Investing in Stagflation

October 13, 2023No Comments

Today we’re going to talk about ‘Investing in Stagflation’. Now, I will just do a quick introduction to some of the factors behind the stagflation thesis, but really I’m going to encourage you guys to refer to my blogs because I’ve written an awful lot more.

Stagflation is an economic cycle characterized by slow growth and a high unemployment rate accompanied by inflation.

You guys probably know because you watch these videos and read my blogs regularly, that I have been harping on about the inflation thing for a long time. In fact, Craig and I at ValueTrend were very early. In fact, I don’t even know anyone who was as early as us when we called BS on the whole transient inflation thing two and a half years ago. We started calling that nonsense, and we were right, and we are continuing to believe that inflation will remain higher than the Bank of Canada and US Federal Reserve want to see it get to.

Now, no doubt it’s come down and it will continue to come down, but 2% is just not likely in the cards. And we have presented a lot of evidence to that over time. We wrote a paper about a year and a half ago, arguing for a sideways market based on some of these factors. And of course, my blog, I’ve been peppering you with logic behind why core inflation will stay higher than what we’ve seen in the past couple of decades. So, with that in mind, we have to then look at the basic business cycle and realize that in the current circumstances, we’re going to likely experience stagflation and go into a very soft recessionary type environment.

I’m going to cover just the brief aspects of this thought, because you really need to go to the blogs and do some of your own research on stagflation. At the end of the day, I’m not going to use this video to convince you that there’s more sticky inflation (stagflation) or that there’s a very likely recession coming, but I’ll cover just a couple of briefs. The purpose of today’s video is to talk about:

Okay, how should we be investing in stagflation? What do we do?

So I’m going to give you some ideas on my thoughts about investing in stagflation. We’re going to go to a little bit of a PowerPoint presentation that I put together.

“Investing in Stagflation ‘s Environment”, and this is being recorded on the 5th of October. So you’ll probably see this on the 10th of October by the time it’s published though. So it’s being published on/around the 10th, but being recorded today, which is the 5th. Alright so, what I want to do is just give you stuff that you already know because you read my blogs and you probably don’t live under a rock, so you know that inflation is in rising. Inflation over time goes up.

Stagflation Consumer Price Index

This is the Consumer Price Index.

And of course, prices always go up over time, you know even at 2% they go up, but they go up at a lesser angle. So this is important to realize that basically right after the COVID crisis and everybody ran out and bought a new motorcycle or a boat or a cottage or whatever it is they were buying, prices went up.

 

Now this is in conjunction with a movement politically across the world, not just in North America, but quite predominantly in North America towards very spendy, left-wing style governments. And these governments, it’s not just here, as I said it was in Europe predominantly as well, were a theory of modern monetary theory, which I’ve discussed in a blog some time ago. In fact, about two years ago, I said, this isn’t going to work and it’s going to cause inflation, and here we are. But basically modern monetary theory says, oh, government can print money and spend all at once because inflation will take care of itself.

Do you remember those words out of Justin Trudeau, “The economy will take care of itself”? Well, the economy has not taken care of itself, and you can see that in the inflation chart here. So we have a problem, and that is that prices are high.

 

Now, will inflation slow down? Absolutely. It peaked out at around 8% in both Canada/US, and it’s down to about half of that right now. But I want to just talk about the effects of the Federal Reserve, and the Bank of Canada, and Bank of England as well, what they had to do in order to kibosh the very effects of their modern monetary theory spending, their reckless spending habits. And that is, they had to raise rates because they caused inflation. And now we have what’s called an ‘Inverted Yield Curve’.

2s 10 s curve chart Investing in Stagflation

Investing in Stagflation: An Inverted Yield Curve

It is when short-term rates are higher than long-term rates. Think about it. If you’re going to buy a 30-year bond, you want – under normal circumstances – a better rate of return than on a three-month treasury bill, right? Because you’re committing for a longer period of time, you have more risk of interest rate fluctuation.

 

So typically, a 30-year bond is going to give you at least 100 to 200, maybe 300 basis points, a higher yield than short-term money market type paper. And that makes sense. Well, what happens is when the Fed or the Bank of Canada or the Bank of England (or whoever) steps in to fight the inflation that their governments created, then they have to raise the short-term rates. They don’t manipulate long-term bonds as much – they do through quant-easing and quant-tightening and stuff – but, let’s just talk about monetary policy, which is – they will raise rates. And, they raise it on the overnight lending rate, the short-term rates that banks pay to borrow money.

