If you ever wanted to know how the treasury yield curve could become inverted, you have a textbook case of this phenomenon right now. The Federal Reserve has raised rates by 25 basis points and they have said they will continue to raise rates for the remainder of this year and probably part of next year. The debate is whether to raise rates (meaning only the short-term Fed Funds Rate) by another 25 basis points or by a more aggressive 50 basis points at the next meeting in May and the next meeting after that. The Fed anticipates that the Fed Funds Rate will be up by 2% when all is done. We’ll see about that.

US Treasury Yields:

Date	1 Mo	2 Mo	3 Mo	6 Mo	1 Yr	2 Yr	3 Yr	5 Yr	7 Yr	10 Yr	20 Yr	30 Yr
04/01/2022	0.15	0.37	0.53	1.09	1.72	2.44	2.58	2.56	2.50	2.38	2.60	2.44
04/04/2022	0.18	0.42	0.66	1.14	1.72	2.43	2.61	2.56	2.52	2.42	2.64	2.48

Inversion

Inversion occurs because investors in longer-term Treasury securities (especially the 10 Year Note) don’t follow in lockstep with what the Fed is doing. That is exactly what is happening now. I believe there has been a long-term bull market (perhaps even a bubble) specifically in the 10 Year Note for several quarters, especially since the beginning of Covid. That bull market continues now. Whether it is international buyers of the 10 Year or mortgage lenders looking to sort-of match durations or any number of other reasons, the yield on the 10 Year has been bought down to artificially low rates. As of yesterday (April 4), the yield on the 10 Year was 2.42% and the yield on the 2 Year was 2.43%, which is a miniscule 1 basis point inversion. Hey, they say a win is a win, and so an inversion is an inversion, at least for the sake of argument with this blog post. Further evidence that the 10 Year specifically in a bubble can be found in the above-linked chart: Yields on the 3, 5, 7, and 20 Year Treasuries all exceed the yield on the 10 Year. Yet another caveat that some of the Fed governors are pointing to is also evinced on the same chart: Though the 10 Year minus 2 Year yields may be (slightly) inverted, the 10 Year minus the 3 Month yield (0.66%) is not close to being inverted; some Fed governors comfort themselves with that data.

Fault

So is it the Federal Reserve’s fault that the Yield Curve has inverted? No, it is not, because the Fed is raising rates for a reason, and that reason is Inflation. The Fed’s primary method of fighting inflation is by raising short-term interest rates. Higher rates temper lending, which tempers economic activity, which tempers price increases, or so the theory goes. It’s course correcting a supertanker, but it’s important information for investors because investors are forward-looking and any data or evidence of what the future may bring will cause investors to make adjustments. With current annualized inflation at 7.9% and with supply chain problems such as the Ukraine situation and a Covid rebound in China, inflation could remain higher than anticipated for longer than anticipated. The Fed is right to take action to address inflation and they are likely several quarters behind the 8 ball and need to catch up. Covid and the fiscal, monetary, and political reactions to it have caused this inflation; the inflation boulder is rolling down the hill quickly.

Why Is It Important?

An inversion of the yield curve is important because, when it has happened in the past, it has presaged an economic recession, which means a decrease in GDP from one period to the next. Negative economic growth. Bad news for companies and employees. The previous time the yield curve inverted was in 2019, when it was thought that the economic growth that commenced as the 2008 Financial Crisis worked itself out was then on its last legs. That inversion did not predict that Covid would hit, but it was Covid that was the straw to the camel. Similarly, the yield curve inverted prior to 2008, whereafter another exogenous event (the Financial Crisis) proved to be the final straw. My point is that the previous two inversion events proved to be prophetic only in the rear view mirror and because of exogenous events. That is perhaps why investors this time are skeptical that this inversion will presage another recession and thus are continuing to like 10 Year Treasuries and are continuing to purchase stocks.

IMO

I believe higher inflation is here to stay because the just-in-time supply chain remains in a shambles, because commodities remain scarcer than they need to be, and because Russia will remain a non-player in international trade for the foreseeable future. Also, in the US, aging demographics are contributing to the “Great Resignation” and a labor shortage that is and will continue to drive wages upward. If the Fed continues to follow the Volker playbook and continues to raise rates to combat inflation, there is a good chance that a recession will result. When and how deep are the unknowns. It’s probably best to adjust your portfolios to be on the safer side, meaning hard-asset-backed stocks (oil, real estate, commodity-based companies). As to bonds, look to short-duration bond funds – more on that later.

