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- Oversold stock market bounces… (dead cat)?
- Russia & China fly joint “nuclear-capable,” bombers near Japan & South Korea
- Only 5 months ago the predicted inflation rate was 2.2%… oops
Inflation Now Four Times Higher Than Experts’ Estimates
May 31, 2022
“Be careful how the herd gathers and runs. It’s not always rational, it’s not always safe, and it’s not always safe for an investor to play when the herd is gathering. So we’ve got that paradox of herding. It’s in effect here, and it’s in a time where you have greater economic, financial, and geopolitical destabilization emerging. Investors are continuing to ignore these factors at their peril. As an investor, it’s pretty critical that you gain your own version of strategic clarity.” — David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
David, while you were top gunning from the top of Red Mountain Pass down into Silverton, I was sitting in a theater watching Top Gun. I’ve got to admit, it was a lot more comfortable sitting where I was than where you were. But you got to tell the audience what you were doing this weekend, because the 50th anniversary of the Iron Horse is something that obviously only happens once every 50 years. But you got to ride the opposite direction, and it was even more exciting than the normal Iron Horse.
David: Leave it to two brothers with a little too much testosterone and maybe a little too much ego.
David: And here they are challenging each other. One’s an engineer with the train here in Durango.
David: And the other says, “I can beat you on my bicycle going from Durango to Silverton.” So ensues the race, and it’s been done every year since then. And so we know those guys and—
Kevin: Yeah, Tom rode on Saturday.
David: It’s great.
Kevin: Yeah, he did. 50 years later, and he’s a good friend.
David: Yeah. And so they opened up a new race this year from Ouray to Silverton, it’s a shorter race, a steeper climb, and perhaps the only year they’re going to do it. So if it’s the first of many, that’d be great, if it’s the only one they ever do, I wanted to make sure and do that.
Kevin: Okay, so I texted you and asked you about it, and you said it was epic. One thing, just say one thing about the epicness of it, just—
David: Well, I went there and back, and that gave me 5,000 feet of climbing and 5,000 feet of descending.
David: And there’s nothing like 5,000 feet of descending. There’s a lot of things that you can rather do than 5,000 feet of climbing.
Kevin: You sent me the emoji of praying hands. Was it a little bit dicey there for a little while?
David: It’s the Million Dollar Highway, and I’ve been on that road with my mother-in-law, where you’ve got those handles inside a car—
David: To help you get into a car. She just about ripped it out as we’re going 25 miles an hour on a clear day, no weather.
Kevin: If you go over the edge, you don’t hit for a while either.
David: No, it’s pretty intense.
David: So coming down that hill was also intense. And probably I think my top speed was 45, but there’s certain turns where—
Kevin: 45 with no guardrail, yeah. Yeah.
David: You’ve got to— Well, you have to slow down quite a bit more than that on a number of those turns.
Kevin: Okay, yeah.
David: But it was exhilarating, it’s beautiful.
David: It’s absolutely one of the most beautiful places in America. They call it the Switzerland of America, and for good reason. The vistas are spectacular, the waterfalls coming down off of the mountains, absolutely stunning. And we had the road completely cleared, all the cars are gone, so it’s you and the road.
Kevin: So was this good training for what’s coming up? I mean, we haven’t mentioned France, but—
David: It’s sobering—
David: Because that’s 5,000 feet of climbing and the elevation gain in France is 10. So yeah, it’s sobering.
Kevin: And that’s coming up in six weeks, is that right?
David: Don’t remind me.
Kevin: Oh, sorry. Yeah, training, training, training.
Well, we better get to the markets. It’s funny though, as we’re talking about going up and down mountains, markets can be very similar. There are times when markets, they go down, they go down, they go down, and then they get into what they call an oversold position. They have to recover. Or the opposite can happen. They can go up and up and up and up and up, and you’ve got an overbought position and you have almost built into the cake a reversal, but is it a real reversal?
David: Yeah, I am mildly competitive, and there is this guy, not quite through with the climbing story, because actually gravity still factors in, gravity of the markets. And the fact that this guy who I stayed ahead of the entire climb ends up passing me on the downhill, and granted, he’s got probably an extra 30 pounds on him.
Kevin: Is that something that needed to be said?
David: The weight?
David: Well, because weight and gravity makes all the difference in the world.
Kevin: Well, of course.
David: There’s no way—
Kevin: But when you’re climbing it makes a difference, doesn’t it? Yeah.
David: Yes, it does. Now you’re right, the language you’ve overbought and oversold is familiar to some of you listening. Any market that trends in a direction for a significant amount of time will gather a crowd. And that directional trend will gather its own energy until eventually there are less investors gathering into the trend and the directional energy fades. So an overbought condition temporarily gathers too many buyers in, then runs out of new buyers to keep it going higher. Oversold is the mirror opposite, too many sellers, too much of a negative consensus, and the downward pressure lessens in intensity. And we’re coming out of an oversold condition after nearly two months of relentless selling. So this last week, a big push higher. I mean, we had 6.6 in the S&P, 6.2 in the Dow, banks were up over 9%, broker dealers 7%, the transports were up 7.1, utilities up 5.1.
Kevin: Right. So you get this relief. In a way you feel like, “Oh, well, maybe this isn’t a bear market.”
David: Yeah. Steven Hochberg wrote last week for Elliot Wave following a tremendous rally across all of these equities and indices, and this is what he said. “The current advance will make investors believe that the market has bottomed.”
Kevin: So the key is the word believe, right?
