Monday, January 11, 2021

Road To Reflation

Now that the blue wave is de facto, the likelihood of true reflation at some point down the road took a major step forward...

My overall thesis is that policy-makers are far behind the curve economically. They are looking in the rear view mirror at lagged economic data while driving the car forward over a GDP cliff. Now that the Dems have their blue wave, the likelihood that they will eventually step on the gas has taken a major step forward. But they are not there yet. 

As I've said many times, Disney markets will not cross Death valley unscathed. Markets will not remain levitated at all time highs waiting for five years of economic recovery to get pulled forward into 2021. At some point, the weekly and monthly job carnage will feed back into lower bond yields and deflation. 

Democrats can't reflate the economy while they themselves are the major proponents of lockdown. Stimulus won't reach the real economy until the lockdowns abate which many predictors posit as second quarter. I would agree - April - June. However, markets have already priced in full recovery and return to normal at 0% interest rates. 

What could go wrong with this record asset bubble in the meantime?

Many pundits are comparing this current everything asset bubble to the Dotcom era and saying don't worry about the buyer frenzy, it is still early days i.e. a ten month rally. I totally disagree - I believe this has been a three year top in the making starting with the tax cut meltup in 2018, the Fed rate cuts in 2019, and now the COVID monetary insanity of 2020.

In addition, most pundits are saying that zero percent interest rates are the primary rationale for owning stocks. Again, I totally disagree. Far from being a great reason to buy financial assets at any price, zero interest rates are a warning that monetary policy from an economic standpoint is totally out of gas. Picture a Dotcom bubble in a 1930s economy - that's what abides today. When the bubble bursts, many gamblers will find that their savings buffer is now wiped out at a time when jobs will be scarce. Worse yet, many people are putting their stimulus checks into the stock market, which accounts for part of the vertical rally last week. 

The Motley Fool is recommending gamblers buy Tech stocks (QQQ) with their "stimmy":

Suffice to say, Gold is the biggest warning that reflation is not taking place as the stock market expects. My opinion is that when markets crash, gold will recover first. At that point, I will look to be a buyer of gold in what could be the opportunity of a lifetime. However, I will scale in over time as the crash itself will be extremely deflationary.

As far as Bitcoin goes, I did some research on that alternative currency as well. I read through the original specification and despite having 25 years of IT experience, 15 as a programmer, I felt my eyes glazing over several times. I suggest that the vast majority of people gambling in Bitcoin have no clue how it actually works. Below is my best effort to condense my understanding, while sparing the minutiae:

Bitcoin is a distributed network that uses cryptographic algorithms to create a virtual internet-based transaction ledger, as an alternative to the traditional banking system. The system relies upon distributed servers "miners" to verify all of the transactions between buyers and sellers. In order to incentivize these miners to support the network, the Bitcoin system gives rewards (Bitcoin) in exchange for computing power ("hashrate"). In order to keep this virtual "sun" burning forever, there are a fixed number of total Bitcoins that can be mined, however, the Bitcoin reward amount is halved every four years. An event that increases scarcity. After each halving, Bitcoin skyrockets in value (2016, 2020) etc. As the value increases due to scarcity, more and more miners and computing power are sucked into the network to reap the increased profits. As more miners join the network, the "difficulty" level of the hashrate increases (every two weeks). This has the effect of requiring even MORE processing power to validate transactions. 

All of which is why server capacity (not shown) and electricity consumption grow exponentially along with the price of Bitcoin:

"At 92.8 terawatt hours annualized, bitcoin’s power consumption is slightly ahead of Pakistan’s consumption in 2016, and not wildly away from the Netherlands’ consumption that year. Put a different way, the electricity consumed by minting bitcoin could power all the tea kettles in Britain for 21 years."

Bitcoin's power consumption doubled since November:

So, is Bitcoin stable and scalable, not really. At current price predictions of $400k one could imagine many more Switzerland's of electricity, creating absolutely zero economic value. As I see it, Bitcoin's primary "value" is as a Ponzi scheme that sucks in the maximum money at the top of every rally and then explodes as it's doing right now. Why that's "good" is not for me to say. I didn't see anything about that in the Bitcoin specification.

Recall last week the Bitcoin Trust had multi-year high weekly volume, so it was overdue to monkey hammer latecomers:

This debate on reflation will be an ongoing saga. As each new proposal comes forward and the data catches up with reality, the model will need to be revisited. The pieces are now starting to fall into place for a paradigm shift towards reflation however, it's an extremely crowded trade and the current paradigm is still firmly deflationary. And about to become far more deflationary when "stimmy" checks get obliterated in Tech stocks. And, the now reversing dollar monkey hammers global risk markets.

(FYI, to get around Marketwatch's pay wall, you have to clear your browser cache. Same with Bloomberg)

I predict there will soon be an ETF for this sector ("KILL?"). But, in the meantime it's a stock picker's market.