Author: Colin Twiggs

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Inflation is coming

Inflation tops investor concerns according to Fed report

Concerns over higher inflation and tighter monetary policy have become the top concern for market participants, pushing aside the COVID-19 pandemic, the Federal Reserve said on Monday in its latest report on financial stability. ….Roughly 70% of market participants surveyed by the Fed flagged inflation and tighter Fed policy as their top concern over the next 12 to 18 months, ahead of vaccine-resistant COVID-19 variants and a potential Chinese regulatory crackdown. (Investing.com)

The market is no longer buying the Fed’s talk of “transitory” inflation.

Fed’s Bullard expects two rate hikes in 2022

St. Louis Federal Reserve Bank President James Bullard on Monday said he expects the Fed to raise interest rates twice in 2022 after it wraps up its bond-buying taper mid-year, though he said if needed the Fed could speed up that timeline to end the taper in the first quarter. “If inflation is more persistent than we are saying right now, then I think we may have to take a little sooner action in order to keep inflation under control,” Bullard said in an interview on Fox Business Network……Bullard has been among the Fed’s biggest advocates for an earlier end to the Fed’s policy easing, given his worries that inflation may not moderate as quickly or as much as many of his colleagues think it will. (Reuters)

The Fed are reluctant to hike interest rates, to rein in inflationary pressures, as it would kill the recovery.

Producer Price Index

Producer prices (PPI) climbed more than 22% in the 12 months to October 2021, close to the high from 1974 (23.4%). Consumer prices have diverged from PPI in recent years but such a sharp rise in PPI still poses a threat to the economy.

Producer Price Index (PPI) & Consumer Price Index (CPI)

Iron and steel prices, up more than 100% year-on-year (YoY), will inevitably lead to price increases for automobiles and consumer durables. Other notable YoY increases in key inputs are construction materials (+30.6%), industrial chemicals (+47.3%), aluminium (+40.7%), and copper (+34.5%).

Producer Price Index: Commodities

Underlying many of the above price rises is a sharp increase in fuel, related products and power: up 55.7% over the past 12 months.

Producer Price Index: Fuel & Energy

Conclusion

Inflation is coming, while the Fed are reluctant to hike interest rates. Buy Gold, precious metals, commodities, real estate, and stocks with pricing power —  a strong competitive position which enables them to pass on price increases to their customers — if you can find them at reasonable prices. Avoid financial assets like bonds and bank term deposits.

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Technology-critical elements

Technology-critical elements (TCEs) are elements for which a striking acceleration in usage has emerged, relative to past consumption, and which are critical to emerging technologies.

Wikipedia provides a useful list:

Rare-earth elements (REEs)

In atomic order:

Light (LREEs)

  • scandium
  • yttrium
  • lanthanum
  • cerium
  • praseodymium
  • neodymium
  • promethium

Heavy (HREEs)

  • samarium
  • europium
  • gadolinium
  • terbium
  • dysprosium
  • holmium
  • erbium
  • thulium
  • ytterbium
  • lutetium

Platinum-group metals (PGMs)

  • iridium
  • osmium
  • palladium
  • platinum
  • rhodium
  • ruthenium

Other elements

  • antimony
  • beryllium
  • caesium
  • cobalt
  • gallium
  • germanium
  • indium
  • lithium
  • niobium
  • tantalum
  • tellurium
  • tungsten
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Retail sales, missing workers and the inflation threat

The October labor report shows hours worked were roughly unchanged from September and still 100K below the pre-pandemic high (5.25m). But GDP of 19.5 trillion is up slightly when compared to 19.2T in Q3 2019, indicating that productivity has improved.

Real GDP & Hours Worked

Monthly retail sales for September, on the other hand, were way above trend.

Retail Sales

People are spending Dollars they didn’t earn, courtesy of record government stimulus.

That is one of the primary causes of rising consumer prices (red below): when demand outstrips supply.

Average Hourly Earnings & CPI

A rising CPI in turn causes second run inflation through higher wage demands (green and gray above) if central banks fail to act quickly. They become embedded and difficult to dislodge.

The combined effect of the pandemic and government stimulus has had a profound impact on the US labor market. The economy added 5.8 million jobs in the 10 months to October, at an average of 580K per month. That rate is likely to slow as the economy reopens and enhanced unemployment benefits end.

We are missing 4.2 million employees, compared to the pre-pandemic peak of 152.5m jobs, and seem unlikely to find them, judging by the 10.4 million job openings in September. High levels of job openings are likely to exert continuing upward pressure on wages.

Non-farm Payroll & Job Openings

The missing workers — aided by government handouts — have either retired, quit their jobs to day-trade Tesla and crypto-currencies, or have re-assessed their work-life priorities. No doubt there will be a trickle back to the workforce — as day-traders encounter reversion to the mean and/or savings run low — but the Fed needs to reassess its full employment target. Failure to do so would leave interest rates too low for too long and allow second run inflation to become entrenched. The only way to then dislodge it is with the kind of drastic measures that Paul Volcker used in the early eighties, with the fed funds rate peaking at 20%.

Fed Funds Rate under Paul Volcker

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David Woo: Prelude to volatility

The bond market had a heart attack last week. Rising inflation caused a massive back up in bond yields in the short end of the market. The market is now pricing in two rate hikes in 2022. The Fed will have to raise real interest rates in order to tame inflation.

Real interest rates are falling. The stock market is taking its cue from the bond market and is rising. Stock prices represent discounted future cash flows, so negative real interest rates make a big difference to earnings multiples.

The Democrats are determined to spend their way to a mid-term election victory, with a $1T infrastructure bill and $1.75T social spending, both light on tax revenue. The GOP will try to stop them when the debt ceiling issue returns in December but they don’t have much leverage.