This influences the yield on treasuries and one-year paper and two-year paper, but it doesn’t so much influence the 20-year paper, for example. Okay? So then you get a discrepancy because if 20-year paper is not going up in yield so much, but short-term paper is, because the Fed is aggressively raising rates to kibosh inflation, then we have what’s called an ‘Inverted Yield Curve’.

 

And, this here is the ratio between the 2-year and the 10-year courtesy of Rosenberg Research. So this, by the way, this is not unique to their research, it’s available anywhere. But, I happen to subscribe to Rosenberg Research, so I’m using their chart of the same thing that you can readily access on the internet in a lot of different places. But, what this is telling you is that the ratio – when it goes down, so the ratio where twos are paying more than tens, and the deeper that discrepancy is – the more this line goes down.

So the spread, you know, as I said, maybe under normal circumstances is 1½ to 2% spread, maybe 3% as you can see up here where you made more in the long bonds. But here we have negative spreads. So we have the difference back in say 1980 of about negative 75 basis points, so you got an extra 75 bps or so for buying a short-term bond than you did for a long-term bond, which is crazy when you think about it. That’s called an Inverted Yield Curve.

 

Well, guess what? Every time that happened throughout history – and we’re going to look at a chart that shows you all of these different times – every time that happened, you got stagflation, and a recession. These gray bars indicate recession. Okay? Well, what I want you to notice here is you are here, as it says in the map, when you go into a shopping mall to show you where you are and you are here, okay? So the spread differential between long 20-years and 2’s is huge. It’s like more than 1%.

So, why is that important?

Well, it’s deeper than it has since been since 1980. So like, since 1980 we’ve been through, you know, a fair number of market corrections and crashes and recessions.

 

Anybody remember the tech bubble? Anybody remember the recession of 1990? The 2008 crisis? These were marked by such an occurrence, and this is deeper. The spread differential is deeper than it has been for a very, very long time, literally since 1980. So I want you to keep that in mind.

This is about as far as I’m going to go in the economics lesson. But, when we have that kind of set up with the yields, well, what happens is, is that people paying their credit cards, their auto loans, their mortgages, these things are coming due, okay?

credit card delinquency rates Investing in Stagflationcredit card delinquency rates Investing in Stagflation

As they come due, they’re rolling into higher rates. Well, the quickest way to see stress on the consumer is with credit cards because that’s paid every month, whereas your auto loan’s not going to come for five years. Maybe your home rollover mortgage date isn’t for three more years or two more years, but credit cards are every month, okay?

So what happens is, is that the credit card delinquencies are the first thing to show you the strain on the consumer. Now, if you watch my video, you’ll see one that I recorded at the cottage and I talked about discretionary purchases by consumers. Things like boats and motorcycles and Sea-Doos and sports cars and all that fun stuff that’s totally falling off a cliff. Well, why? Because the consumer is tapped and in fact, the lower income end of the consumer are starting to default on their credit cards to the highest level seen since about 2010.

This is a game. NOT a mild recession setup.

This is a setup for probably some deep problems. And we’ve got a continued high inflation rate. Again, not as high as it was, it is coming down, but it’s very unlikely to get a heck of a lot lower i.e. nowhere near the 2% target. So this is what’s called ‘Stagflation’.

rosenberg research report Investing in Stagflation

Now, I want you to look into this chart before we get into the whole stagflation thing. This is again from Rosenberg, and what he’s showing you here is every recession since basically 1949, and the average markdown from the beginning of the recession. So if we going to call the recession beginning this month, last month of 2023, next month? A recession is on average about six months in length. And on average about 20 plus percent downside on the S&P 500.

 

So wait, does that mean we should all run out and get out of the stock market? Well, we’re going to talk about that. Because remember, what the Fed does and the Bank of Canada does is that they will lower rates once they start getting notices that we’re entrenched in a deep recession because they have to stimulate, okay?

