Wednesday, March 31, 2021

Deflation Is A Margin Call Away

The consensus calls for asset inflation as far as the eye can see...

Why? Because the IQ bar keeps going lower, and lower, and lower. Morons keep front-running each other to the next level lower, while the crowd feels obliged to follow, for fear of being left out. 

One thing they all have in common, they don't see it coming. Because mass deception has now been normalized. It's a business model. 

"The first quarter of the year has not even ended yet, and Wall Street firms are already building a case for stocks to rise even further in 2021."

Not once has the crowd been right on their inflation prediction. Each time they have imploded:

The reason that Japan hasn't escaped deflation after three decades, is because structurally nothing in their economy has changed. They have spent all this time using and abusing various stimulus gimmicks in order to avoid any true economic reforms.

Sound familiar?

Now we are seeing the exact same thing in the U.S. - bigger and bigger stimulus packages, each having less economic impact. As the chart below shows, most of the stimulus impact has been to the stock market not to the economy. U.S. bond yields are not even back to where they were at the lows of 2009, yet we are told bond yields are approaching the danger zone, NOT because the economy is overheating, NOT because unemployment is fixed, but because the financial markets can no longer stomach normalized interest rates. At no other time in U.S. history would a 2% interest rate be considered "too high".

A 2% yield would get rates just back to the 2009 low. Contrary to popular belief, what has been driving stocks higher IS rising interest rates, pushing banks, industrials, retailers and other cyclicals higher. If rates come down, those sectors crash from record overbought levels.

So, rates can't go up, and rates can't go down:

Forty years of poverty-inducing imported deflation later, and most Americans have now been conned into believing that the definition of inflation means prices they can no longer afford. If their incomes went to zero, they would blame it on inflation. We are now in a vicious poverty trap in which wages can no longer rise, because that would cause "inflation". During the 1970s, true inflation came at a time when wages as a share of the economy were the highest in U.S. history, now wages are the lowest in U.S. history. Unemployment is currently the worst in decades, and under-employment is even worse. Sustained inflation in this broken economy is not even really possible, absent a universal income. Nevertheless, conservatives have successfully redefined inflation as anything that would break this cycle of deflationary interest rates. Why? Because these perpetually low interest rates are great for stonks and bonds. 

This Jedi Mind Trick has led the average American to believe that what we are seeing today is a dangerous level of "inflation".  

For their part, it took forty years, but the Fed has finally figured out that unless they allow the economy to "run hot", there will never be anything approaching full employment ever again. In fact, if we continue in this current deflationary downtrend, eventually there will be full unemployment, because each recovery is weaker than the last. 

The Fed has arrived at this belated conclusion at a time when the Biden Administration is more than primed to take them up on their offer of unlimited free money. Back in the early days of the 2009 great recession, the Obama/Biden administration was stymied by a belligerent Republican Congress. Now, it's payback time. Biden's recent $1.9 trillion mega stimulus combined with his impending mega $2t infrastructure plan is the stimulus equivalent of a middle class economy. However it's an insane amount of stimulus for bond markets to digest. We are fast approaching stimulus overload. So far, rising yields haven't caused a problem for the overall stock market, due to the massive rotation out of Tech/deflation plays into cyclicals. So far, the decimation has been solely in bondland. Many are now saying that the forty year bull market in bonds is now officially over:

"The selloff put an end to the bull market in long-term U.S. Treasuries that began in the early 1980s. The Bloomberg Barclays U.S. Long Treasury Total Return Index, which tracks bonds maturing in 10 years or longer, has plunged about 20% since its peak in March 2020, putting the market in bear territory."

Unfortunately, like Japan, we have done nothing to solve the long-term deflationary crisis. In fact, we haven't even admitted it's a crisis. Instead, we are using ludicrous amounts of stimulus to merely pretend it's over. Amounts of stimulus that have primarily found their way into stocks and NOT the economy. At present, all of the economic data looks fantastic due to what economists call "base effects". Meaning we are comparing year over year improvement relative to a shutdown economy one year ago. So, on a relative growth basis everything looks fantastic. These "base effects" are a con man's paradise. Into this chasm of obfuscated economic data, any specious narrative will be bought and believed. 

However, when we look at real-time indicators of true economic activity, we can see that we are a long way from recovery:

Crude oil demand is at a decade low (lower pane). Oil's recovery price is cycle low (main pane). 

The "recovery" CPI is also cycle low and tracking the oil price 1:1. It's central bank sponsored Ponzi inflation. 

In summary, what we have is asset inflation masquerading as economic reflation.

A Jedi Mind Trick for weak minded fools: Those who believe in the virtual simulation of prosperity and its acolyte QE to their peril.

What would it take for the stock/bond ratio to reverse?


Because as risk assets fall so will inflation expectations. Like a rock.

And then this fictional recovery will turn back into a pumpkin.

Overnight. Limit down.