Reflation Is Dead
Something happened this morning that I think is worth talking about - the official death of the categorical re-flation trade. Thanks Delta Variant and UMCSI!
Over the last eight months, there's been a lot of prognosticating about the state of inflation within the economy, coupled with fears that the Fed had gotten it wrong. Runaway Inflation was considered a key monetary risk, and the CPI printed 5% YoY last month. As a result of all this inflation talk, in combination with COVID-induced supply shortages, commodities have been on a 14 month bull run from the lows last March, with no signs of stopping. Conversely, the ARKK-style bucket has been languishing for months, given the speculative nature of its future cash flows, and thus, reduced NPV (thanks to higher TLT). Today, however, the market is sending a clear sign that these trends are over. Rates are plunging (signaling lower market inflation expectations), and "Real" assets are getting smacked as their perceived value (in less powerful future dollars) comes back into line.
It's one of the main reasons that QQQ is down less than SPY today - Delta Variant fears boost tech / WFH trades. The same stocks which also benefit from lower rates. The UMCSI also leads weaker consumer spending, which adds up to a drop in demand -> less inflationary pressure.
The thing is, if you dig into the numbers, this should not be a shock. Hell, a good chunk of the CPI 5% YoY print had to do with the increasing price of used cars. Aka, who cares?
But let's back up. That explains why oil is down 5% today. Why are my other stocks down?
For some context, since our launch on July 1st, our Equity Macro view (freely available on our site) has been the following:
"Valuations remain rather high on a TTM basis for the overall market, as a combination of COVID related denominator issues and monetary / fiscal policy numerator boosters throw the ratios completely out of whack. While some have written off these values as "distortions", we here at Discordia believe that the market is still a good deal overvalued. Even if you believe the broad analyst community and completely throw out 2020 and 2021 numbers, the NTM S&P guidance puts us trading at 22x earnings, which is still a significant premium to the market's long term average. Some of this premium can be explained by the strong business sentiment and economic climate, and some can be attributed to inflationary expectations, which are also higher than long term averages. We believe, along with the Fed, that the recent bump in inflation will be transitory. We also think that there will be a slowdown in business sentiment sometime in the early fall, as shortages clear up and pricing pressures ease. Lumber and other ag's serve as a a leading indicator of this dynamic, in our view -- lumber having dropped almost 60% in the last 8 weeks."
As you can see, a drop in inflationary expectations immediately takes an axe to the premium that's being afforded this extended market.
Over the long term, as it turns out, deflation is reallllly hard to avoid in a technologically advancing society like ours.
Finally, you mix in the real-world potential that Delta has to send us back 12 months, and you can see why we are where we are today.
Think NLS and PTON being up is a fluke?
Cheers!
Over the last eight months, there's been a lot of prognosticating about the state of inflation within the economy, coupled with fears that the Fed had gotten it wrong. Runaway Inflation was considered a key monetary risk, and the CPI printed 5% YoY last month. As a result of all this inflation talk, in combination with COVID-induced supply shortages, commodities have been on a 14 month bull run from the lows last March, with no signs of stopping. Conversely, the ARKK-style bucket has been languishing for months, given the speculative nature of its future cash flows, and thus, reduced NPV (thanks to higher TLT). Today, however, the market is sending a clear sign that these trends are over. Rates are plunging (signaling lower market inflation expectations), and "Real" assets are getting smacked as their perceived value (in less powerful future dollars) comes back into line.
It's one of the main reasons that QQQ is down less than SPY today - Delta Variant fears boost tech / WFH trades. The same stocks which also benefit from lower rates. The UMCSI also leads weaker consumer spending, which adds up to a drop in demand -> less inflationary pressure.
The thing is, if you dig into the numbers, this should not be a shock. Hell, a good chunk of the CPI 5% YoY print had to do with the increasing price of used cars. Aka, who cares?
But let's back up. That explains why oil is down 5% today. Why are my other stocks down?
For some context, since our launch on July 1st, our Equity Macro view (freely available on our site) has been the following:
"Valuations remain rather high on a TTM basis for the overall market, as a combination of COVID related denominator issues and monetary / fiscal policy numerator boosters throw the ratios completely out of whack. While some have written off these values as "distortions", we here at Discordia believe that the market is still a good deal overvalued. Even if you believe the broad analyst community and completely throw out 2020 and 2021 numbers, the NTM S&P guidance puts us trading at 22x earnings, which is still a significant premium to the market's long term average. Some of this premium can be explained by the strong business sentiment and economic climate, and some can be attributed to inflationary expectations, which are also higher than long term averages. We believe, along with the Fed, that the recent bump in inflation will be transitory. We also think that there will be a slowdown in business sentiment sometime in the early fall, as shortages clear up and pricing pressures ease. Lumber and other ag's serve as a a leading indicator of this dynamic, in our view -- lumber having dropped almost 60% in the last 8 weeks."
As you can see, a drop in inflationary expectations immediately takes an axe to the premium that's being afforded this extended market.
Over the long term, as it turns out, deflation is reallllly hard to avoid in a technologically advancing society like ours.
Finally, you mix in the real-world potential that Delta has to send us back 12 months, and you can see why we are where we are today.
Think NLS and PTON being up is a fluke?
Cheers!
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