David: And started a new upward leg to new highs—
David: Just as it is ready to start the next significant wave down. He says, “It’s the paradox of herding.”
David: So the psychological relief that comes in the wake of seven weeks of market declines, that relief is tremendous, right? The background conditions, however, have not changed. Investors are, of course, open to the relief rally, and can maybe even begin to believe that price action is giving them an all clear. They should get in. Our view is still, rallies in the context of a bear market can be 30 to 50% of the previous decline, become very convincing. Last week was a week of reversals, we’ve got stocks moving higher, we’ve got bonds also recovering, and a tremendous amount of pressure. If you’re looking at many of the indicators that we look at on a weekly basis to measure risk, you might just basically have said, “Okay, we’re good. Everything’s fine.” But our view is still that strength should be sold into, in other words, you should be lightening positions into any rally.
Kevin: There’s a word for what we’re talking about. I mean, dead cat bounce, you get these bounces, they call it a dead cat bounce, but boy, it can suck people right in. Now the markets can do what they do, we’ve talked before that the economics doesn’t necessarily always match. I mean, GDP is looking pretty dismal.
David: Yeah. So I mean, in the background, again, nothing’s changed, prices are improving, they had a great finish to last week, but in the background you’ve got inflation. That remains. You’ve got signs of economic deterioration here in the US which are emerging. So GDP, off 1.5% in the first quarter, lower than consensus, with a telling decline in the pretax corporate profit category. So corporate profits declining by 2.3%, they’re not able to completely offset surges and costs with product hikes. And so the consumer feels like they’re paying more, and they are, but they haven’t paid enough to compensate retail for the increase in input costs. So you can expect higher prices still if corporate America’s going to recover and recoup what are just an increase in costs and a squeezing in margins for them. So consumer’s been on the ropes, particularly since the COVID relief dollars have disappeared, and again, that’s for those who perhaps needed it the most. And then for those who got those dollars, but didn’t need them, they’re just sitting as a bank deposit. But yeah, I think the consumer’s very much on the ropes.
Kevin: We’ve been watching China and just looking at this COVID-zero mentality. I’m wondering if Xi is feeling a little bit of a pushback at this point, because isn’t Shanghai reopening at this point?
David: Reopens this week. And there’s a similar sense of relief amongst the citizens of Shanghai, 25 million people. So there are concerns that remain for the reinstitution of COVID controls, but you already see it, gathering in the street for a beer or ice cream, I mean, simple things. That’s already happening now. And we’re just seeing the containment fences around these residential housing units coming down.
Kevin: But weren’t they— I mean, these Chinese officials, some of them were actually going into people’s houses. I mean, when is enough, enough, like you said last week?
David: Yeah, Bloomberg covered this. It was very interesting. Of course, the Chinese media shut it down very quickly. But you had, on the equivalent of Chinese Twitter, these Chinese officials coming in hazmat suits to clean out an apartment and disinfect the living area and empty the refrigerator and disinfect the— And this goes viral, you’ve got it copied 50,000 times, viewed by over 10 million people before it was taken down. And yeah, that’s what’s noteworthy. In the past few days leading up to Shanghai reopening, you’ve got this outburst on social media, that it’s just not acceptable, the hazmat suited COVID enforcers entering Chinese residencies.
I mean, the response was a signal to the state, “It ends here. Our homes are our sanctuary, you come in and we come out onto the streets and in force.” So I think the Beijing government discovered a red line and Xi is going to be facing some trouble over these issues, where, “Look, you shut down society, that’s fine. You put fences around our buildings, that’s fine. You walk into my living room in a hazmat suit, not fine, not fine at all.” On top of that, he’s been silent about the fact that the vaccine, which was mandated, was never suited, never designed, never engineered for the latter variance, it was matched for Delta and nothing else. So he’s got a little bit of egg on face there too.
Kevin: Well, you talk about a red line, but this is a society that has had to live with Sesame Credits. I mean, talk about coming into your living room, Sesame Credits, it’s how do you control a society?
David: Yeah. I was reminded of that this last week with the Davos Man meeting, Davos Man being the elite of the elite, determining the best course for all men. And we had this idea of a carbon signature being assigned to each person on the planet. And so that we’re measuring what you eat, the quality of the food that you eat, whether or not it’s enough bug protein versus animal protein, whether you travel too far from your home and waste fuel.
Kevin: Isn’t that the same as people in hazmat suits coming into my house?
David: It’s the Davos Man dining on filet and Châteaubriand—
Kevin: Probably from ’82.
David: After landing his jet.
Kevin: Yeah, after landing his jet.
David: After landing his jet in Davos.
Kevin: Yeah, right.
David: But just determining how it is that we, the simpletons of the world, should be living, and what the limit should be on our own personal predilections and appetites. So not to directly tie Soros to the Davos Man, but Soros had an interesting perspective in a recent Project Syndicate article. And he was being very critical of the control factors in play, top-down control factors. Very interesting, looking at artificial intelligence being advanced and enabled in the context of COVID for what he described as basically the controllers gaining more and more control, adding leverage for repressive regimes, and introducing fresh challenges to open societies. It was a very fascinating read, so data collection and surveillance, matched with social programming and incentivization. Again, coming back to Sesame Credits, he didn’t mention Sesame Credits directly, but that’s essentially what you’re talking about in terms of social programming.
