been a reversal of fortune for investors, who weathered the S&P 500’s quickest 30% plunge (March) in recent memory as the coronavirus pandemic emerged, followed by the quickest reversal (April).

Markets had a spectacular second quarter. The S&P 500 gained 20%, its biggest quarterly increase since the fourth quarter of 1998. In April and May, markets seemed determined to hit new highs no matter what. In fact, the S&P 500 pushed within 5% of its all-time high on June 8.

Since then, the market story has shifted to one of indecisiveness and confusion. Pretty well all of the gains on the S&P 500 for 2020 were made after the U.S. election (the last 60 days). There have been success stories, like the technology stocks, but the overall market has been running in place for weeks.

There’s no doubt now that reopenings have sparked a fierce economic recovery that supported the April and May rally. Companies in May and June rehired at a rapid pace, adding 7.5 million jobs in the U.S. This has been a crucial development for the recovery, as it has helped U.S. consumer confidence strongly rebound.

We’re certainly not quite out of the woods yet, though – a reality that’s become apparent over the past month. Confused investors still struggle to reconcile stock indices at near or record highs, as that would seem to imply the world is getting back to normal. News flow suggests otherwise. Sure, there has been a lot of improvement, but economic data and earnings estimates indicate we may be a long way from the pre-COVID economy. In the last couple of weeks, new COVID-19 hotspots have popped up around the world (including London), sparking fears that another outbreak could lead to more economic pain. After two months of victories, and even despite several vaccines, there are reasons to still be cautious.

Yes, outlooks are tough to write in any year, but especially after one like 2020. Anyone that thinks they can predict what this will look like coming out on the other side is simply guessing. We’ve never in our history intentionally put the entire global economy into a coma. No one can predict the unpredictable, but we will continue to do our best to analyze economic and earnings trends to project where the markets could go in the short and long term. While we believe things are moving in a positive direction, there still remain a lot of unanswered questions. Things are getting better, yes, but I suspect 2021 will not be a walk in the park.

In addition, 2021 growth forecasts have stabilized over the past six weeks, which is a positive sign for the market. When estimates stop deteriorating, it has historically been a sign that earnings growth will stabilize and can begin to recover, barring any unforeseen hiccups.

Monetary and fiscal policy have undoubtedly played big roles in this recovery. Each has helped fuel the stock market rally via liquidity, as mentioned earlier. Many believe under a Biden administration, with Janet Yellen at Treasury, the odds rise for additional stimulus announcements. We shall see.

Policymakers’ unprecedented actions early on led to a surge of available cash for consumers and companies, which has flowed through the system to drive consumer spending and calm markets. The   rapid Q1 policy response has been a clear victory. The economic downturn has been devastating, but it could’ve been a lot worse if the Federal Reserve and lawmakers hadn’t acted as quickly as they did. The Fed, as voiced by Chairman Powell many times, is still fully committed to the cause, and that’s led to a surge of cash in the financial system, which we expect will continue to support the stock market.

The 10-year Treasury yield is still low, showing investors are hiding in more conservative bonds. Gold, which is considered a hedge for economic turmoil, is trading at seven-year highs. The CBOE Volatility Index, or the VIX, closed the year below 30 (but still nearly 8 points above its historical average), a sign there could be an above-average chance of stock volatility ahead. The VIX has averaged 19 over the past 30 years, so anything above that is considered a sign of nervousness in the market.

While the progress has been encouraging, it isn’t clear how sustainable the current rate of economic recovery will be. The response to coronavirus case increases remains the key risk. We have already seen some hotspots walk back reopening plans because cases have surged. It may be a stretch to say the entire U.S. economy will completely close again, but progress could slow as the economy recovers.



Source: Ally Invest, Standard & Poor’s, CFRA, The National Bureau of Economic Research
*A bear market is a decline from 52-week highs.


Fiscal policy, or the stimulus doled out directly to consumers and businesses from the government, may be at risk of disappearing soon. U.S. enhanced unemployment benefits were scheduled to expire at year-end. Future fiscal stimulus isn’t guaranteed, either. U.S. lawmakers are discussing another spending package. The threat of fiscal stimulus running out is always a near-term risk for stocks.

As stated above, the Fed has been committed to stabilizing markets with monetary policy since the crisis. However, any loss of support (reduced bond buying, etc.) wouldn’t bode well for the market either.

If that isn’t enough to digest, it looks like we will have a change in the White House on January 20. Given the current social, economic and cultural shifts, there is increasing uncertainty surrounding policy.

The markets’ biggest pro is stimulus. The Fed’s ongoing efforts could cushion equities against another big decline, as we’ve seen investors rush in to buy any dips lately. In fact, any new Fed stimulus or more fiscal stimulus could provide another boost for stocks. Conversely, stocks’ biggest con could be the lack of more stimulus.

There’s always a lot to take in as an investor, but more so these days. If you’re investing over a longer horizon (five years or longer), it’s always best to ignore near-term ups and downs in the market.

Its true, markets are cyclical. There has been ongoing debate on “growth” names (like technology) versus the “value” names (like cyclicals). Today, stocks trade at record-high valuations, while commodities are historically undervalued in relation. The set up may be in place for a macro pivot in the relative performance of these two asset classes.

Capital always seeks to redeploy towards the highest growth and lowest valuation opportunities, and this rotation has had several false starts over the past decade.

“Cheques for free”?

