Inflation changes everything

Most of us have learned, over and over, sometimes painfully, that a healthy mix of stocks and bonds may drop in price, but will soon bounce back. And the drops aren’t even that bad, because stocks and bonds become anti-correlated during bad times. Well, all this is now wrong – or at least not to be trusted.

I’m writing this because my gut is telling me to buy lately, and I have been nibbling, but my brain is telling me to calm down. Writing helps me think things through.

It looks to me like we’re at the beginning of a “run on the bank” – the “bank” in this case being all assets with long duration. Lots of factors are pointing that way. (1) We’re still near the peak of a global bubble in nearly all asset classes. (If you’re relying on “forward PEs”, you need to read a few Hussman articles, whether you think he’s too pessimistic or not.) (2) After 40 years during which problems could be solved by just lowering interest rates, that is no longer true. Nearly everyone has adjusted their intuitions about investing based on the old system. (3) We have older investors (in the US anyway) holding far more duration than they should be, just because they need high-single-digit returns to maintain lifestyle. Which applies to most investors, but at least some of the young ones may choose to just ride out a big drop (others might panic anyway, and make the drop worse). (4) People are coming to understand that with high inflation, you want zero duration in a sense – any consumer items you know you’ll need in the short to medium term, you should buy immediately, even if it means selling investments to do so. (5) Inflation may well be stickier than most of us think; the Fed sure isn’t in a big hurry to get rates over 8%. (6) And it also scares me personally that no one seems to be even considering a large, persistent drop in asset valuations on the order of a decade or more to break-even. Everyone thinks Hussman is some pathetic weirdo. Just like with covid, I worry more when others aren’t worried. It means they’re still over-invested.

Now normally, at least based on the last 40 years, the Fed would not allow a huge drop in asset prices. But this time it finally is different: everyone around the world – not just investors – has experienced painful inflation, and the Fed has made it clear that they will not let it persist. Maybe they’ll pause their tightening if inflation seems to be dropping, but one thing they won’t do, I think, is what they always did in the past when assets dropped: make money dramatically cheaper. If they did that now, they’d risk shouldering a massive amount of blame if/when inflation heats up again.

Of course there’s still some point at which investor and recession pain outweighs the pain of severe inflation on everyone – and when truly mouth-watering values draw those with cash back in. Who knows where that point is, but it’s very possibly well below fair value of investments. I think it’s reasonable to look to past secular bottoms, when the Fed wasn’t very relevant. If it’s anything like the secular bottoms of the 1930s or 1980s, that could be something like S&P below 1000, and a decade or two to return to prior peak. Not that I’m personally putting all my eggs in that basket, but I want to be financially and psychologically prepared for it. I have some stocks (always love BRK), some precious metals, and more cash than feels comfortable.

6 Likes

Everyone thinks Hussman is some pathetic weirdo.

I don’t think he’s a pathetic weirdo. I think he gives objectively bad investment advice. For example, if you invested $10,000 in his flagship Strategic Growth Fund upon inception in 2000, you would have $13,000 today.

On the other hand, if you invested $10,000 in VTSAX (Vanguard total stock market) you’d have $44,800 today. Even in the event of some future huge market catastrophe, you’d still be financially vastly better off by ignoring Hussman. But just for the sake of argument, let’s say you are super-risk adverse. That’s Hussman’s target audience, right? Yet $10,000 in VBTLX (total bond market) in 2000 would be $20,000 today.

Point is, humble retail investors who simply do nothing but buy broad, low-cost index funds absolutely crush Hussman’s returns. And if Hussman’s best efforts are not only worse, but much worse than the most basic, simplest investing strategies, then why should we rely on his guidance?

29 Likes

Hussman looks at the history when the Federal Reserve did not suppress interest rates to negative. That was when the most important commodity in our capitalist free market – money – was not rigidly controlled by a quasi-government, quasi-private banking system – the Fed.

Those who base their future expectations on the past 20 years of Fed monetary suppression of interest rates may be shocked if the Fed returns to a neutral fed funds rate.

Then the huge gains they tout will vanish. Hussman would be vindicated.

Will the Fed actually hold to a neutral fed funds rate if a nasty recession resulted? I don’t know. But I do know that I don’t like losing paper gains when the bubble is bursting.

Wendy

5 Likes

I think wendybg is right.

Hussman has consistently and obstinately underestimated the willingness and ability of the Fed to change the rules. He keeps fighting the Fed and the Fed keeps winning.

If the Fed sticks to its guns with regard to raising rates and quantitative tightening, we could be looking at a sustained downturn instead of the usual Fed engineered V shaped recoveries that we have seen in recent decades.

Or maybe I am just a nervous nelly,

1 Like

Point is, humble retail investors who simply do nothing but buy broad, low-cost index funds absolutely crush Hussman’s returns.