And what he writes is about this development having far-reaching consequences, creating even more contrast between the US, an open society by his definition, and now greater conflict with both China and Russia, closed societies that rule by intimidation. So he goes on to discuss the $300 million in annual spending. He’s not particularly quiet about what he gives or how he gives, but the $300 million in annual spending that he puts towards shaping society. And he’s done that every year since the late 1980s, an interesting side note.
But it was interesting, in part because it was the week of the Davos Man. And you had a man who’s been to Davos many times offering a criticism of top-down controls and the abuse of AI by the controllers, by repressive regimes, right? So this is, I mean— Anyways, you should read the article if you’re unfamiliar with his ideas, particularly on reflexivity, whether you like him from a political standpoint or not, you’re sympathetic to his views or not, he has very valuable insights to offer on the financial markets. He didn’t make a fortune by accident.
Kevin: No. And he doesn’t spend a fortune on shaping society by accident. So it sounds to me like the pot calling the kettle black, but you’re right, I’m sure there are some things that we can pull from that.
David: His ideas on reflexivity are absolutely fascinating.
Kevin: Well, speaking of carbon footprint, though. Okay, look at oil. I mean, how far can oil go up before I can no longer have a carbon footprint because I can’t afford it?
David: Oil markets now have the front row seat to the continued conflict in Ukraine and the broader reopening in China. So Brent prices started to move this weekend and I started scouring the news venues for news of China opening. I thought, “What else could be driving the price of oil?” And sure enough, Brent prices are pressing above 120. They touched a low in early May, 20% lower. So the next destination looks like the 130 range for Brent, maybe a few bucks cheaper for WTI.
But like the reopening trend here in the United States, you’ve got pent up demand dynamics in a variety of Chinese cities, which are going to shift consumption trends, and I think there’ll be new pressures. We’ve talked about supply concerns, and perhaps some of those are alleviated as people go back to work in China and distribution and shipping comes back online. But I think now we have perhaps the worst of both, the demand confusion dynamics, as well as supply dynamics in play, given the European war dynamics, which are still in effect.
So noteworthy of the exports of oil from Russia to India and China, you’ve got vessel counts and floating barrels en route that are currently two to three times the typical quantity. If it’s 27 million barrels, which are typically floating and moving from Russia to India and China, it’s between 70 and 80 million barrels en route, and with new vim and vigor in that trade.
Kevin: Which, don’t you think that’s significant? I mean, what’s significant about that is the United States has controlled the world through its empire with reserve currency status of the dollar, but also controlling the flow of oil. And when you’ve got Russian oil going to India and China, especially with China now reopening, we’re starting to see a power shift. And last week you brought up something that I’ve been thinking about. It may not be a fait accompli that Xi is just in, in China. We start looking at these countries and go, “Oh, well, Xi will be there for the rest of his life. Just look at the way things are going.” But he’s got some competition right now. Even this gathering in the streets that you were talking about for a beer, ice cream, and basically, in a way, giving a hand sign to leadership saying, “You know what? You don’t come into our houses.” Do you think that it’s a fait accompli that Xi will be getting in for his third term?
David: Yeah, I think there’s a lot of things that are not necessarily a fait accompli. I mean, we looked at the progress that Kissinger made in the 1970s in establishing the dollar stability following a significant decline. And that was established through petrodollar recycling, going to the Middle East countries and making sure that crude oil contracts traded in US dollar terms, it created a floor for our currency. And now we have something similar in terms of an increased trade with Russia and China and the proposal of moving that trade, denominating it either in rubles or RMB.
So what is a fait accompli? It would appear that internal dynamics inside the Communist Party in China are shifting towards an openness to less restrictions. Last week, we discussed the economic concerns vocalized by Premier Li Keqiang and Liu He in contrast to Xi Jinping and his COVID security concerns. So on the one hand, focusing on economic reopening, maintaining viability, vitality, not letting the decline accelerate from here, and Xi Jinping taking more of again, a command and control dynamic.
Kevin: Wasn’t there a gigantic conference call too. I mean, you can shift the people— Talk about controlling people, we were talking about that with Soros.
David: Yeah, I wonder if Xi wasn’t outmaneuvered. You have Premier Li who had an emergency call with thousands of party apparatchiks to focus their attention on a rapidly deteriorating economic picture, the need for support, imploring them to do whatever they can for the economy and to vigorously engage. So less than 72 hours later, we have Shanghai reopening. Perhaps it’s coincidental, but it’s not as if it’s a perfect reopening. There’s going to be strict testing every 72 hours, masking of course, stringent limits on indoor activity, those will still be in effect.
But those conditions of house arrest which have been in place for the last several months, that is easing, and so mobility is back. And the tone of the conference call was incredibly negative. It involved over a hundred thousand officials being reminded of how dire the Chinese economy is. And certainly raising questions about the veracity of official Chinese statistics, because apparently Chinese statistics would say, “Well, things are not as good as they could have been, but they’re still very good.”
Kevin: It’s a little like being a nuclear scientist in Iran. You know you got a target on you from the rest of the world. How would you like to be a statistician in China? It’s a little bit like Tiananmen Square on paper, you know what I mean?
David: Yeah. No, in an election year, is it the statistics or the statisticians that are tortured more in China? Will Xi get his third term en route to being ruler for life? And again, there’s nothing that is a fait accompli. But you wonder if Taiwan somehow fits into his strategy and we’ll come back to that in a bit.
Kevin: Okay. But it’s not just in China, look at what Wall Street is calling for on inflation figures.
David: Are you talking about— Oh, it’s tortured statistics elsewhere. Yeah.