I watched last night’s news channel coverage of events related to Russia’s attacks on Ukraine, and also have been reading various investment analysts’ takes on what the military action may mean for US equity markets. These takes have ranged the gamut from “buy the dip” to “don’t buy the dip”. Today’s equity markets reflected the lack of consensus among the experts as they opened up way down and closed way up – up about 3.4% for the day in the case of the Nasdaq 100 Index. I am in the “buy the dip” camp, and I also believe that Putin and Russia will have a tough time in Ukraine. One TV pundit speculated this is the beginning of the end of the Putin regime. I won’t go that far but I think this is a big mistake by Putin. Here are the reasons why I think so:

• Russia may have the superior armed forces, but their history has been that they have been much better in defense than on offense. WWII may have been a hard-won success, but Russia had been invaded and was playing extreme defense. More recent Russian military action in places such as Afghanistan and Chechnya, wherein Russia was playing offense, were not as successful. By the way, this is not just true for Russia – the US’s record in offensive operations has been less than stellar. It is really difficult to succeed with an offensive operation because your opposition is fighting for their very existence.
• Ukraine’s military may be smaller, but they will be well-armed with Western armaments, likely with the exception of airplanes and helicopters. Russia will likely establish air superiority – Russia’s missile strikes during the fist night seemed to have that aim in mind. All that said, while short on numbers and short on air power, look for Ukraine’s armed forces to score some unexpected hits.
• I’m skeptical that the Russian people are all in for this war. Putin’s statements prior to last night’s activities indicated that the pretext for the war is to avenge genocide that either has occurred or may occur in the Donbas region in eastern Ukraine, and to cleanse the Ukraine government of the “nazis” in place there. Do the Russian people really buy that? Because it is not based in reality. If the Russian people don’t buy the pretext and unless they really believe their very existence is threatened by the current Ukraine government, it will be very difficult for Putin to muster the public support for this military operation, even in Russia. This is 2022, not 1956, and the Russian people are online and have access to information on demand. They may interpret such information differently than Western Europeans or Americans do, but they will probably know when they are being lied to. Perhaps they are used to it now, after having been lied to by Moscow for decades. Once Russian troops start dying, even in small numbers, it could be difficult even for the tyrant Putin to maintain support. Even in Russia.

Small Markets

Regarding the “Buy/Don’t Buy” question, I think it boils down to Russia and Ukraine being small markets that will not significantly affect the profits of US companies. The level of commerce between these combatants and US companies, while important, is not as important as the level of commerce with other markets, including emerging markets. American consumer goods are not manufactured there, so supply disruptions and related inflation will likely not be a factor. Oil and energy is one area that will be affected. Russia is basically a petro-state. For a country whose universities produce some of the best engineers who have achieved great things in science, it is a sad statement to say Russia is on the same level as Saudi Arabia. Energy prices have increased in the run-up to this conflict and there is a good chance prices will continue to head north. That said, oil is a commodity, and there are other sources of oil that can make up for the absence of Russian product. Perhaps this conflict also will factor in to the Federal Reserve’s actions for the coming year; perhaps interest rates won’t rise that much. Equity markets do not like uncertainty, and Russia does provide uncertainty. I think the balance is in the side of the Russia/Ukraine situation will not affect the US economy that much, especially in the long term. This will be true moreover if my surmise that the military operation does not go as smoothly as Putin believes actually comes to fruition.

IMO

The Russia/Ukraine conflict in and of itself will not have significant repercussions with US companies, especially in the long term. The oil and energy sectors will be most affected, and others will make up for any vacuum that results from the absence of product from Russia. Putin will have a harder time than he thinks in Ukraine because its pretext is fake and because its military is not designed for offensive operations. As someone who has been in Ukraine, it is all very sad to me. I will finish with a photo of Edwin Starr, the artist of my favorite anti-war song, appropriate titled “War”, as well as a link to that song on YouTube:

https://www.youtube.com/watch?v=dQHUAJTZqF0. War by Edwin Starr on YouTube

I have written before that investors get spooked by the threat of higher interest rates because higher rates on US Government debt means higher discount rates for the future cash flows of stocks and hence lower stock prices. Another reason that investors get spooked by projected higher interest rates is that rate increases by the Federal Reserve have in the past presaged recessions. It’s not a perfect correlation and it may take a couple of years for the recession to hit after the rate increases are commenced, but this chart from the Federal Reserve website shows that rates have gone up prior to recessions:

Look at the last three times the Fed raised rates:

• Starting in about 2016 and throughout the latter part of the last decade, ending with the (short-lived) Covid recession, which might have been longer lived had the Fed not bent over backwards to drop rates and to inject $Trillions into the US economy;
• Starting in 2005 and ending with the “Great Recession” caused by the mortgage-backed bond crisis; and
• Starting in 2000 and ending with the “Dot Com Bust” recession.

This is not to say that the Fed predicted Covid, or the Great Recession, or the Dot-Com Bust. Rather, I believe these events were the catalysts that plunged an already overheated economy into recession. In all of these instances, the Fed increased rates in an effort to cool economic activity and keep inflation in check, whereafter these bad events occurred and we had a recession.

This Time?

With the previous three times, the inflation threats that the Fed attempted to combat were tame in comparison to what we have now. At 7% annualized, the current inflation rate is a much larger beast to slay. I am dubious that 1/4% increases off of a near-zero current Fed Funds rate will have much of an effect on the inflation rate. There was nothing incremental about what the Fed did to try to help the US economy during Covid, and those relatively drastic actions did help but have also stoked inflation. Now the Fed will attempt to address inflation in an incremental way. Nevertheless, the stock market is spooked.

Statistically Significant

A counter-argument can be made that the data reflected in the FRED chart above is not statistically significant. Recessions are a part of the economy and likely occur despite actions central banks take to combat them. Just because the Fed raised rates and a recession happened a couple of years later doesn’t mean it will in the future. Rate raises are not necessarily causal. There are too many other factors involved with macroeconomics to aver that a rate raise by the Fed will presage a recession.

IMO

In the past, it has taken a couple of years from the commencement of rate increases until the onset of a recession. The Fed has not even raised rates yet – all they have done so far is state that they plan to do so, as well as plan to wind down other efforts to prime the pump. Which means that the Fed is still accommodative, which leads to the high inflation rate. Don’t look for a recession in 2022; instead, look for fairly strong growth. If the Fed Funds rate is increased 4 times in 2022, as is predicted, that means it will sit at 1% or maybe 1.25% at the end of 2022, which is not exactly high. The problem is, stock investors will likely continue to have the jitters. If corporate earnings continue to grow as projected, and investors remain jittery at the same time, it could mean there could be bargains to be had as long as the jitters continue.

How do you react when you see other people walking among other people while looking at their cell phone? Do you think that they should either walk or look at their phone but not at the same time? Or do you sympathize because you are guilty of the same behavior? Cell phoning while walking is one thing, but cell phoning while driving is another, more dangerous activity. With cell phones, iPads and the like, it seems that the temptation to multitask is too great to avoid. What’s worse is when people look at their phones with their ear pieces in and walk all at the same time – stay away from such offenders unless you want to get run into!

Be Self-Aware

People who multitask as I describe are not bad people but they are guilty of not being self-aware. They do not consider the effect of their actions on others. Try navigating the grocery store aisles when other shoppers are unaware of their context and are thereby creating an obstacle for you. If you are in a grocery store, you should be aware that you are not the only shopper in the store and that there are other shoppers there who may pluck something from the same aisle in which you have chosen to reside. Likewise, please be courteous to other pedestrians by making sure that your actions don’t cause you to be in other people’s way. Also, don’t text and drive!

Financially Self-Aware

What does my point about cell phoners and slow people in the grocery store have to do with your finances and planning? Being self-aware of your current financial condition is an important starting point for making a good plan and sticking to it. The first thing you do when you make your financial plan is to do a personal audit of your current situation, including your job and the industry in which you work as well as your salary and your investment portfolio. The question you need to answer is, “Where am I at, and what do I need to do to get to where I want to be?” Your current age and your health also play an important part. For instance, a single working 40 year old might have a different financial plan and set of goals than will a married and retired couple in their 60’s. Then there is the current asset mix in your portfolio, including in your retirement plan. Perhaps you decided to be 80% in stocks 2 years ago, but now you are 90% in stocks because your stocks have outperformed other assets in your portfolio and now you are 2 years older. If so, perhaps you should reassess your portfolio so that it is commensurate with your current situation.

