Have you been paying attention to inflation lately? Has inflation affected you in some way? Unfortunately, it will be getting far worse. And, I wanted to spell out some of the things that are affecting inflation and why it matters. I have been getting a lot of questions from subscribers wondering what to do next given the harrowing warnings I’ve been giving in my recent video analyses. Here, I wanted to outline my thinking and what I think will occur in the coming months.
First, I have a saying that I like to apply to economic events whenever there is an outside influence: For every action, there is an equal and opposite reaction. Yes, the ol’ 10th-grade physics stand-by applies to economics. These outside actions: The global pandemic and the resulting three stimulus programs to stave off the damage have effects that will ripple throughout the economy. But, these ripples may be more like tsunamis.
Let’s take a look at some factors.
It was a global pandemic and it affected the world completely, but in many ways differently. I am going to focus only on the United States but, you can apply these metrics to each respective country.
Let us first look at the jobs data to show how the pandemic affected the United States:
Above, you can see what the past 20 years looked like up until the onset of the pandemic. There were two major economic events leading up to the pandemic, that being the Dot Com Bubble bursting and the Great Recession. Both of these saw large-scale job losses. The Great Recession is attributed to losing some 9M jobs total.
But, even combined these pale in comparison to the job losses of the pandemic shut down:
I purposefully showed the previous data points above to show how drastic the losses were comparatively. The job losses in just one month alone were some 20M. During the Great Recession, there was no one data point that even approached 1M in job losses. As mentioned previously, the Great Recession lost a total of 9M jobs. But, quickly the jobs were recovered.
As it is turning out, jobs are quickly coming back after the initial loss of so much employment:
Of the 20M jobs lost, some 13M have already been gained back in the ensuing 11 months. That is impressive considering the losses and the reasons why.
Even more, the economy is very likely to see increased job gains considering that about 50% of the country is fully vaccinated with more on the way. These individuals that are vaccinated are also expecting life to return to as much as normal as can be… And, as quickly as possible.
Given this, the fact that it is now vacation season, expect a surge in economic activity. This will continuously drive employment gains. It may be that over the next three months time we see an additional 1.5M jobs created and then with more individuals vaccinated this may drive an additional 2.5M jobs created during the last four months of this year. This could be a total of about 75% of the total jobs lost regained in a short period of time.
While that sounds like a good thing, I caution about the potential that for every action there is an equal and opposite reaction.
Money In The Pocket
Another thing that occurred due to the pandemic was the Federal Government’s stimulus check programs. An enormous amount of stimulus was created in order to help those that recently lost employment. Three rounds of stimulus were approximately $4,200.00 per person in the United States, excluding payouts for children (All of this tucked into the stimulus programs).
It is that stimulus that I want to focus on. In total, some $5 trillion in stimulus was created by Congress for the country. This eclipses total spend on the Great Recession by more than triple. But, it was not just the stimulus that is a concern. It is the manner in which it was created. For most of the stimulus bill, the Federal Reserve merely created new money to take on the responsibility of debt holder for the United States.
Given all of the new money in the system, this will have an effect on economic indicators. After all, for every action, there is an equal and opposite reaction.
Housing was something that initially everyone thought was going to collapse. There may have been a pause in some areas. In fact, my home town, or should I say: city, that being San Francisco, was hit especially hard from the pandemic. Individuals could no longer justify paying such high rents to live in a city they could not enjoy due to the shutdown. But, the city is an exception, not the rule. Other cities grew.
One thing that did happen, as people sought a different kind of living atmosphere, was a housing surge in areas just outside of cities. Companies were sending people home to stay safe. Some chose to look for new locations. This drove housing demand. Prices started to increase.
As you can see over the past 25 years housing data shows that activity has surged lately. The latest data points are even higher than the data prior to the Great Recession. That should be ominous.
Also, stimulus programs were created to stave off foreclosures. And, mortgage programs were created to ensure that homeowners that would be affected by the pandemic had relief. This created a distortion in the mortgage market. Mortgages are at all-time lows:
Mortgage rates at an all-time low are always a good thing. Except when they are not. With interest rates so low, even lower than just prior to the Great Recession when there was a seriously imbalanced housing bubble because of low interest rates, this is what is driving the housing market right now. With mortgages so low this is driving entrants who otherwise could not afford homes into the market.
But, there are even limitations to that. As it turns out homeownership rates are still high but, not at their highest.
Some of the data points appear to be anomalous and misaligned. Nonetheless, the general trend is upwards and pushing towards levels not seen since just prior to the Great Recession.
Given the heightened demand for housing without a requisite supply increase, prices will continue higher.