Kevin: Tortured statistics elsewhere, yeah.
David: Okay, yeah. Well, remember that consensus amongst your top Wall Street economists five months ago, well, I guess it’s six, because you’re talking about December numbers.
David: Six months ago, the consensus was that inflation would average 2.2% for all of 2022.
Kevin: Right. What pressure did they feel? They didn’t have a Xi Jinping on top of them, they’re just basic— The pressure is they want to keep making money.
David: I mean, think of that. Yeah, I think everyone’s heard the joke about economists accurately predicting 10 of the last five recessions. I mean it’s like— No, they’re really good, they’re really good at predicting—everything except what’s going to happen.
Kevin: Well, but you were talking about herding earlier in the show.
David: Well, and I think—
Kevin: Does inflation also create a herd?
David: It’s a form of intellectual herding. It’s probably an example of anchoring bias. The possibility of higher inflation has been so elusive for so long that a sub 2% number as the anchoring statistic made an above 2% number seem like an aggressive estimate. 2.2% for the whole year, when we haven’t been able to get above 2% for the better part of a decade? So anchored by the preconceived notion of sub two with a two target, now we’re running four times that number. I mean, official CPI is 4X the end-of-year estimate. We’re actually six to seven times if you’re counting inflation as it is versus how it’s desired to be after substitutions and revisions to weightings of components and the hedonic adjustments and all those fun things.
Kevin: Well, I told you I was at Top Gun this weekend, which by the way, for every listener, I don’t recommend movies necessarily, but this movie pulled it off. But you think about it, 1986 was when Top Gun 1 came out. And now Tom Cruise hasn’t aged a year, okay? So I don’t know what he does, but Tom Cruise looks about like he did back in 1986. He’s Maverick, he flies every plane that you want him to fly and more, including a P51 at the end. Okay, so I mean, it’s got everything. But 1986, Reagan was in office at the time when Top Gun came out before. We were measuring inflation in a way that would actually put our inflation today in the teens, right?
David: That’s what I mean, I mean their estimate of 2, 2.2%, the reality is it’s six to seven times that if you go back to the ’86 measures.
David: And the—
Kevin: So Top Gun 1 measures, we’ll just start calling it the Top Gun 1 measures.
David: Top Gun 1 measures.
David: Wall Street Journal reports on the Fed’s newest inflation forecast for 2022. They’ve got a few economists, more than a few PhDs, I think about 600 of them. And so they’ve increased—
Kevin: Isn’t that 599 too many?
David: Probably. The Fed’s inflation forecast for 2022 has been 4% for the year, and they’ve revised it up to that, now it’s 4.3%.
Kevin: How are they going to get there?
David: And then they’re expecting a decline to 2.5 percent in 2023.
David: So one of the significant insights arguing against what they’re saying is that wage increases are now impacting services as well. So we’ve seen product increases, right? But services have been fairly muted in terms of the inflationary impact. Not anymore. So we’ve got another inflation component which is expected to continue to rise. Nevertheless, will still average down to the 4.3% rate. So I mean, if you were to say, well, that’s what it’s going to be for the full year. That would take the last half of the year, averaging less than 1%, to reach closer to 4.3. And again, that’s if you’re looking for an annual average. Otherwise, if you wanted a standard decline in input cost by 50%, that’s what would be necessary.
Kevin: So you’re talking about food and fuel and that type of thing?
David: Right. So what are the probabilities of food getting cheaper? I mean, just ignore the blockade that the Russians have, where the Ukrainians can’t export their wheat. Egypt’s feeling the heat of that and a lot of their other primary trade relationships. Food, probably not. Fuel, no. Education, it’s not going to get cheaper unless it gets free. And that certainly is an initiative that, whether it’s Elizabeth Warren’s been a champion of or votes coming in November, and there’s a good probability of getting $10,000 of student loans canceled for each student that has debt. So education, maybe if you look at that as a balance sheet reduction, but not a cost reduction. Medical services, probably not. Electronics, who knows? Maybe, but how do you get a 50% decline in inflation between here and the end of the year? To me, the Fed’s fresh inflation forecast of 4.3% speaks to needing to get out a little bit more often.
Kevin: So maybe statisticians should be afraid for their life. Yeah, maybe I’m not as sympathetic to statisticians in this day and age, but this day and age we have known some German economists. I can go back to Klaus Bucher, I remember Klaus talking to me about the inflations in Germany and how Germany, they could never stomach it again. And we even talked to economists, Germans, who said that the European union would fight inflation at all costs because the Germans were in. But then the French came in, I’m probably going to offend some people here.
David: But even worse than that—
Kevin: But the French—
David: The Italians came in.
Kevin: Came in and then the Italians, yeah.
David: Yeah. Mario Draghi is head of the ECB, and happy Mario, what does an Italian do with his own currency, let alone a collective currency?
Kevin: Well, and then you get Goldman Sachs ex-employees, you know what I’m saying?
David: Oh, yeah.
Kevin: And so all this— You put this statistician thing in, it’s like, well, a statistician can say anything if he’s not held accountable. So inflation, what would they say? Revise it here, 4.3%.
Kevin: But you can’t hide 8% inflation in Europe.
David: No, and that’s a pan-European number. The most recent number this week, up 8.1% across the region. Spain’s at 8.5, Germany is at 8.7. That’s a 60-year high in Germany.
Kevin: Yep. So the Germans, they were not able to hold the course.