I say all of this, but you can also go too far with the self awareness. For instance, stocks have been hit so far in 2022 and Treasury bond yields have gone up. If you are too much in tune with your current situation, perhaps this mini-correction in stocks causes you to want to sell and head for safety, if such a place exists. There is a happy medium between being too aware of current market conditions and taking more of a patient approach with your plan. Be aware, but not too much, and if you are on top of the markets on a daily basis, don’t allow the roller coaster market to deter you from executing your financial plan.

IMO

The same people who you see multitasking with their phones probably also go to yoga class. One of the important tenets of yoga is being present in the moment and being aware of your body. Perhaps these multi-taskers believe that yoga is their penance for being torn in many ways with the rest of their endeavors. When it comes to your personal finances, my recommendation is that you be more Namaste and less frazzled, unless you want to remain frazzled for many years to come.

Hello and Happy New Year! Let’s all hope that our nation and the rest of the world continue to make progress against Covid and that fewer people get sick and fewer still die from the awful disease. That said, we are not off to a great start. Anecdotally, it seems like a lot more people are getting sick with Covid over the past 4 weeks or so – more than even a year ago. I don’t trust the official numbers at all because test results taken at home don’t have to be reported, and because asymptomatic people who have Covid may choose not to take a test at all. Fortunately, due to having been vaccinated and also to the potential lower virility of current versions of the virus, the percentage of people getting very sick seems to be lower.

Full Rose Bowl

Despite the “tsunami” of new Covid cases, even among the already vaccinated, state and local governments don’t seem to be panicking – yet. Case in point: The Rose Bowl stadium on New Year’s Day was full an rollicking, entertained by the outstanding game between the red hued teams of Ohio State and Utah. To state the obvious, the Rose Bowl is in California, home to some of the most stringent Covid standards during the first 12 or so months of Covid. Remember the days of the Red, Purple, and Orange Tiers? And the complicated mathematics that went behind placement into one of those tiers, which then dictated what activities citizens could or could not do? Despite all of the recent bad Covid news, even California has not yet resurrected its Tier mathematics. Restaurants are not being forced to forego indoor dining, and except for mask wearing, life goes on pretty normally here in the Golden State. Had the old Tier metrics remained in place during this current Covid surge, I can’t imagine that the State would have allowed the Rose Bowl – and the parade, of course – to be held. Perhaps the State health authorities held their collective breath and looked the other way, because there is no “social distancing” in the Rose Bowl, but kudos to them for allowing some normalcy to take place.

California is not alone. So far, there do not seem to be wholesale cancellations and closures throughout the US. While some colleges are going remote for a short time at the beginning of the Winter/Spring term, most primary schools are open for business, although teachers are sick. Private sector companies are perhaps delaying back-to-the-office plans but they are not closing down. Unemployment has not spiked, at least not yet. On the contrary, worker shortages due to Covid or due to other reasons seem to be the larger problem. Mask mandate that have been put in place have often come with end-dates, which of course could be changed, but at least they appear temporary.

Fears Not Realized

Back in late November/early December 2021, when the Omicron variant was new, the stock market sold off, with the S&P 500 down about 5% at that time. The reason given for the sell-off was not concern that people would get sick from Covid, but that governments would overreact and revisit the shutdown policies that they had previously enacted. So far, these fears have not been realized. Governments have so far kept out of the way and have let the current Covid wave play out. The results have been that the health care sector is busy but not overwhelmed, and our economy has been transacting more or less as usual. Investors have liked what they have seen so far: the 5% correction became a buying opportunity, and the S&P 500 Index is back up at a new all-time high.

IMO

It’s not pretty if you contract Covid, but these variants seem to play out over a 6 to 8 week period. It seems like governments are realizing this and are not using their biggest weapons just yet. If the 6 to 8 week life holds true to this Omicron variant, and data from other countries suggest that it will, then I believe those big weapons will remain in the arsenal but not deployed. The worst stories with this variant will be about those who got sick or worse, and fortunately not with the economy that was forced to shut down and jobs that were lost as a result.

