Van Hoisington and Lacy Hunt argue (as they have been for years) inflation fears are overstated. They believe inflation will moderate by year-end and undershoot the Federal Reserve’s 2% target. In other words, they take the “transitory” side of the debate, but for different reasons than many others.

  • Inflation is a lagging indicator that troughs several quarters after recessions end. In recent cycles, the lag ranged from 6 to 29 quarters.
  • Rebounding productivity, supply chain restoration and technological advancement are all disinflationary forces.
  • Real per capita GDP growth continues to lose momentum as debt levels move higher.
  • Poor demographic trends (aging population, lower birth rates) produce a negative real investment effect that outweighs rising wages.
  • If the pandemic leads to more domestic manufacturing, the new plants will employ robots, not people, thereby shrinking labor demand.
  • With the policy rate stuck near zero and the Fed strongly opposed to negative rates, the Fed’s main policy vehicle is out of action.
  • Banks are unable to price the risk premium into their loan rates, causing loan volume to shrink.

The authors think the historically long lag between recession and inflation may be even longer this time since the initial conditions were so much worse. They conclude the trend in long bond yields remains firmly downward.

 

US Economy

 

  • The April jobs report was shockingly weak relative to market expectations.
  • Many economists suspect that the weakness was due to supply constraints rather than a slowing demand for labor. For example, wages unexpectedly rose, suggesting that employers are forced to boost pay to attract workers.
  • Much of the growth in payrolls came from Leisure & Hospitality
  • What is causing the tightness in the labor market? Some have suggested that the larger-than-usual unemployment benefits are keeping many workers from taking a job. According to some estimates, nearly half of Americans receiving jobless benefits are making more now than they did when working.
  • Business inventories-to-sales ratios continue to tighten.
  • US COVID cases have been moderating.
  • The pace of vaccinations has slowed.
  • The job openings report provided further confirmation of the tightening labor market. Vacancies blew past market expectations.
  • And the job openings rate hit another record high.
  • The Leisure & Hospitality unemployment-to-openings ratio is now in line with the overall jobs market.
  • Many restaurants are struggling to get workers and will be forced to boost pay.
  • Demand for factory workers and teachers is surging.
  • But openings in healthcare are off the highs.
  • Many unemployed workers are not ready to return.
  • Small firms increasingly view the extra unemployment benefits as the reason for hiring shortages.
  • And some state governments are cutting these benefits to encourage workers to return.
  • The NFIB small business optimism index improved less than expected last month.
  • The share of small firms unable to fill job openings hit another record high.
  • Price indictors are soaring, as inventories run low.
  • Small business pricing power points to higher consumer inflation ahead.
  • BlackRock expects inflation to overshoot the Fed’s 2% target during the next few years.
  • Government tax revenues are soaring.

 

Capital Gains Tax Hike

 

President Biden has proposed raising the top federal tax rate on long-term capital gains from its current level of 20 percent to 39.6 percent. The rate would apply to people with income of $1 million a year or more. There are many good reasons to oppose an increase in the federal tax rate on capital gains. The capital gains tax taxes you on income you’ve already paid tax on, discourages capital formation, taxes capital gains that are due to inflation, and doesn’t raise as much revenue as a static analysis would predict.

Also, it will generate less tax revenue for state governments and, therefore, less money to spend.

How much in taxes do you pay?

Let’s say you make $100,000 in a year and pay federal income tax on it. You have been taxed once. If you spend all your after-tax money on consumables—rent, food, entertainment, etc.—then end of story. You have been taxed once. I’m ignoring the sales taxes you pay because many items you buy are not taxed and sales tax rates in the United States are typically less than 10 percent.

But what if you save, say, $10,000 and use it to buy shares in a company? The company makes money and pays you dividends. In a sense, then, you have been taxed a second and third time. The second time is the 21 percent tax on the company’s profits, which means the company has less to pay you. The third time is the federal income tax you pay on the company’s dividends.

Then the company does really well, and you decide to sell your shares at a price substantially above what you paid per share. You then pay a capital gains tax. That makes quadruple taxation.

 

Tesla, Chapter 2

 

Recently Tesla’s regulatory-credit business took a major hit.  One of the bigger companies buying Tesla’s credits announced during its first-quarter earnings call on Wednesday that it won’t need to buy them anymore after this year.

Stellantis (STLA), a Netherlands-based carmaker, formed in January through the merger of France-based PSA (which owned the Peugeot brand) and the multinational Fiat Chrysler Automobiles (which owned the Chrysler, Dodge, Fiat, Jeep, Maserati, and other brands).

Before the deal, Fiat Chrysler was one of the largest buyers of Tesla’s regulatory credits. But now, PSA’s electric-car division is under the same roof as Fiat Chrysler which means the latter business will no longer need to buy the credits from Tesla.

Stellantis said it will save roughly $360 million per year by not having to buy the credits in Europe. Roughly two-thirds of that amount – $240 million annually – went to Tesla. Fiat Chrysler was one of Tesla’s biggest credit buyers, paying $2.4 billion for them since 2019.