David: Central banks have to reverse course or risk the reputation of everyone in the profession. Now the problem is, you’re really not seeing much of a course reversal. If you’re looking at Lagarde, it’s just dragging her feet. With prices a massive concern, I think it’s going to be interesting to see if central banks are willing to narrow their focus and limit bandwidth to things like price stability, because frankly, of late, they’ve been talking about changing the world and having the power to do so, whether it’s climate change or social justice issues or whatever.
Kevin: Yeah, but they’re not even elected, I mean, these are unelected— Remember Paul Tucker?
Kevin: When you had him on and he was like, “You’ve got unelected people running the world.”
David: Right. Well, I mean, he comes from the central bank community. Paul Tucker was on our podcast last year with both an impassioned and articulate case for unelected officials staying well inside their lane, lest they lose the ability to operate even in their lane. So we can almost imagine efforts to promote price stability, right? And perhaps if we strain our creative brains a bit further, we could even wonder what a world without inflation targets looks like. Think about that. We now confuse this issue of price stability with inflation targeting as if they’re compatible, when actually they’re diametrically opposed.
Kevin: Well, it’s the illusion of control. The illusion of control, when you give a central bank mandates, everything from employment to climate change, to inflation, to making sure that the markets don’t come down, there’s this assumed control. And look at New Zealand with inflation targeting.
David: Well, they’ve always been progressive when it comes to central banking, and they were one of the first to come up with inflation targeting. You could call them the king of inflation targeting.
Kevin: It infected the world.
David: But now they’re raising rates, right? So now what does it mean to be progressive in this era? To actually control inflation? That might be the new form of progressive that central banks could adopt. So last week was the fifth hike, this one by 50 basis points, they’re now at 2%, the expectation is that they’re going to raise rates to 4% by next year, where they expect to stay 4% or higher through 2024. I mean, they’re taking inflation seriously. And if you don’t, you know what happens? Your currency will tell you the full story.
Kevin: So, speaking of currency, because the dollar’s been very, very strong, but it seems to be weakening based on the fact that the Europeans are probably going to have to take control as well, or at least raise rates some.
David: Well, dollar strength has been commensurate with this notion of quantitative tightening and being more responsible with the balance sheet. And here just a few weeks ago, I mean, I tell you as an asset manager, we’re on pins and needles, as we got to say, May 13th, where the US dollar and the euro are breaching these very critical levels. And the US dollar and euro, they reached that dramatic inflection point, the dollar’s two month rise from the mid nineties to a peak on May 13th at just over 105, that move higher was in large part spurred by momentum, driven by expectations of QT, reversal of crisis era interventionism, et cetera, et cetera.
So strength there, and we’re seeing the euro breakdown, right? Then the market has this reappraisal as Lagarde steps out and says, “Well, maybe we will raise rates. Maybe we’ll see rates in positive territory by the end of the third quarter.” They’re all squishy commitments, but at least there are some commitments. And at the same time we’re seeing other Fed voices or hearing other Fed voices come to market and say, “No, don’t worry about policies becoming too restrictive.” So the prospect of higher rates in the eurozone has now helped support the euro, and the prospect of maybe even a pause in September, in terms of Fed tightening, has taken some of the upward trajectory out of the US dollar.
Kevin: I don’t envy you for managing money and having to try to figure out on a daily basis whether the addict is going to go back to the drug, because that’s really what you’re trying to do. You’re trying to figure out, okay, are we actually tightening, or is the addict— And what I’m talking about the addiction is to just loose monetary policy is a lot like a drug and you have to ask yourself all the time. I mean, how appealing is it in the face of what they face?
David: Yeah. Well, going back to that original idea, we started with, overbought and oversold. We had the dollar overbought, the euro oversold, gold oversold, but also the dollar breaking out to new highs and the euro breaking down technically, which means as far as gold’s concerned, anything goes. I mean, do we drop $200 an ounce? That was the pins and needle scenario of May 13th. And those reversed, we in fact were overbought on the dollar, and we’re nowhere near that. Now 101 and change instead of 105, and the euros rebounded off of its lows as well. So irresponsible monetary policy, that’s what over time is so hard on a currency.
David: You can see the yen’s disastrous 2022 year to date performance in light of Kuroda’s interest rate cap, 10 year Treasuries and JGBs rather, will not go above 25 basically.
Kevin: So does Powell, I mean, is he addicted or can he actually break the drug?
David: Yeah, I mean the flip side view is that Powell and company might deliver a tougher set of policies going forward. And that’s what was energizing the dollar bulls. But since May 13th, and particularly last week, you’ve got Bullard out of the Kansas Fed, Bostic, another Fed chief. The market’s belief in follow-through from the Fed has been dissipated over the last two weeks, certainly listening to Bullard and Bostic. You get the idea that maybe you don’t have as much to be concerned about. What does that do? Okay, well, the dollar is weakened, the euro found support. And unfortunately for the consumer, the inflation trade remains a reality in the backdrop. Look at oil, again, back to 120. Yes, that’s a part of the Ukraine/Russia thing continuing. Yes, it’s a part of Chinese reopening. But it’s also the speculator saying, “Yep. And if inflation is not dead, then we do like black gold too.”
Kevin: Dave, before I came to work with your family, I was going to school and was a toy store manager. And I remember how far ahead the buyers had to buy the toys for the next Christmas. Pretty much by spring, you had to know what the big toy was going to be at Christmas time, that’s about nine months early. Then you had to have all your supplies in by about July or August. Supply chain issues right now, I’m just wondering, and I’ve done this with lumber and hardware before, too. Supply chain issues you have to be months and months in advance, even when things are normally running, what about now?