And, the surge in demand has outpaced supply abilities. Here’s a look at the price of lumber:
This is the chart on Lumber. Lumber has never been this high. Supply needs to increase in order for prices to moderate. But, if lumber supplies normalize this could merely push more individuals back into the housing market if the cost of building declines back to average price levels.
The distortions are affecting every day activity. Because of lower mortgage rates this has driven more people into the housing market. Because of the pandemic, supplies have been limited. This all helps to demonstrate that for every action there is an equal and opposite reaction.
A good chunk of the money for the stimulus, the $5T in spending, was invented out of thin air. The United States did not simply borrow the money from abroad but, instead had the Federal Reserve take on the debt load by inventing new money.
I do not want to suggest any political agenda, opportunity, or dysfunction. That is not the intent of this analysis. But, instead, the stimulus programs happened and I want to show what the outcome may likely occur from this.
Here is a look at M1 over the past year:
As you can see here, there was an approximate 200% increase in M1. M1 is the money supply at one level, that being demand deposits. This means there is far more money now than previous.
But, to put that into perspective, let’s look at the long-term M1. money supply:
This chart gives more of a visual perspective to what is going on in the money supply. Just prior to the stimulus programs there was just over $4T in M1 money supply. Now, with three consecutive stimulus programs, you can see how this is going to affect the economy.
One of the things that are important to understand is that M1 is closely associated with fractional banking. Banks lend out money on a fractional basis; they have reserve requirements. With so much new money in the system, this will pressure banks to lend out even more.
Given economic activity as it is, with a potential surge in economic activity, this is only going to exacerbate already pressured supply levels. From a purely classical economist standpoint, the only plausible effect would be higher prices. After all, for every action, there is an equal and opposite reaction.
There is increased inflation in every aspect of the economy and I believe it is going to get far worse. This is going to continue to pressure the Federal Reserve to raise interest rates to lower demand on housing and construction. Plus, with the general economy moving towards increased economic activity this will drive the Federal Reserve to push further with increasing interest rates.
There are many products where prices are increasing rapidly: Food, lumber, gas, to name but three. Price pressures are going to continue to mount with such increased economic activity.
On thursday, the United States prints CPI data, that of consumers. My expectation is that this is a catalyst event. And, i expct taht what we sill see are the effects of price pressures. The potential of this being a huge wake-up call for the inflation situation is a high probability event. With current economic activity from the housing market, with hte money creation just mostly getting started, and with other price pressures such as oil prices trending higher and higher, I expect continued increases in inflation. And, whatever we see printed on Thursday I believe is just the beginning of an ugly unfolding of econimic activity.
Across the board, interest rates are going to have to go up. The Federal Reserve has already stated that they may be discontinuing corporate bonds. Should they do that, the bond market would collapse as hedge funds and investment portfolios exited their holdings. This would drive up interest rates.
As the Federal Reserve stepped in to control liquidity they would be decreasing bank balance sheets as they worked to reduce demand and liquidity. This, again, would drive up interest rates. The ripple effects from this would be the S&P 500 selling off sharply from ultra-high levels driven by a low-interest-rate environment.
Given an increase in interest rates, this will push mortgage rates up significantly. Then, demand falls off of a cliff. Housing prices will drop precipitously. Demand will dry up.
If the numbers we see are too high then expect the long-end of the curve to sell off sharply. This will push traders out of their stock positions.
What to do?
First, ask yourself what it is you are trying to accomplish. As a value investor, you should be focused on the value you get from owning a share of a company. But, as a value investor, once you own a stock you only consider that your entry point. After all, the greatest value investor of our time, Warren Buffett, never talks about stock gains. He talks about ownership of companies. This is what value investors focus on; owning companies.
But, not all who read my content would consider themselves value investors but are merely getting into certain stocks for certain reasons. Price drive may be one of them. Given that, it may be that you want to take some off of the table. However, I am not.
But, not all at once
On Thursday of this week, we will see the consumer price index. I expect, as most do, that there is going to be an increase in the CPI. This will spook the broader market and we may see a sell-off like we did just last month; 5% in two days’ time.
If you figure yourself more of a trader and not an investor, you may want to sell off some of your holdings before that catalyst event. If you consider yourself more of a value investor and not a short-term holder, you may want to look at lower prices as an opportunity to increase holdings.
This is entirely up to you and what your goals are. For me, I am not loosening any of my positions. If anything, I will likely play the potential move downward by buying puts against the S&P 500. But, I am holding my cannabis holdings. After all, as a value investor, my favorite position is forever.
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