A major paradigm shift is upon us
Inflation has broken out of a 40-year range
I believe this shift in regime offers both short and long-term opportunities
A thread
Inflation has broken out of a 40-year range
I believe this shift in regime offers both short and long-term opportunities
A thread
2/ In 2022, we witnessed the largest breakout in inflation since the 1970s
3/ The low inflation era began in 1982
Between 1982 and 2020 inflation rarely went above 4% or below 1%
Between 1982 and 2020 inflation rarely went above 4% or below 1%
4/ This had triggered one of the largest secular bull runs for the market
5/ Other comparable periods where inflation remained between 1-4% leading to massive runs in the stock market include:
- 1920s
- 1930s
- 1950s
- 1920s
- 1930s
- 1950s
6/ When inflation is unstable, it has been a problem either to the upside or the downside, aka deflation
7/ And now that inflation has broken out from its range, it destabilizes the trend that’s been in place since 1982
8/ Since 1982, the Federal Reserve has been able to focus on growth by stimulating the economy by lowering interest rates
9/ The Federal Reserve has 2 key mandates:
- Prices stability
- Employment
- Prices stability
- Employment
10/ Prices have been stable since 1982, so the Fed’s focus has been on keeping unemployment rates low and growth high
They did this by being stimulative and accommodating towards the economy and the markets
They did this by being stimulative and accommodating towards the economy and the markets
11/ But then why is the current inflation breakout such a big deal if most economists believe that inflation is heading back to the Fed’s target level i.e., 2%?
12/ The odds that inflation easily returns to 2% and stays there are very low
The probability of this being just a one-off spike with normalized inflation returning is minimal
The probability of this being just a one-off spike with normalized inflation returning is minimal
13/ The Fed uses interest rates to modulate inflation
And they’ve been able to cut rates since 1982 to boost the economy continually
And they’ve been able to cut rates since 1982 to boost the economy continually
14/ But when inflation comes back into the picture, they are caught in a tricky place:
- Raising rates too much results in a hard landing with a recession and deflation, like in the early 1900s
- Raising rates too little results in an entrenched inflation episode like the 1970s
- Raising rates too much results in a hard landing with a recession and deflation, like in the early 1900s
- Raising rates too little results in an entrenched inflation episode like the 1970s
15/ In either case, the stock market turns into a rough ride during these periods
16/ But the near term looks more constructive
A lot of the inflation peaks have coincided with major market bottoms
A lot of the inflation peaks have coincided with major market bottoms
17/ In fact, even the recent peak in inflation has acted as a tailwind for the stock market
18/ The greed in the financial system is not going to dissipate overnight
And the fierce competition amongst institutions to post high returns as the markets have gone up in this easy money environment is still omnipresent
And the fierce competition amongst institutions to post high returns as the markets have gone up in this easy money environment is still omnipresent
19/ Investors are looking for the first reason for the markets to go up
And inflation coming down significantly might be the fuel for a final leg-up for the markets
And inflation coming down significantly might be the fuel for a final leg-up for the markets
20/ That said, peak inflation is coinciding with another unusual regime: yield curve inversion
It's important to leverage a framework that incorporates these two macro regimes together to assess where we're headed
It's important to leverage a framework that incorporates these two macro regimes together to assess where we're headed
21/ Thanks for reading!
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