David: Well, think about the last few weeks and the earnings reports that we’ve gotten from Target and Walmart, where your purchasing managers have done their very best to work with and work around supply chain constraints, and they’re getting the product that they can, and it turns out it’s not all the product that people want, so now they’re massively discounting. And supply chains may ease a bit over the next 90 days, but purchasing managers will have a very difficult set of decisions to make as Christmas ordering and the shipping, which relates to end of year stuff, all that happens one to two quarters in advance.
Kevin: Yeah, when things are running correctly.
David: That’s going to draw year-end demand into this Chinese reopening crunch. They’re reopening, they’ve got their domestic demand which is increasing. You’ve got an increase in exports, if you’re talking about Christmas ordering, which begins happening June, July, August for the end of the year. Bottom line is that natural resources and finished goods will really not see any price relief till 2023 at the earliest, right? So that’s the reality in terms of supply chains. Now you have to take into account what is happening with the Fed. The games begin this week. June is the start to balance sheet shrinkage. June 1st, this Wednesday we’ll get things kicked off. The great debate is really how much pain before Powell and company—
Kevin: Takes a pain killer.
David: Abort the mission and return to status quo purchases. The stated target right now, if they’re going to reduce the balance sheet, the stated target is two and a half trillion dollars in shrinkage of the balance sheet by 2025. And I’m sure that is going to pass through to other asset classes. You begin to see it in fixed income. It’ll have its effect on stocks. And this is, I think, where the pain shows itself, and where the Fed all of a sudden responds. You’ve got Bostic and Bullard, they’re trying to reassure the markets that the Fed put remains, that they will back the play in terms of market volatility, won’t let things collapse. Which, again, suggests that beyond the daily noise about inflation mitigation and a policy change and tightening, that inflation’s going to be with us for a long time, because you can’t fight it too hard or the consequences will be too painful, and the Fed won’t tolerate that.
Kevin: Well, and I wonder if they can tolerate another real estate crash, because it’s strange when prices continue to rise, but we’re starting to see a pretty dramatic shrinkage of how many homes are actually selling. So how long can prices continue to rise with that in effect?
David: Yeah, the housing data is not looking great. Although prices look impressive, new home sales hit a two year low even as prices tacked on another 20%. So actually the Case-Shiller 20-city index came in hotter than expected at positive 2.4% month over month and over 21% year over year. Meanwhile, you’ve got pending home sales, which came in less than expected—it tumbled 3.9% month over month, and we’re down 11.5 percent year over year—that’s pending home sales. So volumes are decreasing even as prices are rising, and I tell you what. As I continue to talk to friends in the real estate sector, both the development and sales side, I continually hear realtors describe the market as unstoppable.
Kevin: The main—
David: Ever, ever.
Kevin: Well yeah, they may feel it’s unstoppable, but they’re celebrating right now that there’s actually inventory on the market, without realizing that if that continues, there’s going to be a lot of inventory on the market, because— The main complaint of realtors, you and I both know here in this area and all across the—
David: No, I don’t think so.
Kevin: Yeah, there’s just no inventory, prices were rising, but now there’s inventory—
Kevin: And contracts now are taking longer to get signed, is what I’m hearing.
David: Realtor.com put up the supply of homes for sale jumping 9% last week, compared to the same week a year ago. National Association of Realtors expresses concerns over what they say is, “the latest contract signings marking six consecutive months of declines and the slowest pace in nearly a decade.” So contract signings are slowing, supply of homes for sale jumps 9% from a year ago. The market dynamics are going to be interesting because you’ve got sellers who are scrambling to list wanting top dollar, not realizing that buyers are already back on their heels being forced to look for deals in the face of rising rates, because again, ever increasing sticker prices, you just can’t have it all, can’t have it all. Rising costs, the rising—what would be described as unaffordability of housing—is an issue for the buyer. So sticker prices are up, anecdotal commentary is that bidding wars are already gone and that offers are getting scarcer by the day. But again, you talk to a realtor, this time is different, prices can’t go down, there’s so many cash buyers we’ll never run out of them.
Kevin: And that’s just human nature, but what’s changed, last week we pointed out that in the past, when we’ve had inflations, we’ve had them regionally. Inflation is regional to where a person has somewhere else to go with their money, but we have a worldwide inflation problem right now.
Kevin: We just talked about Europe, we talked about Asia. What if we have a worldwide real estate collapse? Which we didn’t have back in 2006, that was not worldwide.
David: Yeah, and I’m not negative on real estate. It’s just the reality of the relationship between the cost of that asset class and higher interest rates and higher interest rates are being driven off of inflation. So to the degree that inflation is a lingering factor, higher rates are a lingering factor. And if higher rates are a lingering factor, then you’re going to see pressure on home prices.
David: We talked about New Zealand earlier raising rates and having a 4% target. Well, they’re at 2% now and they expect to be raising it to 4% by the end of the year. So New Zealand raises interest rates last week, and they very realistically expect a 15% decline in real estate prices by year-end. Now that’s more realistic. Borrowing costs have a bearing on affordability. The size of the buying audience is not infinite. The pricing of assets— I mean, that reality is going to hit the US at some point and there’s going to be a host of late entrants into the housing market who thought they were buying a dream home or whatever else, within 18 months of purchase, they’re going to have negative equity.
Kevin: So not just New Zealand, though, I mean, China, the Chinese real estate market is huge.