Based on last quarter’s profits of $533 million, Tesla’s annualized profits equals roughly $2.1 billion right now. So Stellantis’ $240 million in regulatory-credit payments per year amounts to roughly 11% of Tesla’s annualized profits.

That doesn’t sound like a big number. But, without selling credits, Tesla wouldn’t have been profitable in any of the past six quarters. Go figure. Losing money selling cars and making it up selling credits isn’t a sustainable business model.

It isn’t merely that Stellantis won’t need to buy any more regulatory credits.

It’s that the credits are designed to incentivize all car companies to earn them instead of destroying their bottom lines by having to buy them. The credits are a tax and avoiding this tax is as simple as either building or acquiring an electric-car business.

That’s how they’re supposed to work. They penalize car companies for not producing electric cars.

So how long will it be until the rest of Tesla’s regulatory-credit revenue disappears as other carmakers get into the electric-vehicle (“EV”) market and earn their own credits?

Tesla has no special intellectual property that prevents other companies from imitating any aspect of its business. At some point, all of those other companies can – and will – buy all the same robots for their factories, make or buy similar batteries, make or buy the same software, and produce products at least as good as Tesla’s.

I’ve driven the top-line Tesla Model S. It was a very nice car that accelerated like a rocket but it’s nowhere near as luxurious as the new Mercedes-Benz EQS.

If I’m right about the regulatory credits, then Tesla’s financial results will soon become a purer reflection of its ability to make and sell cars at a profit. And the lack of profitability will eventually disappoint even the most cluelessly optimistic Tesla shareholders.

At roughly 200 times last quarter’s annualized profits, Tesla bulls have zero room for error. With this sky-high valuation, their most optimistic projections absolutely must come true.

Oh, this just came in last Thursday:

 

 

The announcement put pressure on Crypto prices.

 

CPI (Consumer Price Index)

 

The CPI report massively overshot market expectations.

 

 

Economists have cautioned that the CPI jump could appear larger due to the base effects of 2020 when prices were weak amid pandemic shutdowns.

 

 

The Fed has also maintained that the pickup in inflation will be transitory, but traders in financial markets don’t appear to be so sure.

While these price gains are substantial, they are not that unusual from a historical perspective. We just haven’t seen such increases in recent years, especially in the core CPI.

 

 

A spike in used car prices was a significant contributor to the core CPI jump.

 

 

 

The “flexible” CPI, which is sensitive to demand, rose sharply. Note that the Fed tends to focus more on the sticky CPI.

 

 

How is the CPI calculated? The measure uses a “basket of goods” approach that aims to compare the costs of various consumer goods and services. These can include transportation, food, rent, haircuts and medical care (80,000 items are included in the report). Each month, data collectors from the Bureau of Labor Statistics call, visit, or check the websites of thousands of retail stores, professional offices and other establishments to assess nationwide price information. Specialists then examine the data for accuracy and make statistical adjustments based on any given item’s value.

The anticipated 3.6% jump in the headline number for April would be the largest since Sept. 2011, and follows a 2.6% Y/Y print last month, which already was above the Fed’s inflation target. On a core basis (excluding food and energy), the CPI is expected to have increased by 0.3%, or 2.3% Y/Y. “I just think that in general there’s this thought that inflation may rear its ugly head,” said JJ Kinahan, chief market strategist at TD Ameritrade. “We see a little bit higher rates, not significantly, but a bit higher rates. And I think this struggle between value and growth also continues at the same time.”

Outlook: Investors have already seen widespread price increases on commodities like copper and lumber, while the bond market’s forecast for inflation over the next decade has risen substantially. That’s helped trigger swings in the stock market, sending the CBOE Volatility Index on Tuesday to its highest level since March. Meanwhile, executive usage of the word “inflation” has increased 800% in Q1 earnings calls, according to Bank of America, while last week’s big jobs report miss is being viewed as a sign that companies will have to raise wages to lure more unemployed people into the workforce.

Housing is hot. We’ve all heard the stories about sellers quickly getting multiple offers at far above the listing price. What explains this frenzy? Barry Habib said on the SIC (virtual) stage it’s just supply and demand. Between the Millennial generation forming new households to people relocating because they can now work remotely from anywhere, home demand is way up. Meanwhile supply isn’t just flat; it was already falling and fell even more in 2020.

 

 

In this context, “supply” is a slippery term since homes are so varied. But whatever buyers want, there’s clearly not enough to go around. The high (and still rising) prices may persist for a while.

Lumber is a key input for housing construction and remodeling, but unraveling the relationship isn’t so easy. Are lumber prices up because builders are demanding more, or are home prices high because lumber is expensive? The answer is “both.”

 

 

How many houses can be built with $50k worth of lumber?

 

 

As with home prices, this has a supply element as well. Many producers reduced output when the pandemic struck last year. An ongoing US-Canada trade dispute is also affecting supply. Still, the percentage change is bananas. Spot lumber is up 6X from the April 2020 low.  At some point, these prices will force builders to postpone or cancel construction plans, and lumber will come back to earth. When that will be is anyone’s guess.