 

And this only adds to the inflation argument. They’re kind of in a hot bottle of water here because they’re going to have a recession on one hand, and inflation higher than they wanted it on the other. So they’re in a bit of a pickle. And that’s what I think is going to cause a sideways, very volatile market. And I just rewrote my book Sideways – well, I didn’t rewrite it – but I changed the introductory chapters talking about the very fact that we’re probably going to enter into another one of these many sideways markets.

So, let’s just assume that net-net the market declines, say something like 20% over the next six months just using the averages. (That’s not a prediction.) Well, what do we do? All right, so again, the setup is that we’ve got inflation, we’ve also got recession coming, so that’s called stagflation. Alright?

Let’s talk about investing in stagflation environments, because that’s the purpose of this video.

How to invest in a stagflation environment

So first of all, I want you to understand, and I’ve repeated this in every webinar, seminar and speaking engagement at the Money Show in September 2023. I said this, I’ve said it in my blogs, and I say it in my videos, don’t listen to the media. They either talk incorrectly to back up some sort of an agenda, especially when the media is bought as it is in Canada, they will back an agenda saying, “Oh yeah, don’t worry folks, it’s not a recession”.

You’ve got to watch that, okay? Because if you’re being paid by your local government, like 600 million a year as our media is, and you’re going to get some maybe bias towards printing whatever they want you to believe. So don’t trust the media. And the media also talks about whatever’s happening right now, and it extrapolates it to make you believe that that’s just the way it’s going to be.

 

I’ve noted on many, many, many blogs that when the media is saying, “Oh, it’s doom and gloom”, it’s actually near the bottom. When the media is saying, “Oh, the market’s picking up, it’s going to go up.” Well, I’ve called many times where they said, well, that’s wrong. They’ll quote the analyst. So the guys like me, they’ll quote, but they’ll quote it spelling out the story that they want you to hear, okay?

So just be aware of that. Don’t trust sell-side research, which is basically research pumped out by big brokerage firms. Why? Because they want you to buy stocks, alright? They’re always bullish. Next thing in a stagflation-type environment and the volatile environment that happens in what I perceive we are going to be seeing is what could be called a non-trending or sideways market.

 

‘Buy and Hold’ when investing in Stagflation environments is dead.

I’m going to offend people, but any idiot can make money in a bull market. So, investment advisors become heroes because stuff’s going up. You just buy the market. You do, okay? People at home, they do that.

Remember that ‘Couch Potato’ or whatever it’s called, so-called investment program? You’ve probably read books on it. Advising “Don’t listen to guys like Keith Richards, he’s a market timer, you should just buy-and-hold indexes.” Well, yeah, that’s great. Except that if you look at my book Sideways or some of the stuff on my blogs, there have been four distinct sideways markets in the past 100+ years where markets stayed absolutely flat, went up and down like yo-yos, but net-net made little or no returns over 7, 10, and even 14 or 17-year periods. Long, long periods. So do you want to be a buy-and-hold investor, buy a bunch of index stuff, the ETFs, for example, and then wake up 10 years from now and look at your portfolio and it’s more or less the same, I’d probably think not, especially with inflation being what it is.

 

So buy-and-hold is dead. Instead, you’ve got to trade, okay? And I’m going to talk about that in a minute. So, the other thing I want you to keep in the back of your mind is that when the recession is officially acknowledged by your friendly local government, they’re going to start easing. Now, that’s not today. So when you’re watching this video, you can’t go out and say, “Keith Richards said buy bonds”. I did not just say that, but what I am saying is that you watch what’s going to happen as recession is acknowledged or slowing, if that’s what you want to call it.

Stagflation and a slowing economy is acknowledged and that’s when bonds are going to pop. They’re deeply oversold right now, but they could get worse. So just keep in mind, you’ve got to follow your technical rules and trade, trade, trade. So let’s talk about stuff.

wall street journal article screenshot

Why I don’t like the media. This is a good example. “Japan is the most exciting market in the world.” This was the Wall Street Journal, October 4th. So it was actually yesterday that this story came out.

chart of ewj

Here’s Japan. Well, it looks like to me every other bloody market in the world. Craig and I owned this ETF (EWJ), but we sold it right here.

Why? Because it had our technical resistance point. You could see it bounce, bounce. There used to be support there. So we sold right up around here. Here we are today, probably coming to a point where it’s going to be a great trade. ‘Most exciting market in the world?’ I don’t know. We’re going to look at some other charts that kind of look the same. In a sideways environment, you have to learn to trade and almost everything moves in the same direction.

