May was an eventful month and while the S&P fell ~4% at one point, crypto stole the volatility show. $ETH, for instance, rose ~50% during the first 12 days and then proceeded to fall >50% over the next 12 days before recovering some. While $BTC lost almost 50% of it’s value, it didn’t experience the gains $ETH had early in the month and thus is down substantially more over the same time period. If you look at some of the altcoins, some of them experienced drops of 80%+ raising many questions over whether crypto is an asset class or not. I have noticed that anytime there is a significant pullback in crypto in a short period of time, questions are raised about its validity as an investment due to high volatility. IMHO, the asset class is still young and is difficult to forecast where this is all going. Furthermore, it’s still very unclear what purpose crypto solves just yet and if it can go from the early adopters to the mainstream.

Within crypto, we saw a new meme token called Shiba Innu ($SHIB) take off, which is a meme of another meme-coin (Dogecoin). Currently, $SHIB has a market cap of over $3B but that’s down from over $12B at one point during the month. Vitalik Buterin, founder of $ETH, donated what was worth $1B USD of $SHIB to the India Covid Crypto Relief Fund.

Adding fuel to the crypto fire, Elon Musk/Tesla said it would no longer accept $BTC as a form of payment for cars due to environmental concerns. Crypto Twitter (“CT”) unleashed a torrent of backlash at Musk for flip flopping and seemingly pumping up $DOGE, a token without any real application. I personally am a little dumbfounded at the decision and environmental finger pointing given the known harm of mining for materials needed in EV batteries and solar panels. I also find it odd at the amount of arguing that he’s engaged in on Twitter and would think someone running 2 multi-billion dollar companies would use his time differently. ??‍♂️

Enough on crypto for now. Most of this month’s recap is going to focus on inflation and whether what we’re seeing is transitory or not. I have ready many articles on how various companies are having to raise wages in order to attract employees. Bank of America, Chipotle and McDonalds to name a few. I’ve heard through various accounts that it’s been tough to lure back employees when they are making “enough” via unemployment and some still have concerns over their safety/health. Ultimately, employees will be forced back into the workforce as the additional unemployment insurance winds down, however, I’m hearing the labor market across the board remains tight.

The spike in unemployment and the subsequent recovery has broken records. It normally takes over 25 months to recover 70% of jobs lost during a recession while this time only took 6 months. This was an unusual recession to say the least.

Source: Stanley Druckenmiller

And while we are seeing reports of wages rising, it hasn’t shown up in the data (just yet).

Where it is showing up is the total employment cost, which includes benefits like paid time off and healthcare. These are real costs that also affect hiring decisions. The red bar on the right shows ECI just posted its biggest quarterly increase since 2007. That’s certainly notable. But also notable is that the years leading up to 2007 had many quarters where employment costs rose this same amount or even more. So the real story may not be that employment costs are unusually high. It may be that they were unusually low from 2008 until 2020.

The CPI saw a big spike last month. The increase is partly from CPI being unusually low 12 months ago, as much of the US economy went on COVID-19 hiatus. This will persist a few more months, so it may be fall before we have a clearer view of underlying inflation.

Unrelated to inflation but still important, the cumulative fiscal deficit from the start of this recession is larger than that of all recessions from 1980-2007 combined.

Source: Stanley Druckenmiller

Back to inflation, the PPI for inputs to construction industries has surged. If you know anyone who’s building a house or doing a renovation, they’re talking about price increases.

So are these moves up in inflation transitory or persistent? According to Hoisington Management, today’s core problem is that excess debt suppresses economic growth, without which demand can’t rise enough to generate inflation or push up interest rates over the medium term. This is a structural problem, which at this point we really can’t fix.

This is why the velocity of money is the lowest on record and just surpassed the low reached in 1946 which was following WWII. If you look at debt levels then, they were also very high relative to history.

Is inflation just a US phenomenon? CPI elsewhere (the local versions of it, at least) is still well below ours even in places where COVID-19 had a smaller effect. The US is the world’s largest economy, but we don’t stand alone. It is hard to imagine a scenario where the US has significant inflation and the rest of the world doesn’t.

“As for the inflation situation, what I come away with is that what we are seeing is a price-level adjustment coming out of the pandemic and the price data can easily be explained by an economy reopening in the face of several supply constraints. The Fed has made a great case and prepped the markets and the general public prior to the data as to why this is not a lasting supply-demand imbalance. This is not real inflation we are seeing; we are seeing tremendous distortions and disturbances in the data that are being skewed by the lingering effects of the pandemic and everything that has followed. And I have to say that the Fed has been masterful in laying this out; whether you want to agree with them or not is a different matter, but this is one of those times when I do”

Lacy Hunt, Hoisington Management

What Lacy is saying above is that the supply chain imbalances caused by COVID are transitory and not likely to be persistent. He refers to this as a price-level adjustment caused by supply constraints. I see this easily with house prices as the supply of available homes is not keeping up with the demand.

The biggest question IMHO is the direction of interest rates and inflation and how that will/could impact asset prices. If the Fed has to raise rates to slow inflation, that is going to hurt bond prices and likely stock prices which require low rates to justify 20+ PE ratios. I believe that price increases/inflation are transitory as Lacy Hunt describes and not going to last. Currently, the 10 year treasury yield is 1.63% which is still incredibly low and very negative when you adjust for inflation (“real yields”). It should be higher given this although the bond market might be looking out to 2023 when GDP is expected to fall back into the 2-4% range. However, even if this occurs, 1.63% still feels very low. Ray Dalio even said he’d rather own $BTC than bonds at these levels given the inverse risk/reward bonds provide. My expectation (guess) is that inflation will run hotter than usual but not anywhere close to 1970’s hyperinflation. Whether it’s 2022 or 2023, the Fed will raise rates to normalize but won’t make it above 3% as growth won’t support it (or markets).

A few charts on stocks in the US. Equity flows in 2020 were monstrous.

Along with US equity issuance.

And the S&P 500 real earnings yield went negative for the first time since 2007. The other times this has happened is marked with red dots on the chart and doesn’t bode well for returns in the short term.

Portfolio management at this juncture is tricky since we’re heavily underweight bonds which removes a leg of the stool. We also don’t want to be blindly overweight equities either given the concerns and valuations I’ve highlighted above. While I cannot give specifics over this blog, I am excited how we’ve positioned clients and are achieving downside protection (hopefully ??) while providing market upside potential.

I hope you enjoyed this months financial markets update.  If you have any questions please contact us directly. If you’re interested in a topic that you’d like us to address, please email us so we can include them in future updates.

If you’re interested in starting a dialogue and learning how we can help, please contact us.

Best Regards,

Jared Toren
CEO & Founder

Sources: Edges & Odds, WSJ Daily Shot, 361 CapitalSteve Blumenthal’s On My Radar

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