We’ve discussed the new Modern Monetary Theory (MMT) world, with its double-barrelled fiscal and monetary stimulus, and how it is colliding head-on with an aggregate of years of declining investment in the basic industries such as materials, energy and agriculture. I’ve written several times about it, but I think the “end game” for the Fed is to “inflate” its way out of this. Anyone who does any grocery shopping knows inflation is not even close to 2%.

The scarcity of jobs and abundance of debt were already factors preventing the economy from reaching its full growth potential even before COVID-19. The paradox that is thought to have held inflation in check over the course of the last decade could have been due to a combination of globalization along with technology productivity gains. But the COVID-19 crisis has created both a simultaneous demand shock and supply shock at the same time. I would suspect a new wave of rising commodity prices, set up by past under-investment in basic resources, to soon ripple through the global supply chain, creating a headwind for real living standards.

Welcome to the “Great Reset”

The global economy could be at risk of commodity supply shock inflation, something we have not experienced since the 1970s. Both the Bloomberg Commodities Index and the CRB Index closed 2020 at a 12-year resistance line. A significant breakout from here would be a big shift in the macro-investing landscape. Yes, the aging demographics problem and significant technological advancements are deflationary tailwinds. But one reason why consumer prices have not gone higher is due to a long-standing period of depressed commodity prices, a trend which may be about to change. The COVID-19 crisis through the global lockdown created a disinflationary environment (as seen in the bottom right of quadrant).


 

Source: Gavekal Research


Is it possible we could be quickly moving into an Inflationary Boom (i.e. top right of the quadrant)?
 

Here’s what the U.S. debt levels have looked like since the 1970’s:



Source: fred.stlouisfed.org

Both parties are complicit in allowing the debt bomb to get bigger. Yet the track record has been the same: ever more debt, ever more wealth inequality and a shrinking middle class. Not sure if this is a fantasy that money for nothing can solve all problems, or is an effective solution to more complex issues. But it’s more than just deficits and debt. Every penny of that debt is taxed or borrowed from the private sector. These massive transfers of wealth and income from current and future taxpayers to the government distort the economy in massive ways. Facts matter. Debt definitely matters.

MMT advocates believe that debt doesn't matter. But MMT widens the wealth gap between rich and poor to the point where those that know their history, it makes Marx right as the proletariat revolt. The concept in theory is that taxes are used in MMT to control inflation. But we all know the unintended consequences that occur when theory is put into practice, especially by governments. That also would assume we know what the level of inflation is at.

Looking at this chart, it looks like U.S. economic growth is on a plane to be strong in 2021. If that happens, a shift to the upper right quadrant (i.e. Inflation) is more likely, as well as demand picks up, with a beat-up supply chain in place:

 

Source: Gavekal Research

Inflation could really accelerate significantly in the next 12 months. Historically, that would mean the bond market will react and yields will rise from an abnormally low level to a more normal level. If the Fed tries to stop those rates from rising, the U.S. dollar may weaken, which will be even more inflationary for the U.S., and would transcribe into deflation for the Euro zone.

No one is talking about the possibility of higher oil prices, as if they are going to remain low forever. That would add an extra shot to the inflation piece.

So, I started this edition by saying yearly outlooks are pretty well counter-productive. Nevertheless, here is my outlook for 2021:

The bulk of 2021 will be more of a “Groundhog Day” (I’ve have heard that term more over the past four months than in the last 10 years). Over and over and over again. People are already sick of being locked down and the restrictions. Many who loved working from home just a few months ago are now not enjoying it, as there is no separation from office to home, so it feels like no change. We’ve seen service levels at many businesses collapse. Productivity is not the same, team dynamics and creativity are simply not there for many. We are hearing more and more about COVID-19 fatigue. I think it’s very real and no joke. When this all started last spring, we all heard and read how it might create a “kinder” and “gentler” society – I’m not so sure of that. People seem less patient, frustrated as hell. On many levels. With the vaccines now hitting arms, it’s a big positive, and maybe the latter half of 2021 shines. But in meantime, we still have some time to go. I will add, as our friend from Fidelity Investments Mark Schmehl has said many times, he believes there is going to be a huge pent-up demand that explodes when we come out of this. He’s a lot smarter than I am, so I will enthusiastically endorse that belief (which also adds to my inflation argument, by the way).

If you don’t remember anything you’ve just read a day from now, just remember this:

If the S&P 500 can rise 15+% in a year from hell like 2020, a year of a global pandemic not seen in 100 years, huge record unemployment numbers, global economic shutdowns, huge civil unrest, actual negative oil prices and an historic U.S. presidential election – maybe you should put that market-timing argument to rest any time someone brings it up.

We seem to be heading into 2021 with a widely held consensus on both an economic- and a market-expected performance not seen in some time. That alone makes me a bit nervous, especially with U.S. markets at all-time highs and speculative activity raging (think Robinhood, Tesla, Bitcoin, SPACSs, etc.). Given the vaccine news, many investors expect economic activity to spike and rebound. But if inflation starts ramping up, the problem could become the reversal and rising of interest rates, on top of rich valuations. Few investors are expecting inflationary pressures.

I truly have no idea what markets will do in 2021. As I said earlier, we’ve never been here before, and anyone who thinks they can predict what things will look like after intentionally putting the global economy into a coma (which has never happened before in history, so there is no history to follow) – well, there’s nothing we can base predictions on.

With a bit of luck, maybe we will get a sniff of whatever the new normal is going to be by spring / summer.

In the meantime, good riddance, 2020…

We truly wish everyone all the best for 2021. Let’s hope for the best. – Vito

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