The stock market has been volatile this past week, today included. There have been many factors that have abetted the volatility: increasing Covid cases due to Omicron, the Fed statement on Tuesday wherein the stock market liked that the Fed would raise interest rates in 2022, followed by consternation that the Fed would raise rates, and finally by “quadruple witching” options contracts that expire today (Friday). Moreover, 2021 has been a good year in the stock market and investors likely are taking some profits to lock in gains for the year. I believe all of these issues and others set up 2022 to get off to a good start and to be a good year for the stock market. And by that I mean the major indexes, not specific stocks.

Why Bullish?

There are several broad reasons why I remain bullish for 2022:

• Interest Rates: I have written before that higher interest rates affect high-multiple tech companies not necessarily because higher rates mean higher borrowing costs; most tech companies aren’t leveraged to the hilt so borrowing costs aren’t a huge factor for them. Rather, higher rates cause pain with tech company stocks because higher rates mean higher discount rates used for net present value calculations on future corporate earnings, and higher discount rates translate to lower theoretical values for the tech companies. All that said, I believe discount rates have room to expand from where they are now and still justify current valuations. As my favorite economist Brian Wesbury of First Trust Advisors says in a recent blog, current valuations can still pencil at a 10 Year Treasury Rate of up to 2.5%. That rate is currently about 1.5%. If the Fed does 3 rate rises in 2022, that would mean a rise in short term rates of 75 or maybe 100 basis points for the year, phased over time. And that doesn’t mean the 10 Year yield will rise in lockstep with the Fed’s actions. Wesbury projects the 10 Year to end 2022 at a yield of about 2.0%, and we can all work with that. By the way, if so, that would be good news for the mortgage and hence the housing markets as well.
• Continued Government Stimulus: 2022 will still see plenty of monetary and fiscal stimulus, if perhaps at a lesser rate than during 2021. The Fed said they would taper its bond purchasing, not stop it in its tracks, and so there will be that for at least Q1 2022. As for fiscal stimuli, the Infrastructure bill has passed and some of that will be doled out in 2022. Though Build Back Better doesn’t look too good, I believe some spending bill will pass; even “stick in the mud” Senator Manchin has said he is ok with $1.5 Trillion of new spending. That’s not chump change. Look for a new effort to pass a spending bill early next year. I’m not arguing here that it should happen, merely that if it does happen it will be stimulative to the economy and corporate earnings, the future ramifications be damned.
• Inflation: I have also written before that the Fed wants to inflate its way out of the turbulence it faces. Inflation is good for corporate revenues and it could be good for corporate earnings if corporations keep there costs in control, which is of course easier said than done. Owning hard assets – housing, gold, land, but not automobiles – has historically been good during inflationary times, and so can be stocks. Take high margin tech stocks: while they may be affected by things such as higher chip prices and certainly by higher labor costs, they are not as affected by higher raw materials costs as are traditional manufacturing companies. Moreover, the revenue side for tech companies is likely more price elastic than are revenues for manufacturers. For instance, I would bet that Google or Facebook would have an easier time raising the rates they charge to advertisers than a supermarket has in raising its prices. I believe the tech economy will fare better during an inflationary period than we have seen with companies in past inflationary periods. That said, it has been a while since we have had real inflation, so let’s see how it plays out.
• COVID: While we are seeing an increase in case numbers and some states are back to having mask mandates (kind of), we are far better off than we were 12 months ago when we were at the beginning of a Winter surge that ended up getting a lot of people sick and resulted in shutdowns much more significant that the current mask mandates. With vaccination rates as high as they are, and with all signs in the direction that Omicron is relatively more mild that previous variants, look for this Winter to be not nearly as problematic for Covid as was last Winter. We’re not done with Covid yet but it certainly looks better than it did.
• TINA: TINA remains a factor: There is no alternative. Interest rates, though a bit higher (possibly) in 2022, still offer little in the way of return. Going farther out on the risk spectrum will still look appealing by comparison.
• Technical Factors: If investors are selling now to realize 2021 profits and to perhaps stay in cash while the Omicron variant plays out, perhaps 2021 may end the year oversold and 2022 may see renewed buying. Just a hunch on my part.

IMO

I remain in the camp of recommending that investors overweight stocks during 2022. I’m not a doom-and-gloomer by nature and so tend to have a bullish bias, but I believe the factors I outline above tip the scales in favor of continued upward pressure on stock prices.