You completely missed the point of my post. That, plus all the recs you got, makes me think I’m onto something.

2 Likes

The equities markets are going to be value oriented in the US from the end of this year going forward. Industry is coming back to the US, more labor intensive the factories will be possibly in Mexico.

The Europeans will begin to rival us in tech.

I think Hussman could be onto something. I could careless how he plays it. I wont read him for advice.

As far as dollar cost averaging? People do that to focus on the jobs. What they were hired to do ideally. The advisors tell them to hold no matter what. People are not supposed to be nose to the screen trading. No company can have a contingent of asset planners saying sell it all now. It has never happened in the history of modern American investing that millions of working Americans were told by whatever bank or brokerage time for all our clients to sell. ML did something in the depression that left an impression whatever it was, a long time ago. With that in mind the analysts are worthless when you need them.

How many analysts said prior to last November time to only be in cash?

I really don’t know much. Fragments of crap here and there. I am in cash.

Every one of you know not to trust Wall Street analysts. But none of you explain it. There is your explanation. When you need one they are worthless.

macroNcheese

a really interesting and well thought out post. thanks.

david fb

macroNcheese

a really interesting and well thought out post. thanks.

Who knows where that point is, but it’s very possibly well below fair value of investments. I think it’s reasonable to look to past secular bottoms, when the Fed wasn’t very relevant. If it’s anything like the secular bottoms of the 1930s or 1980s, that could be something like S&P below 1000, and a decade or two to return to prior peak.

The S&P at 1000 from the current price (3674.84) is down 72.8%

The S&P at 1000 from the all time high price (4818.62) is down 79.2%


Everyone thinks Hussman is some pathetic weirdo.

What was the biggest drop in S&P 500 history since 1970? (all the data I could get from Yahoo) If my spreadsheet skills didn’t fail me, the biggest drop from is -56.78% during the financial crisis followed by the 2000 tech bubble bust at -49.15%


**From            Top   To          Bottom     Down**
2007-10-09  1565.15   2009-03-09  676.53  -56.78%
2000-03-24  1527.46   2002-10-09  776.76  -49.15%

The (AntiHussmanic) Captain
bankers are more dangerous to your wealth than even tech oligarchs

1 Like

(5) Inflation may well be stickier than most of us think; the Fed sure isn’t in a big hurry to get rates over 8%.

Perhaps part of the reason why they are in no hurry to raise rates is because the Fed understands that it actually has limited control over inflation today. They are doing the minimal they can do to look as though they are actually doing their job, while trying to not make matters worse.

Housing costs are inflated because of imbalance of supply/demand, as well as corporate purchasing of residential single units in volume for rentals. Corporations do not get mortgages for the purchase of their properties, and are best controlled by local and Federal Gov’t changing the benefits of real estate investing for large landlords, including increasing the property tax rate for non-owner occupied. New construction is constrained by materials availability and shortage of workers. Not much can help the first, increased immigration could help the worker supply, but again, that’s not in the Fed’s control.

Gasoline inflation is largely due to the Ukraine/Russia war, and purchases at the store are inflated due to both Covid lockdowns continuing in China and gasoline costs. The Fed raising rates will have little impact on any of these root causes. Gasoline of course impacts just about everything, but add the war and drought into the food costs. Raising interest rates won’t make it rain or allow Ukraine to sell their grain and plant their fields with new crops.

I don’t know that we can look to the Fed to solve the inflation problem this time.

IP

8 Likes

I don’t know that we can look to the Fed to solve the inflation problem this time.

======================================================

Larry Summers had an interesting interview on NBC Meet the Press show on Sunday about inflation.

Summers said that the Biden Admin should now start cutting Trump era tariffs with China as this will help clarify the trade mess, reduce supply chain issues, reduce consumer costs and reduce CPI by a point.

Summers said that Congress should be putting together a bipartisan bill that would do the following 3 things to reduce inflation:

  1. Reduce pharma costs to consumers by allowing price negotiations as done under Medicare negotiations with pharma.

  2. Partial repeal of the Trump tax cuts to reduce demand.

  3. Short term fossil fuel energy support with long term pivot to renewable energy.

https://www.youtube.com/watch?v=d-yqHsVPAkE

Jaak

1 Like

Summers said that Congress should be putting together a bipartisan bill that would do the following 3 things to reduce inflation:

  1. Reduce pharma costs to consumers by allowing price negotiations as done under Medicare negotiations with pharma.

  2. Partial repeal of the Trump tax cuts to reduce demand.

  3. Short term fossil fuel energy support with long term pivot to renewable energy.


This is the first time I have fully agreed with Summers. The three points are dead on.

As far as reducing CPI by a point by reducing the tariffs the point is not needed and that is a primary effect. The tertiary effects might keep the Chinese creating more of an advantage.

Politically giving anything to China without reason is using political capital needed for the primary three points.
1 Like