 

So, just keep that in mind. That’s what happened during the 1965 to 82 period. A lot of world markets went sideways. It wasn’t just the US. So just bear that in mind. Okay, lots of chop here though. You’ve got levels. If Japan broke here, then it would get into this next level. The point is, it’s a traders’ market, alright? So, don’t believe the news just because they say Japan is wonderful. It’s not, unless you’re trading it.

Okay, “Canadian economy to get back on its feet next year, Deloitte Touche says.” Oh boy, that’s fantastic.

This was done on September 28th, put out in the Canadian press. It’s in every newspaper out there. And you go, oh boy, that’s great. The Canadian economy is going to get back. Well, when have you heard this before from your dearly beloved local government? They’ve been saying this for two years. And “Oh, don’t worry, inflation won’t be bad.” Then, “Oh, don’t worry, we’re not going to go into recession”. Well, none of the above were true, okay? And, here we are looking at a report saying that the market economy’s going to be good next year. Okay, well, here’s a quote from David Rosenberg.

image of David Rosenberg quote Investing in Stagflation

I’m quoting him a little bit more today because he’s an Economist and we’re talking about the economy. “Memo to Justin Trudeau: Aggressive immigration might be a poor antidote to an economy suffering from structural productivity decay.”

 

The problem has happened that there’s been a larger amount of immigration into Canada than the country could handle. Hence, why inflation – one of the factors behind inflation. It wasn’t just the money printing, although that went towards a lot of immigration policy, but the number of people coming into the country and only so many homes, houses, and rental units to go to them, as well as the demand on food and goods and services and all that stuff. So it’s been kind of the aggressive approach to this. And David Rosenberg notes that it was aggressive, the amount of immigration that the government brought in, and the economy couldn’t keep up with it.

 

Okay, Canada’s most important industry is the resources industry. And you’ve probably read this in a recent blog of mine, but Rafi Tahmazian of Canoe Financial manages 350 billion in assets and he was a CEO in the oil industry. This guy knows oil and, he’s one of the better portfolio managers in the world right now, and he is from the US. He has nothing to do with Canada, but he said basically that, “Trudeau’s policies on oil are moronically stupid”. And he’s right. I mean, you don’t disincentivize a major economic part of your economy, you just don’t. So it’s just unbelievable.

tsx chart

And so, you know, when you read the Deloitte quote, “oh, Canada’s going to get back”… well, it has been underperformed in the US forever, and more importantly, it’s been stuck. I mean, even the US is building a bit of an interesting bullish-looking chart. Well, not so much the TSX, it’s been absolutely sideways. Now again, remember a rule ‘buy-and-hold’ is dead. Trade, trade, trade, okay? Can you guys see how you would trade this index? Pretty straightforward to me. Just follow the dotted lines. If you see a bounce off of somewhere around 18,500 or so, you ought to be all over this index. And then trade it out around 20,500 or so.

 

The setup for Canada, I think economically because of people in power, I think is not bullish. But I think there’s always room for a bounce. There’s always a trade. And so looking at it from a fully pragmatic point of view, there’s lots of money to be made on this index. There’s lots of money to be made on the Japanese index, but there’s not lots of money to be made if you just buy and hold, I don’t think.

S&P chart

Here’s the S&P. Much more bullish chart than we looked at with the TSX, but same idea. You know, if we’re going to be entering into a recessionary environment and a long-term sort of consolidation pattern as has been seen over the past 100 years, many times before, then you’re going to have to learn to trade this index. You can see there’s a support level here, the support level, former resistance, now support, which we’re testing right now at around 4,200 as I talk, who knows by next week that might’ve been punched.

And if that’s the case, we’ll go down to 3,800. But I’m not going to make predictions on this video. All I’m saying is it’s a trader’s market. If you see a bounce off of one of these two support levels, you should buy and then you should sell at the next resistance level. So that’s the message I’m trying to impart.

People say, “Well, shouldn’t you just go out and buy bonds?” Guess what happens in a recession? They lower rates. Guess what happens? Your bonds roll into a crummy rate of return and really 5%. That’s interesting. But you’re going to be paying taxes if it’s in a non-taxable account, and you’re going to be more so than capital gains in dividends. And I think you can make an awful lot more money on wise trading decisions than you can on a 5% GIC.