If you think about it, those two concepts don’t go together. Year-end tax planning is short-term by its nature, whereas long-term planning is just what it says it is. It’s cool if you do some transactions that have a positive effect on this year’s tax bill, but you should weigh these transactions against long-term ideas and financial goals. You don’t want to save a few bucks in the short term but in the process give up the opportunity for longer term growth.

Year-End Tax Planning

This being December, it is the time of the year that many of my Financial Planner brethren pen advice about how to do stuff in order to save money on your taxes this year. Most of these pieces of advice involve selling positions that are at a loss so that these losses offset gains you may have realized with other investments. A variation on this theme is to sell a losing position in conjunction with selling a winning position that you want to get out of between now and the end of the year. Keep in mind that all capital gains and losses that you have transacted during the calendar year get rolled up and netted out to determine your net capital gains. These are good ideas, as long as you really want out of all of the positions that you sell, whether they be gains or losses.

Long-Term Planning

My issue is that you really shouldn’t be selling based solely on the transaction’s affect on your tax bill. Warren Buffet doesn’t typically sell to save money in taxes, and nor should you if you still believe in your investment. Don’t make the mistake of selling a position that you believe will be a long-term success story just because you have tax issues. You will kick yourself later. If you are a technical trader looking to make short-term profits, then it is a different story, but if you are a long-term investor, and you still believe in your investment, then selling your position may not fit your long-term strategy. Now, if the story has changed, or if the stock isn’t hitting sales or earnings metrics that you would like to see, then reconsider your investment, but not solely for tax reasons. Taxes can be part of the equation, but they shouldn’t be the entire equation.

What About Musk?

Now you may say, didn’t Elon Musk just sell a few $billion of TSLA stock in order to pay taxes? Yes, he did, but his case was different. Musk had stock options that were expiring, and so he sold some stock in order to pay to exercise these expiring options. In the process, he owed taxes on the stock that he sold. Presumably he came out ahead even though he payed $billions to the IRS. I wouldn’t call what Musk did “year-end tax planning”. I would call it doing what he needed to do in order to boost his position. It would not have made sense to have his incentive stock options expire unexercised especially with the current trading price of TSLA.

IMO

I don’t like taking any action based solely on taxes, and year-end tax planning is no different. Make sure you have a fundamental (or perhaps good technical) reason why you want to sell a position before you actually do it. Don’t have regrets in the future about the fish that got away.

Earlier this week, it was reported that the Consumer Price Index (CPI) had increased by 6.2% from last October to this. It was the highest reported year to year inflation rate in 31 years. Is this bad news or good news? It depends on who or what you are. If you are a consumer, a worker trying to make ends meet for your family, it is certainly bad news. The essentials of life – food, shelter, clothing, gasoline – are that much more expensive. If you are that same consumer but you own your home, then the news is mixed; you struggle on a weekly or monthly basis but your home and thus your net worth are probably higher. However, if you are the Federal Reserve Bank, the news of higher inflation is good. Why is that? Read on.

The Fed Wants Higher Inflation

Higher inflation helps the Fed deal with its biggest long-term problem, which is the Federal deficit that has been made much larger by increased expenditures related to keeping the economy afloat during the Covid crisis. The current federal debt is just under $29 Trillion, which is about 125% of our nation’s GDP. Prior to the onset of Covid, federal debt was about $23 Trillion, meaning the US has added about $6 Trillion of debt in the last 18 months. With the US Congress contemplating $Trillions more of spending, there is no end in sight. The Fed sees the sheer amount of debt as the greatest potential problem it faces. How should the Fed address this mountain of debt? I see two levers it can use:

• Keep Interest Rates Low: The notional amount of the debt is one thing, but the amount the US Government needs to pay to service the debt (i.e., pay the interest on the debt) is another. In order to keep debt service under control, the Fed should try to keep interest rates as low as it can for as long as it can. During a recovering economy, such as that we are in currently, the trick is to keep rates low but not so low that it sparks much higher inflation. The Fed believes currently that an increase in real wages is the key: as long as real wages remain low, then inflation will remain under control, and therefore interest rates can remain on the low side. Time will tell if this theory will prove correct. But, even if inflation does increase, it’s not all bad for the Fed, because…
• Higher Inflation Devalues Debt: During inflation, the value of assets increase, but the value of debt does not, meaning that the relative value of debt goes down in relation to the value of assets. In addition, if inflation causes federal tax revenue to increase because of higher wages and higher current income and capital gains tax revenue due to the increase in the value of stocks, that means there is more federal revenue to service the increased debt, meaning that the federal deficit doesn’t look so bad in percentage terms. In effect, the Fed is trying to spur the economy to grow its way out of its high level of debt. It is a reasonable approach by the Fed, so despite the lip service it pays to its mandate of keeping inflation under control, I believe the Fed is happily pursuing higher inflation because it views the mountain of national debt as a greater issue.

