In his Daily Market Notes report to investors, while commenting on the global supply chains, Louis Navellier wrote:
The yield on the 10-year note, which ended March at 1.74%, went as low as 1.53% last week in a surprising move that defied the various reports showing higher inflation rates and decidedly strong economic activity. There were various assumptions offered for why this counter-intuitive move in rates took place, ranging from short-covering activity, to foreign buying interest, to a sense that economic and earnings growth is nearing a point where it is “as good as it is going to get” for this time in the cycle.
I think a better explanation as to why the bond market staged its late-week rally is how well the $271 billion in new Treasury supply was auctioned off. The explosion of deficit spending has weighed on a couple of prior Treasury auctions, so that had become a bearish narrative, but the strong demand for U.S. debt drove down yields and the dollar, inciting risk-on capital flows into equities that sent the market to new highs.
The removal of yield-risk to the investing landscape means that the rally can sustain its extended and overbought condition for a while. The market has bought into the Fed’s rhetoric that any notion of tapering is not under consideration for some time, so interest rates will remain historically low relative to inflation. Early Q1 results are showing that companies are beating increased earnings estimates and inflation-adjusted returns are more attractive in stocks relative to money markets Treasuries.
One thing is for sure: The stock market is “all in” on what the Fed is marketing in its fiscal policy, and their internal indicators provide a very confident tone whenever Fed Chair Powell or the other Fed members speak out. But, more importantly, the charts indicate that the stock market has a strong stomach for some inflation above the 2% target range, as long as the job gains continue, and incomes keep pace.
Investors should never lose sight that the U.S. is a consumer-driven economy, where cost-of-living drives sentiment, and sentiment ultimately determines market trends. So far, “transitory” is the buzz word for 2021 – not just for inflation, but also for stocks and the bull market. Until the Fed decides on another key word to attach to inflation, the path of least resistance for the S&P 500 is higher.
There are some “inside Las Vegas” terms for gamblers who have lost all rational restraint and are headed for a wipe-out. Congress might be susceptible to such names, except they never have to worry about being tapped out. There’s always more paper at the Bureau of Engraving and Printing.
Deficit-Financed Government Spending Soars
This is not the time to run up huge government deficits based mostly on transfer payments, yet that is what they’re doing. As economist Ed Yardeni wrote last week, “Washington has gone bonkers. Deficit-financed government spending has soared beyond belief.” Here are some of the new statistical realities:
- The March budget deficit came in at $660 billion, a record high for the month and 455% above the $119 billion deficit last March. Outlays were $927 billion vs. income of only $268 billion.
- April won’t be much better because, once again, the IRS postponed the tax deadline into May.
- The deficit for the first six months of Fiscal 2021 (starting last October 1), reached a record $1.7 trillion, a 130% increase over the $743 billion deficit for the same six months in Fiscal 2020.
- The U.S. federal budget deficit totaled a record $4.1 trillion, over the past 12 months, through March. Outlays increased by $3 trillion (+65%) to $7.6 trillion, with no real growth in receipts.
The CPI release last week was hot but apparently it could be explained as “transitory,” which caused the Treasury market to rally and yields to fall. I am of the opinion that Japanese and European financial institutions will continue to buy U.S. financial instruments, as there are simply no yields to be had in Japan or Europe, making U.S. dollar-based vehicles the only option. Still, that does not mean that Treasury yields will rise above the level of inflation, which is expected to rise faster.
The Consumer Price index rose last month at an annualized 7.2% rate and it is likely headed higher (the 0.6% monthly rise times 12 months, yields a 7.2% annual rate, but it would be even higher with monthly compounding). Needless to say, if I expect inflation to rise further on the reopening of the economy, I wouldn’t expect Treasury yields to fall in a meaningful way. I think we will most likely see Treasury rates above 2% by the end of the second-quarter, notwithstanding the decline last week.
Issues For The Global Supply Chains
The world is simply growing too fast for the global supply chains. Taiwan accounts for approximately 65% of the world’s semiconductor production, but the worst drought in 50 years is proving to be very challenging to semiconductor production, which requires a lot of water. There are three major industrial parks in Taiwan, where most of its semiconductor chips are made. Major companies have had to curb their water intake. One major chip company has arranged for trucks to bring in extra water supplies, while another is exploring using groundwater.
Another industry crisis is expected to be the lithium battery shortage. VW Group announced, during its “Power Day,” that the premium lithium batteries with cobalt, which is in scarce supply, will be reserved for its premium vehicles, like Porsches, while cobalt-free batteries will be used in lower-priced electric vehicles (EVs).
Clearly, the Fed has succeeded in fueling inflation, but we now have to see if this inflation is “transitory,” which is how the Fed has previously described it. So far, the inflation news has been essentially in-line with economists’ expectations. If you’re worried about future inflation, this is a good time to invest in growth stocks , which post earnings above the rate of inflation, as stocks are typically great inflation hedges.
Over in China, wholesale inflation is brewing. The Chinese National Bureau of Statistics announced that its producer prices soared to an annual rate of 4.4% in March. In China, despite a robust manufacturing sector recovery there, Chinese household spending has not been recovering as fast as it has in the U.S.