The Real Reason The US Has Inflation

Email agenda:

Estimated read time: 4 minutes 3 seconds

1. The REAL reason the US has high inflation

2. Oil signaling doom and gloom for stocks

3. Don't buy risk-on assets

Good morning and happy Tuesday - let's get smarter

Why the US has high inflation

There are many factors that cause inflation and Nancy Pelosi or others will tell you they this is because of Russia

The truth is inflation comes from excess dollars chasing the same supply of goods

It’s almost like you’re bidding for something on eBay - when there’s more money chasing the same item, the price goes up

So what caused super high inflation in the US?

Quantitative easing or QE during COVID-19

Quantitative easing is when a central bank (“the fed”) purchases securities (gov’t bonds, etc) on the open market to reduce interest rates and increase the money supply

To execute quantitative easing, central banks buy government bonds and other securities, injecting bank reserves into the economy. Increasing the supply of money lowers interest rates.

Lower interest rates helps increase borrowing by people like you and I, which hopefully leads to spending (i.e., stimulating the economy)

Since March 15, 2020, the Fed has purchased $80 billion of Treasury securities and $40 billion in mortgage-backed securities every month, pushing the Federal Reserve's balance sheet to $8.66 trillion on December 7, 2021

Not only did they increase the money supply by buying bonds and other securities above, they sent stimulus checks to individuals

All of these policies you can argue were necessary to help prevent COVID from being a depression, but excesses get corrected

Too much of anything to the upside leads to a correction

Over-stimulating the economy through increasing the money supply from 1. Buying securities and 2. Stimulus checks

=

Inflation

Too much money supply chasing the same amount of goods = prices go up

What’s the opposite of the fed buying long-term bonds to spur economic growth (quantitative easing)?

Quantitative tightening (QT)

This is the process of the fed selling the bonds or letting them mature, reducing the money supply, in an effort to slow inflation

This tends to lead to higher interest rates, less borrowing, less spending, so less economic growth

How does that impact stocks?

Josh Steiner from Hedgeye pointed out: The fed has QT’d to the tune of $52B in total over the last 3 months and the S&P 500 is down ~4.1% over that timeframe. In the four months between now and year-end the Fed is supposed to QT by $380B

So the process of reversing the stimulus checks and buying of US gov't bonds during COVID that led to inflation (QE) has begun and we have QT to now help slow inflation

And we have only just begun the QT process, and the fed is expected to tighten to the tune of 7x what they currently have

Still think the bottom is in?

Oil Signaling Pending Recession

If you look back at the last 12 recessions since 1946, 11 out of 12 were preceded by oil crashes

If you look back to 1954, 10 out of 10 recessions were preceded by an increase in short term interest rates (per Josh Steiner of Hedgeye)

Here’s what has happened to oil prices the past 3 months including some violent down moves last week:

Here’s what has happened short term interest rates (2 year US treasury yield) over the past year:

History doesn’t repeat itself, but it often rhymes - Mark Twain

We continue to believe the next few quarters will be rough for the US stock market due to slowing inflation (disinflation), slowing corporate profits, and slowing US GDP growth

Everyone wants to call a top or a bottom

I have no way of knowing if this is the “top” and don’t care

But what I do know is bear market bounces often sucker people in and drive intense FOMO, only to spit you back out

Our data-driven decision making process tells us that some of the core asset allocations we have discussed previously: $UUP (US Dollar), Japan, Utilities, are better places to have your money than the S&P 500 ETF or the FAANG (Facebook, Amazon, Apple, Netflix, Google) big cap stocks that everyone owns

What I am doing / not doing

My biggest position still remains the US Dollar $UUP

Not losing money is just as important as making money

Capital drawdowns of 10-15% take huge gains just to break even

Here is what $UUP, bullish US Dollar looks like over the past 6 months

Here is the S&P 500

Stocks/Crypto/Risk Assets

Risk assets can be defined broadly as anything that performs poorly during high volatility time periods

As we have discussed, you can look at volatility by looking at the VIX for the S&P and VXN for the Nasdaq

Bull markets typically have VIX in the mid to low teens, let's say a VIX of 12

When the VIX is at 12, this is a time when investors want to be risk on, because volatility is low

Higher volatility is inversely correlated with returns

So the higher the VIX and VXN, the worse the market tends to do

Why?

Volatility = the standard deviation of outcomes increasing

Aka volatility is NOT your friend because the higher it is, the more bad things can happen

If the VIX is in the 25+ range, risk assets such as stocks and crypto overall tend to underperform

Why risk-off assets such as the worlds most trusted currency (the US Dollar) and bonds, tend to outperform

Not buying crypto or stocks in general on down days

The outlook for stocks and cryptos is still bleak in the back half of 2022

Be patient on adding risk assets, the time will come but that time is still not now

- Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.