David: Well, so yeah, coming to a theater near you, top housing, not Top Gun, but also you’re right, China is probably the most at risk in terms of the category of real estate depreciation. Volumes have already dried up. Prices remain elevated. But that’s the nature of a command and control economy, where you can basically say, “Don’t lower your prices, keep them exactly where they were.” And you have to be worried about a gun being put to your head or a tank rolling over you.
Premier Li is working on getting local governments to do their part to avoid a price collapse and to avoid an entrenched economic contraction. And I think this is where the politics in China become very interesting, because he’s proactively promoting a growth, or preservation of growth, agenda while you’ve got Xi Jinping, who’s prioritizing other public policy issues. And how those are advertised, how those are promoted with the PR campaign, ends up being developed into over the next few months. I think it’ll be very interesting in terms of the reconstitution of politburo membership, and ultimately who wins the election in the fall.
Kevin: I can’t help but sound a little nostalgic because seeing the second Top Gun, I go back to 1986. And you factor in what was going on at that time, Russia, or the Soviet Union, would’ve actually still been seen as the main threat worldwide. And we had a president at that time, keeping politics out of this, the president was highly popular at the time, you look at the popularity rating. Now what we have 36 years later, we have China as one of the big factors as far as our future goes, but we also have a leader right now, I mean, whether you’re Democrat or Republican, Biden’s just not popular right now. It’s a whole different feel with Top Gun 2.
David: Well, and this is where the Federal Reserve inflation expectations are completely disconnected from reality. The man on the street, the woman on the street, who are paying significantly higher prices, these are people who are not stuck in their basement and they’re having a hard time making ends meet. So it’s not a surprise to me that Biden’s approval ratings are somewhat at home in the basement. The Reuters/IPSOS Poll last week, even though it oversampled Democrats, 45% Democrats to 35% Republicans, you’d think there’s some positive impact from the oversampling, still comes up with a 36% approval rating.
Kevin: Didn’t help him a bit, yeah.
David: The lowest of his presidency, again, in the basement. And I wonder, because this week is a significant week, I wonder what the conversation between Jerome Powell and Biden will be as they get together, have a little conversational shindig at the White House.
Kevin: Isn’t it interesting, we talked about unelected officials.
David: I would suggest to Jerome not to ask the question, “Does your dog bite?” Because Biden’s does.
Kevin: Well, it bites, but actually what bites even more, is— Jerome Powell, okay. So you have political influence on an unelected official, and really, wasn’t the Federal Reserve— I mean, hasn’t this issue been cleared up in the past, where the Federal Reserve, our central bank is supposed to be separate from political pressure?
David: Yeah, I mean, I was reading a CFR author—Council on Foreign Relations author—from their website this last week. And there’s the myth of political independence. And I think Powell does a pretty good job of remaining politically independent. But the myth is that we fully established independence in March 1951 with the Treasury-Federal Reserve Accord. And that’s when Truman basically said, “Look, we’re not going to be monetizing debt anymore. That’s done.” And so the Truman Treasury and the Federal Reserve come to this accord, and this is what is noted as the line in the sand. We now have an independent Fed.
And I mean, you roll forward in time clock, and Arthur Burns was an absolute disaster. Everybody knows that there’s been a series of Fed presidents since 1951 that were a phone call away from the president. So yeah, I mean this particular author was trying to make the case that the current scenario is a lot like the 1950s inflation, and being driven by supply constraints and things like that. It’s not like the 1960s and ’80s. Don’t worry about the ’70s version of inflation, said this particular CFR author—actually a previous member of the Federal Reserve, seven years from 1999 to 2006. So it’s not the ’60s to the ’80s, and in his view, admirably, the author explains, admirably in his view, inflation was contained in the 1950s by aggressive wage and price controls. So there’s no conversation about fiscal largesse, there’s no comment on monetary policy and their contributions to the inflationary milieu. Fairly convenient. The real answer is price controls. Imagine that. This is a super smart person coming to a really stupid conclusion.
David: Harvard undergrad, Harvard law, Harvard PhD, Cambridge University teaching post, previous CEO at TIAA-CREF. And the answer to inflation like in the ’50s, is clear, price controls.
Kevin: Price control.
David: Wage controls. You don’t have an increase in these things if you just arbitrarily set them.
Kevin: You can’t raise prices, you can’t raise prices, that’s the answer. And like our friend Bill King would say, “How’s that working out for you?” Yeah.
David: How’s that working out for you?
Kevin: How’s that working out for you?
Kevin: Before we finish up Dave, I remember in a firearms class that I took, that it was really interesting to hear the instructor say, “Never pull your firearm out unless you’re in a situation where you intend to use it.” In other words, you better mean it because things get really different if you pull a firearm out. And I think about Taiwan right now, and we’ve been careful, as the United States we’ve been careful to say, “Yes, we support Taiwan.” But there seems to be some clarity coming right now, which is a little like pulling a gun out. Are we or are we not? Is you is or is you ain’t my baby right now with Taiwan? I mean, are we basically there if China invades?
David: Yeah, part of the reason why Taiwan figures prominently in my mind is because you have one more factor that increases economic frictions to the degree that there’s constraints on global cooperation and a trust factor that’s extended between countries. You start seeing an increase in costs. And in this case we want to preserve our relationship with Taiwan, they’re one of the great semiconductor producers in the world, we could not exist without them, not for a good 10-year stretch. It would take a long time to replace them as a trade partner, one of our largest trade partners. And so what happens there is fascinating. The TRA, the Taiwan Relations Act, that dates to 1979 and it says, “We will provide arms of a defensive character.” But it is not explicit on the issue of direct military intervention. So the White House keeps on coming back, three times in the last nine months the White House has come back and contradicted the president on his Taiwan comments. He’ll say something like, “We got your back.” Or, “We’ll be there for you.”