Who Wins, and Who Loses?

People who own assets will benefit from higher inflation. Owners of stocks, including owners of 401k and IRA accounts, and managers of pension funds, as well as owners of homes and certain other types of real estate, will benefit from higher inflation. These assets will rise in value during inflation. Are you a Crypto player? Bitcoin has had a strong run this year, corresponding with the 6.2% inflation number. Same with gold.

On the other hand, if you don’t own assets, you will lose out. If you rent an apartment, expect your rent to increase, which could put you in a bind if you are also trying to feed yourself and pay for gasoline to get to work. Inflation makes the gulf between the haves and the have-nots much worse. If you thought economic inequality was bad before Covid, wait until you see what the statistics look like in a year. If there was civic unrest then, be prepared for more unrest in the future.

IMO

Don’t pay as much attention to what the Fed says. Instead, pay attention to what they do. They are keeping short term rates low and are continuing to make open market purchases of bonds (perhaps at a tapering level) so that the yield curve and debt service coverage remain manageable. At the same time they are allowing inflation to run above their 2% target, saying 1) it is transitory; 2) the higher current rate is just making up for years of inflation below 2%; and 3) the unemployment rate remains higher than before Covid and real wages aren’t high enough yet to spark long term inflation. Inflation helps their cause, and low rates help them get there. All of that tells me that you should be long and continue to own appreciating assets such as stocks and stock indexes.

Back on December 22, 2020, I wrote that Tesla was severely overvalued and that investors should get out right away. It was trading at about $600 per share at that time and its market cap was more than those of the next 9 automakers combined.

How Wrong I Was

Since then, TSLA has doubled to about $1,200 per share, with about 400 points or 2/3 of that uptrend having occurred since October 1. Instead of the next 9 automakers, TSLA is now worth more than the next 11 automakers combined, and its market cap is in the stratosphere at over $1.1 Trillion. Congratulations to Elon Musk and the entire Tesla team for this outstanding achievement! Had you followed my advice back in December, you would have missed out on doubling your money in TSLA. Oops!

But…

Despite the facts of the matter that prove my December call to have been totally wrong, I believe that my reasoning was sound. And, if I believe my reasoning for recommending a Sell back then was sound, then what do you think my recommendation is today? Sell, even more emphatically. Let me clarify: If you own a block of TSLA and you still think it could go up more, then sell part of your block and have at it with a smaller position. If you can, cash out on your original investment and go forward with “house money”. If you don’t own TSLA now but like what you see (who wouldn’t), don’t buy now, but wait for a correction. If and when TSLA corrects, look beyond the stated reasons for the correction and buy in at that point if you are so inclined. Stocks that run up quickly (say by 100% within a year) tend to endure periods of profit taking and consolidation. Wait for that if you must play in the TSLA sandbox. If no correction occurs, don’t play.

Meme Stock

TSLA has clearly become a “meme” stock – a stock that is popular on social media and among retail investors. Just during the past week, I have had people whose investment experience is otherwise limited ask me about TSLA call options. These are not investment pros; rather, they are everyday folks who are caught up in the TSLA frenzy and are eager to play. That tells me that TSLA has become untethered to any sense of fundamental value and is currently trading based on the “greater fool” theory. Granted, TSLA is profitable (a fantastic achievement!), but it trades at 380 times current earnings and 148 times projected future earnings (Source: Finviz.com). As I said back in December, only if TSLA hits every most-optimistic growth rate can one justify a 148 times forward P/E. And, if and when TSLA does hit the most optimistic metric, the stock will probably go up again. I don’t view myself as a fundamentalist, value-based “cheapskate” investor. I don’t think P/E ratio is a valid valuation metric for growth companies. I do like playing momentum opportunities when I see a good one. However, TSLA at $1.1 Trillion and 148 times forward earnings following a doubling during the past year is beyond the pale.

