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.