Okay, so next thing, Gold.

chart on gold

Now, some research that I’ve looked at shows that Gold can be an outperformer during a recession. I don’t tie the Gold. I’ve done enough research on my own on Gold to know that it kind of marches to its own drum. The only thing you buy Gold for is to hedge the US dollar. So I assume that Gold can outperform during recession because the US dollar falls. So that’s the only reason Gold would rise, because there’s really no correlation between Gold and the stock markets at all. They’re completely non-correlated. They’re not negative. Whereas Gold is negatively correlated to the US dollar.

So be that as it may, you can see, it’s a sideways market and I think there’s one level of support coming in here, but the real support level, like the perfect place to buy Gold, is somewhere near $1,700. So if you see it anywhere near there, you ought to be considering buying, especially if it bounces of course.

But you could get a pop because this is an old resistance level, right around that $1,800 level that turned into support at one point, it may just find support. You can see it’s 1,830 or so on this chart. It could find support very soon and bounce back up to here. These kinds of movements can happen. So, you know, aggressive traders could consider that trade. Alright, Oil.

chart on crude oil

Now you guys maybe know if you’ve watched my blogs regularly that Craig and I pounded the table on Oil since the beginning of 2023 and we were right, it moved up a lot this year. You can see it was moving sideways and it moved out. Now it’s hit resistance at around the $93 level. So we started selling, so we sold half of our Oil, but we do think that eventually Oil could break, but it doesn’t matter what I think, you wait for it to happen.

 

If it breaks past around $95, the next target could bring it anywhere between that $100 to $130 level. So there again, a trade. Meanwhile, if Oil does go back to the bottom of this zone, which might be in the $70 range, I doubt it will, but if it does, then that would be a great place to buy it. Right now we’re only half in the trade. We have a lower exposure, but we made lots of money on it by trading this year.

If we had gotten trapped in the believers, the thematic investors’ way of looking at things, which is oil’s going to go up because Russia is cutting or whatever, then we wouldn’t have sold. You have to trade. Look at the charts, don’t look at the news. Okay, forget what the news says about Saudi Arabia or OPEC or whatever, or just trade according to the charts.

So I’m being very passionate here because this is something I really want to drive into your cranial vaults, is that you cannot do things the way you were doing them a couple of years ago. Those days are over. The future ain’t what it used to be.

So final thing, which is the 30-Year Treasury Bond, and I’m just pulling this up because it’s the long bond and you can see that it had been a pretty good place to be since the seventies. It had its burps and warts, but generally speaking, trended up. That may be ending.

We all know that this level of support was cracked recently on the long bond, but there’s a pretty major support level here. Somewhere around the 2,700 on this particular index, which is the Ryan Index. The number isn’t important. The long bond is coming into a level of support.

They are influenced by short-term monetary policy, but not as much as we saw with the Inverted Yield Curve as the short stuff. But they’re still influenced, and they’re influenced very much by inflation. So if inflation continues to come down and rates stop going up, and maybe even start to ease, and that’s a big picture situation that hasn’t happened yet, but if that situation happens in the next six months or three months or whatever it is, you’ve got a case for an oversold bounce on bonds.

In some research I was reading again from Rosenberg, who was looking at what works during recessions, if you’re kind of a buy-and-hold investor, (which obviously I am not a proponent of), bonds are one of those things you can buy. Why? Because rates go down. It’s a very simple formula. When there’s a recession, the government has to stimulate.

So what’s going to happen is bonds are probably going to go up in price, but we are not there yet. This is just planting something in your minds to keep an eye on because maybe there’s an opportunity coming if we’re right about all this recession stuff we’re talking about. I hope that I’ve covered lots of information for you here. I think this was probably one of the more important videos I’ve done.

Pass this Investing in Stagflation video on to your friends because I think it’s important because this is a big-picture plan that anybody that you like should probably see. If you don’t like them, don’t let them see it because you don’t want them to benefit by all the good stuff that I’m showing you here, because they’re your enemy. Alright? I’m very tongue-in-cheek sometimes, so ignore my humor. I will wrap it up by saying thanks for watching and we will see you in another week. Have a good day. Happy trading.

 

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