ARTICLES

US Inflation

The S&P500 has continued to make new record highs one after another. It recently recorded its 200^th straight trading day without a correction of 5% or more. This is not a record, but it shows that the upward trend is becoming more exponential. A few months ago, we drew your attention to the fact that since the low point of COVID-19 in March 2020, the S&P had gone through a series of “mini-corrections”, (read article here). That pattern has continued – to the point where investors have become almost blasé about these short downward trends like the 3-day sell off that we had last week. Consider the chart:

For some time now we have been warning that rising inflation in the US would inevitably result in a more hawkish stance by the Monetary Policy Committee (MPC) of the Federal Reserve Bank (Fed).

The rise in the US consumer price index (CPI) in July (last month) was 5,4%, a 13-year high – and just about the same as the figure for June – but much higher than economists’ expectations. Economists generally, together with the Fed and President Joe Biden have been saying that the June inflation was high due to “base effects” and would soon decline. But that has not happened – at least not yet.

At the same time the MPC has now said that they intend to commence “tapering” the level of quantitative easing (QE) sooner than previously expected – maybe even before the end of this year.

Both the UK and the US have become politically addicted to Q/E. It is the solution to their budgetary problems. If they run out of money, they simply manufacture more. Q/E is perhaps appropriate during times of extreme economic collapse – such as immediately after the 2008 sub-prime crisis or the initial lockdown impact of COVID-19, but it is hardly appropriate now with the US economy growing rapidly.

Money is just a symbol of the goods and services in the economy. If the money supply rises more quickly than the real growth of the economy, then the surplus must sooner or later be reflected in rising inflation. In effect, you have more and more money chasing the same basket of goods and services – so the price of everything has to go up.

This idea of increasing the money supply to pay for government expenses was originated by the Romans. Periodically they would call in all the gold coins in the realm usually on the pretext of having them re-minted with the new Caesar’s image. They took the opportunity to add 20% of lead when the coins were melted down and so were left with 20% in the bottom of the pot when everyone had been given their re-minted coins back. This enabled them to finance the next Punic war. In those days this was called “debasement”. Today, we call it “inflation” – but it is the same thing – a subtle, undisclosed form of taxation. The government creates the money and the purchasing power of the cash in your pocket goes down.

In 2008, before the advent of Q/E, the value of the Fed’s balance sheet was under $1 trillion. This rose quickly with Q/E and by 2009 it was over $2 trillion. It reached $4 trillion in 2014 and stayed there until 2020 and the impact of COVID-19. Since July 2020 the Fed has been creating and injecting about $120bn a month into the US economy. Its balance sheet is now worth just under $8 trillion.

Due to the fall in oil prices and the hoarding of cash following the sub-prime crisis, inflation has been relatively low since 2008 – so the Fed could get away with printing money. But now that the US economy is growing at break-neck speed Q/E can only result in rising inflation – which is exactly what appears to be happening.  It is noteworthy that new car prices surged 6,4% in July (YOY) while used car prices rose 30% between March and June 2021. By the beginning of July 2021, fuel prices in the USA, were the highest they had been in 7 years.

On the fiscal side, Joe Biden has recently managed to get a $1,2 trillion infrastructure spending package through both the House and Senate with bi-partisan support. He is working on a new $3,5 trillion “tax and spend” bill which he is hoping to pass through both Houses soon. One of the senators involved has described these bills as an “inflation bomb” which is being dropped on the US economy.

Q/E is like cocaine. It is highly addictive. It enables politicians to spend as much as they want to without the irritating necessity of sticking to the budget. At the same time, debt levels in America have reached extraordinary levels. The national debt is at $28,7 trillion and rising fast (https://www.usdebtclock.org). Obviously, this is not a number that can ever be repaid by the conventional methods of raising taxes or reducing government spending.

As we have previously indicated, the growing fear of inflation in the US is likely to precipitate a 10% to 20% correction in the S&P500 fairly soon – and that will result in South African listed blue-chip shares coming off quite sharply. Our view is that this correction, when it happens, will not be the start of a bear trend (although it will be touted as such by the bears at the time). We believe that the bull trend will continue until it becomes apparent that a new phase of rising interest rates in the US is hurting economic growth. And that is unlikely until at least 2024.

So, the correction will almost certainly be a buying opportunity, but you should monitor the rising levels of inflation in America and choose your moment to get out of this market and into cash – because eventually, inevitably, this great bull trend will come to an end. Remember the stock market truism:

The further up the trend you are, the closer you are to the top.

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