Don’t Short

One work of caution: Don’t short the stock. Buy a put if you would like, but TSLA puts are costly. My advice back in December was to sell, and not to short. Had you shorted at $600/share, you would have lost your shirt during 2021. It is very hard to predict when a popular meme stock will fall from grace. Don’t try it yourself at home.

IMO

When the kids are in there playing TSLA just like the hottest video game, you should think that there is trouble ahead. I can’t tell you when that will be, but I can see short attention span kids fleeing the stock as soon as they lose money or find the next sparkly thing to throw money at. I still believe that new entrants into the electric car market – both established auto companies (Volvo, BMW) and new entrants (Rivian, Polestar) will eat away at TSLA’s share of the e-car market. If you have “fun” money that you are willing to risk, then be my guest with TSLA, but don’t bet the farm on it.

Two legacies of the Covid-induced worldwide economic shutdown (or at least major disruption) seem to be higher levels of inflation and an increased number of workers (at least in the US) deciding to call it quits. Inflation, I believe, is a direct result of the shutdown and governments worldwide believing they could turn world economies off and back on again like a water faucet with little impact. Absent Covid, inflation would not be a problem now. The increase in the number of people retiring, however, has roots more in demographics than in Covid. Let’s look deeper.

Inflation

More evidence comes out seemingly every day. Today, this article on Fox Business states that the median expectation of inflation over the next year is 5.3%, which is a lot higher than the Federal Reserve’s 2% projection. Rising oil and energy prices continue to play a role, as this article about natural gas’s rally and this article about Saudi Arabia’s increased shipments to Asia attest. Now, as the information technology sector has exploded as a part of the world economy and the influence of the energy sector has ebbed, we aren’t necessarily going to experience 1970’s-like inflation or stagflation. However, rising energy prices will cause inflation, whether you drive an electric car or an “old-fashioned” gas-powered contraption. Then there are the continuing supply chain bottlenecks. My own eyeball inspection of the queue of cargo ships waiting to be unloaded at the Port of LA/Long Beach tells me that particular bottleneck is not abating. Christmas is coming soon and retailers are telling shoppers to get started now. Hope they have room in their houses to store stuff in secret for a couple of months. Lastly, there is the possibility of a US Budget bill with a price tag of somewhere between $1.5 Trillion and $5 Trillion. Apart from the politics of the budget, when the government infuses $Trillions into an economy that is already supply-constrained, even in the short term, prices are bound to increase. I have stated before that I believe high inflation is more of a short-term phenomenon, but the speed at which these supply chain issues can be resolved will dictate how quickly the inflation rate will be more normalized. Also, the smaller the budget price tag that is ultimately signed into law, the less likely higher inflation will become an issue.

Resignations

This article posted today says that 4.3 million American workers quit their jobs in August, the most in over 20 years. Workers in food service and retail led the way, and who can blame them? The motivation to want to work at a restaurant now, after having been laid off perhaps for weeks or months during the past couple of years, is probably not it once was. It is likely that many of these former waitpersons are now pursuing their dreams in the information technology sector or some other job that offers more stability. However, I believe demographics plays a role as well. The “Baby Boom” peaked during the late-1950’s, and people born then are now in their early 60’s. Though they probably would have been looking to retire sometime during the next few years, the disruptions caused by Covid have likely tipped a lot of them to retire sooner than they otherwise would have. So, I look at the phenomenon of increased numbers of workers quitting their jobs as part Creative Disruption – workers seeking more stable employment – and part ageing demographics. Regardless, workers quitting is inflationary. Restaurants either have to pay its wait staff more money and thus increase prices on the menu to remain profitable, or dip lower down in the skill level of the workforce, which is probably not to the restaurants’ collective benefit.

IMO

The water faucet analogy was never going to happen and we are now seeing how far-reaching the effects of what we have been through and are continuing to go through on display. The narrative has been that Covid is on the retreat and we are now on the upswing with respect to macro economic performance. However, things like product shortages resulting from supply chain issues or fed up workers moving on to better pastures intervene in the narrative. That’s why you have free markets and buyers and sellers engaging in everyday commerce. I believe in the long term the government stimulus is inflationary and will result in higher asset prices, including higher corporate earnings and higher stock prices. It won’t pick winners, except to the extent that larger, more well-capitalized companies will probably grow at a more rapid rate than will smaller insurgents. Stay long the larger-cap indexes and you should achieve your financial goals if you are a long-term investor.