Hyperinflation Hype? How should we model this market?

There is a lot going on in financial markets right now – it is truly a fascinating time to watch this unfold.  Everyone will remember the coronavirus-lockdown periods with for the rest of their lives, with the intensity of the terror attack of September 11, 2001 over a longer period of time.


Our economy is truly complex.  The last two decades in particular have been driving up efficiency along with fragility.  Supply chains became globalized, with key parts of a finished product being produced only by a few factories located wherever production was cheapest when those factories were built.  Just-in-time inventory procedures meant that critical components were no longer stockpiled so that small disruptions can cause significant delays.  Labor became more tenuous as the gig-economy replaced many previous career-track jobs.  Rents in many places were taking over 50% of tenant incomes, at a time when the majority of Americans would not be able to cover a $400 emergency expense.  In short, there are many reasons that a small shock to our system can cause an economic avalanche to fall.


Here’s a chart of where we are with the S&P 500 related picked from this article: https://stockcharts.com/articles/chartwatchers/2020/04/this-is-how-ive-created-my-all-926.html

SPX Retracement.jpg

Here’s where we’re at with the federal reserve balance sheet, picked up from this article: https://wolfstreet.com/2020/04/09/qe-4-cut-in-half-this-week-but-still-1-8-tn-helicopter-money-for-wall-street-and-wealthy-in-4-weeks-of-federal-reserve-balance-sheet-money-printing-and-bailouts/


There are many voices louder than ever calling about hyperinflation.  Gold has been doing well, bitcoin is going up in parallel with the S&P 500, and it seems like there is no other option with all of this money being printed.  However, there has been a prior deleveraging event which included extreme central bank action for decades that we should all keep in mind (put together using yahoo finance and paint):



The NASDAQ from 1999-2002 shows a similar pattern to the Nikkei above.

These bear markets are mind-wrenchingly hard to trade.  If you simply went short in April 1990, your position would be looking aweful in July – and you could easily lose everything if your bet was too short-term.  Many investors are long-only because timing is much more crucial when you are short anything – going short on the market is a short-term bet by nature.

Now assume you’re a long-only investor and you’re playing it safe. You see a nice bottom forming in September 1990 and a full year later in August 1991 you see a higher bottom.  Nothing would prepare you for that monster 69% down-move during the entire year that followed, bottoming again in August 1992.

The time frames that these events play out over are daunting, and the volatility is enormous.


Back to the idea of hyperinflation.  Clearly the Federal Reserve is pumping a lot of money into the system, but what is it doing and where is it going?

John Mauldin was talking about this today in the following article: https://www.mauldineconomics.com/frontlinethoughts

Wolf Richter has been writing about this for a while as well: https://wolfstreet.com/2020/04/09/qe-4-cut-in-half-this-week-but-still-1-8-tn-helicopter-money-for-wall-street-and-wealthy-in-4-weeks-of-federal-reserve-balance-sheet-money-printing-and-bailouts/

There is a massive battle going on right now between the deflationary forces of debt-deleveraging and the federal reserve plus the federal government.  According to John Mauldin’s article: “Inflation Is Always and Everywhere a Function of Demand.”  Think about that for a second, and relate it to some of the money being spent right now.

  • The Federal Reserve increased it’s balance sheet by 1.77 Trillion in 4 weeks.
    • 1.1 Trillion went into US treasury securities
    • 400 Billion went into dollar liquidity swaps with foreign central banks, primarily the BOJ and the ECB
    • 130 Billion went into loans to special purpose vehicles created with the US treasury in order to back investment grade corporate credit markets
    • 109 Billion went into Mortgage-Backed securities

The US budget deficit over the past 6 months was $744 billion and with all of the stimulus packages and unemployment benefits this is set to skyrocket, so the US government is spending much of this money.  But how much will this spending stimulate demand?

Here are some points to consider about how this government spending affects demand:

  • Unemployment benefits do not increase overall demand – they partially offset lost wages.  Overall, the demand of these employees goes down as they have less to spend.  People with excess income tend to cut spending and save more as unemployment increases because they view their economic positions as more precarious.
  • Loans to small businesses to help see them through months of lost income do not increase overall demand.  They are trying to prevent small businesses on lockdown from shutting down completely, and many will still end up bankrupt.  These companies are scrambling to cover fixed costs with sharply reduced revenues.
  • Loans to large businesses, including in energy, will not increase demand.  Most of these companies are scrambling to cover fixed expenses with huge revenue shortfalls.  These loans generally require that they keep their employees – many of which they have no use for during lockdown.  Unlike the past decade, this money won’t be fed into stock buyback programs.
  • Mortgage-backed securities are in a crazy position right now, which many articles such as this one illustrate: https://wolfstreet.com/2020/04/10/mortgage-forbearance-hits-shadow-banks-clamor-for-bailout-from-taxpayers-federal-reserve/
    • Banks are losing money as lower interest rates sparked massive mortgage refinancing requests. This was not offset by a wave of new mortgages as home sales have slowed enormously during lockdown.  The risk of non-payment has also gone up considerably as massive layoffs and announcements of forbearance programs has sharply increased non-payments.  As a result, the federal reserve has in many ways become the buyer of last resort as investors – who tend to be highly leveraged – are trying to reduce exposure to these to avoid bankruptcy themselves


So now what?  Well, here’s where I currently stand:

My regular account is not maxed out in short-bets, down about $13k in the matter of a week (though  it was $6k up the weekend prior).  As I said above, going short is harder because it always involves a relatively short time-frame.  2/3 of my short bets will go to zero if they don’t play out by mid November and the rest will go to zero if they don’t play out by mid January.  As of now I am fairly confident that they will end on the upside, but as you can imagine the next few months are critical.  By the end I will be called a genius or a fool, and I argue that both tend to be intertwined.

My retirement account has been sitting on the sidelines for the most part, though I’ve been playing with the gold miners a bit by purchasing on dips and then selling when momentum starts shifting back down.  I still have some gold mining stocks left but I will likely sell the last of it this week and sit back for a while, as they are up considerably since last week and I ultimately expect the deflationary story to beat the inflationary one.  I will probably refrain from going short with this money as the next few months play out, because I want to be able to come in with something if I end up being wrong.  Maybe I’ll continue to channel trade with some of it, playing a different game with smaller stakes.  There is much to learn from the market, and high volatility provides a great learning opportunity in putting short-term trading strategies to work.

Best of luck to you, and remember to stay positive.  Now more than ever people are looking for creative outlets, and writing is a great one for me.  It seems like a very historic moment for my blog: A small-time individual investor going through the ultimate bear-market ride in real time with real money on the line.  Looking back at history can make it seem so obvious like it’s set in marble, and it’s easy to forget that no one living through it knows how it will play out.  No matter how this ends up, I find it fascinating.  Happy Easter!

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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2 Responses to Hyperinflation Hype? How should we model this market?

  1. Jared Bockoff says:

    Well put regarding being able to look back and realize the future is not clear in real time. There are too many variables to be certain about, too many obscurities in this enormous and complex system we call the global economy.

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