We hear a lot about labor shortages. But in fact, employment is still far below where it would be if the post-2008 trend had continued. Employment grew steadily since the last recession, then plunged when COVID-19 struck the US in early 2020. It is still far from recovering to trend. Today’s “hot” labor market doesn’t represent a boom. Even under optimistic forecasts, it’s merely a return to what would be happening absent the pandemic

These charts show contributions to the core CPI. COVID-sensitive sectors and items impacted by chip shortages drove the latest gains (2nd chart).

 

 

 

Stock Market Consensus – David Rosenberg

 

  • The consensus is that U.S. equities will deliver strong performance as the economy recovers, and that higher inflation will drive rising interest rates. All of that is wrong, according to David Rosenberg.
  • Inflation will be transitory: The “fiscal juice” from stimulus checks and the re-opening of the economy are outstripping supply, creating temporary inflation. Supply will catch up when demand subsides as the effect from the stimulus wanes, according to Rosenberg. That will happen before the end of the year.
  • When the effect of stimulus checks expired last year, the GDP declined by 2.5%. We will see a repeat of that this year, according to Rosenberg.
  • Inflation is not a temporary phenomenon; it is a process of ongoing acceleration in the price level.
  • We don’t and won’t have a trend of inflation, Rosenberg said. Fed Chairperson Jay Powell will be right that inflation will be transitory, he said, just as deflation was a year ago when the pandemic began.

Rosenberg recalled one of Bob Farrell’s classic market rules:

  • When all the experts and forecasts agree, something else is going to happen.
  • The consensus has never been more lopsided, he said, and that is reflected in asset allocations that heavily weight stocks relative to bonds.

We are not going have a redux of the prior century’s “roaring ’20s,” despite the covers of many business magazines.

  • Rosenberg said that era had nothing in common with today; the debt-to-GDP in 1920s was 10%, which allowed for declines in personal tax rates, which will not happen in the 2020s.
  • GDP declined 3.5% last year, which was the worst drop since 1946. A decline rarely happens two years in a row, he said, and we are experiencing the expected recovery.
  • There was a corresponding 5.5% decline in employment last year, but that means the economy gained in productivity. Productivity is an inflation killer, he said.

“We can produce more with less labor input,” Rosenberg said. Real GDP is now within a percent of its pre-pandemic high, but employment is down about eight million.

  • The economy is booming not just because of the re-opening. The critical piece was the government’s $3 trillion in fiscal support. There has been no organic growth, he said. “It has been largely a fiscal stimulus story.”

“How could we not have a recovery?” Rosenberg asked rhetorically.

  • When you strip out the government transfers, real personal spending is on a downward trend.
  • The share of personal income from government spending is 28%; it has never been that high, according to Rosenberg. That is today’s “soup line,” he said, and it is temporary, based on borrowed money. Approximately 10% of the labor force is receiving government support.

Economic growth has been four parts stimulus and one part reopening, according to Rosenberg.

  • “We are basically 80% reopened,” he said. There will be no more incremental growth from re-opening.
  • There will be small growth form pent-up demand on the services side, particularly from travel and leisure. But that is an $800 billion sector in a $20 trillion economy, making it a recovery in only 4% of GDP. “We spent like never before on durable goods during the recession,” Rosenberg said, and that represents a $2 trillion sector that is up an unprecedented 12%.
  • Don’t count on growth from pent-up demand in the services sector, which he called a “nebulous concept.” Some services are lost forever, like demand for restaurants and haircuts that consumers have long since forgotten about.
  • At the same time, we are massively oversaturated on “stuff,” he said, from growth in durable goods.
  • The small growth from pent-up services demand will be offset by the bigger “pent-down” decline from durable goods, he said.

Other parts of the economy are in decline, according to Rosenberg, including commercial construction, exports (a $2 trillion sector), and travel and tourism.

Fed Chairperson Jay Powell is forecasting 6.5% growth this year, which is implies 2% growth in Q4. The consensus is 5% growth for Q4, according to Rosenberg. The earnings consensus is 10% growth, which he said is “not going to happen” with 2% economic growth.

  • “Earnings will disappoint,” he said, “and that is the principal risk for the markets going forward.”

“What I am worried about is what nobody else is talking about,” he said. That is not inflation or supply shortages of goods, which will be remedied.

  • We have a housing bubble, he said, although not as big as in 2006-2007. Houses are 20% overvalued relative to income and rent.
  • The Shiller CAPE ratio of 37 makes stocks the second-most overvalued in history, surpassed only during the dot-com era.
  • That is a constraint on future returns, he said, and is consistent with 0% real returns for next 10 years.

He is also worried about the net worth-to-income ratio, which is at an all-time high. Rosenberg says it will revert too.

  • “That has me worried,” he said. “If that mean reverts, we are going into a recession.”

 

The Amazon Effect

 

 

Empire cycles

 

 

Thought of the Week

 

“Three of the 4 major valuation measures of the SPY (Crestmont PE, Tobins Q and Buffett indicator) are higher than at any time in history along with margin debt, euphoric or complacent sentiment and most indices trading at 3 standard deviations above the main trend line.”

– Steve Forbes

 

Picture of the Week

 

 

 

All content is the opinion of Brian J. Decker