Kevin: He pulls the gun out, they put it away. Yeah.
David: But after a third time confirming the position of support for Taipei, it’s clear where the president stands. And maybe I spent too much time reading Counsel on Foreign Relations this last week. But the CFR writes that the past nine months, and after three different instances of verbal support—this assumes a series of re-briefings to remind him what he’s not allowed to say—he says it all over again. So he’s either senile and an absolute idiot, or he’s communicating. And the CFR would say, “No, he’s communicating.” We’ve emerged from 40 years of strategic ambiguity to a new posture of what they describe as strategic clarity. And we are not going to allow you to extend your reach and influence regionally beyond a certain point. You’ve got your nine-dash line? Well, we have our own line too.
US Secretary of State Antony Blinken was clear that we don’t support Taiwan’s independence, maybe a nuanced thing, separate issue from aiding in defense if Taiwan is attacked, but that’s where our official policy towards China is now being codified around these words, invest, align, compete. Competitive when it should be, said Blinken last year, collaborative when it can be, and adversarial when it must be. That was the way Blinken put it a year ago. The president’s comments, if you look at those, “Yes, we’re going to back the play of Taiwan. If there’s an incursion, we’re going to help them.”
The two groups that should reassure the most are Japan and the Philippines. My parents live in the Philippines, and it’s been interesting to see the overtures from the Chinese to the Filipino government. Not particularly positive if you’re talking about a treaty country with the US, to see something of a migration of interest in the direction of China. But if they’re listening to the US president, then they understand the explicit obligation for intervention and aid in the case of the Japanese and the Filipino government, Filipino people, has just been made explicit with Taiwan.
Kevin: You mentioned strategic clarity, that’s exactly what I was talking about with the firearm. Don’t pull it out unless you plan on using it, that’s strategic clarity.
Kevin: But we’re not getting clarity, actually, from the administration at this point, you’re actually— Yes, Biden has shown some strategic clarity, and the others are saying, “No, no, that’s not what we’re doing.” And this is all in the face— Solomon Islands have aligned themselves now with China. So at this point we don’t have strategic clarity. We’ve got everybody wondering, what’s the next step? And unfortunately, I don’t think we trust the leadership, it’s not quite Top Gun 1.
David: No, timing, complexity, there’s a whole bunch of things in motion. You got, within China, internal economic pressures. If you’re talking about the credit markets and the developers and things like this, you’ve got internal political pressures. So those two things are interesting enough in and of themselves, but then the external pressures also add a nuance to the cocktail. Biden kept all of the Trump-era tariffs in place with the Chinese, that’s a part of the external pressure, but then you’ve got the Russian alignment of interest. That’s a big deal going forward. And then you come back to, again, the internal economic pressures. COVID-Zero had a significant impact in China. Highway road haulage has declined to 70% from the previous year across the whole country. In Shanghai, it’s at 17% of what it was a year ago.
David: So domestic shipping is in complete collapse, right? And to these pressures, and to these— again, to the strategic clarity that perhaps Biden has brought, here you have Biden wrapping up his Asia tour last week and Russia and China feel that they need to send a signal.
Kevin: They had their own Top Gun.
Kevin: They had their own flying.
David: Is expressed through flying joint long-range nuclear capable bombers near the Japanese and South Korean air defense zones. Yeah, and so they fly a joint patrol, right? This is Russia and China flying joint patrols of long-range nuclear capable bombers near the Japanese and South Korean air defense zones. This is all according to Reuters.
Kevin: So Russians to the Chinese, these guys are looking at each other cockpit to cockpit going, “Hey, what are you doing here?”
Kevin: Oh, and I think it’s a signal.
David: Yeah, yeah. And these are bombers, right?
Kevin: Yeah. Nuclear capable bombers.
David: Of course, you had the routine sorties into the Taiwanese airspace also occurring, just with more planes than usual. But the bomber patrols were within hours of Biden’s remarks on Taiwan, following Biden’s remarks on Taiwan. So they scramble them and say, “Yeah, let’s send a message.”
The news media and the Press Corps are calling the Taiwan remarks an ill timed gaff, right? The Council on Foreign Relations is calling them an important shift to strategic clarity. I’ll probably go with the CFR on this one.
Then you’ve got North Korea, midweek last week, launches three of its largest ICBMs and they join the choir boys, not happy with the US seeking strategic alliances throughout Asia. And again, this comes back to de-globalization and an increase of constraints to cooperation. That is the wave of the future. And with that comes continued pressure on supply chains and prices. So if you want to continue to play out what the implications are of inflation into asset prices, you can’t simply say, “Oh, look, Shanghai opened up. Supply chains are back to normal. Everything’s going to be fine. Just give it a few weeks.” No, no, no, there’s far more going on here.
So be careful how the herd gathers and runs, it’s not always rational, it’s not always safe, and it’s not always safe for an investor to play when the herd is gathering. So we’ve got that paradox of herding. It’s in effect here. And it’s in a time where you have greater economic, financial and geopolitical destabilization emerging. And investors are continuing to ignore these factors at their peril. As an investor, it’s pretty critical that you gain your own version of strategic clarity.
Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.
This has been the McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.