Financial conditions will have to tighten a lot more in 2022. The Fed is way behind the curve and is going to have to play catch-up.

Conclusion

Inflationary pressures in the US economy are growing, while the Democrats plan a further $2.75T in fiscal stimulus which is light on tax revenues.

Long-term yields lag far behind inflation, with real interest rates growing increasingly negative. The assumption is that the Fed will tighten sharply in 2022 to curb inflation. We expect that the Fed will taper but is not going to rush to hike interest rates for three reasons:

  1. The Fed would be tightening into a slowing economy, with growth fading as stimulus winds down;
  2. High energy prices will also help to cool demand; and
  3. US federal debt levels — already > 120% of GDP and likely to grow further with proposed new stimulus measures — are a greater long-term threat than inflation. The Fed and Treasury are expected to work together to boost GDP and tax revenues through inflation, keeping real interest rates negative to alleviate the cost to Treasury of servicing the excessive debt burden.
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Job openings flag upward pressure on wages

Job openings fell by 660k in August, from 11.10 million to 10.44 million. Unemployment fell by less, from 8.70 million to 8.38 million (-320k), as absentees return to the workforce. Unemployment declined steeply (-710k) to 7.67 million in September and we expect an even larger decline in job openings as more return to the workforce.

Job Openings & Average Hourly Wage Rates

Job openings in August exceed unemployment by 2.06 million. While this is expected to reduce over the next few months, as stragglers return to the workforce, the persistent gap is likely to add upward pressure to wages. Average hourly earnings growth, currently at 4.6% YoY, is expected to rise in the months ahead.

Small Business - Difficulty in Finding Workers

The number of people who quit jobs voluntarily – to work for another company that offered higher wages and benefits and a signing bonus; to change careers entirely; to stay home and take care of the kids; to spend more time with their money; or whatever – spiked by another 242,000 people to a record of 4.27 million in August, up 19% from August 2019…….This enormous number of quits is the hallmark of a tight and competitive labor market that encourages workers to switch jobs to seek the greener grass on the other side of the fence. (Wolf Richter)

Job Quits

Conclusion

The economy is recovering but the persistent gap between job openings and unemployment suggests that upward pressure on wages is likely to continue into next year. Rising wage rates add pressure on prices of consumer goods and services, adding to the inflationary spiral.

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Deconstructing Evergrande’s effect on China

Elliot Clarke at Westpac says that China will be able to withstand the shock of Evergrande’s collapse and that power outages are a bigger threat.

We still think that the property sector contagion is part of a broader issue that China will struggle to overcome, as Michael Pettis succinctly explained:

China’s debt problem

Tweeted by Prof. Michael Pettis:

In the past — e.g. the SOE reforms of the 1990s, the banking crisis of the 2000s, SARS in 2003, the collapse of China’s trade surplus in 2009, COVID, etc. — whenever China faced a problem that threatened the pace of its economic growth, Beijing always responded by accelerating debt creation and pumping up property and infrastructure investment by enough to maintain targeted GDP growth rates. It didn’t adjust, in other words, but rather goosed growth by exacerbating the underlying imbalances.

That is why it had always been “successful” in seeing off a crisis. But when the main problem threatening further growth becomes soaring debt and the sheer amount of non-productive investment in property and infrastructure, it is obvious, or should be, that accelerating debt creation and pumping up property and infrastructure investment can no longer be a sustainable solution. All this can do is worsen the underlying imbalances and raise further the future cost of adjustment.

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Recent breakouts

Our recent breakout scan returned a number of promising stocks for review.

Australia

Orica (ORI) – rising Trend Index indicates buying pressure. Follow-through above 14.50 would complete a double bottom reversal.

Orica (ORI)

Canada

Precision Drilling (PD) – Trend Index trough above zero indicates strong buying pressure.

Precision Drilling (PD)

UK

Metro Bank (MTRO) – not a conventional breakout but rising Trend Index indicates buying pressure.

Metro Bank (MTRO)

USA

Marathon Petroleum (MPC) – Trend Index troughs above zero indicate strong buying pressure.

Marathon Petroleum (MPC)

More Breakouts

Spirit of Texas Bancshares (STXB) – shallow trough is a bullish sign. Trend Index holding above zero indicates strong buying pressure. Breakout above 25.00 would signal a fresh advance.

Spirit of Texas Bancshares (STXB)

CURO Group Holdings (CURO) – Trend Index trough above zero indicates strong buying pressure.

CURO Group Holdings (CURO)

Curtiss-Wright (CW) – Trend Index trough above zero indicates strong buying pressure.

Curtiss-Wright (CW)

Acuity Brands (AYI) – Trend Index troughs above zero indicate strong buying pressure. Follow-through above 200 is bullish.

Acuity Brands (AYI)

Apollo Gloabl Management (APO) – Trend Index trough above zero indicates strong buying pressure.

Apollo Global Management (APO)

Williams Companies (WMB) – Trend Index trough above zero indicates strong buying pressure.

Williams Companies (WMB)

Home Bancorp (HBCP) – shallow trough is a bullish sign. Trend Index trough above zero indicates strong buying pressure.

Home Bancorp (HBCP)

APA Corp (APA) – Breakout above 24.00.

APA Corp (APA)

Occidental Petroleum (OXY) – Breakout above 33.00.

Occidental Petroleum (OXY)

Shallow corrections and Trend Index troughs above zero indicate healthy buying pressure.

A word of caution: the above stocks are selected on the basis of technical analysis and do not consider fundamentals like sales, earnings, debt, etc.
Please do your own research. They are not a recommendation to buy or sell.

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