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The Fed is too easy, but profits are spectacular

Despite numerous signs that inflation is running well above the Fed’s target, the FOMC today showed no signs of panic. Instead, they hinted that the current…

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This article was originally published by Califia Beach Pundit

Despite numerous signs that inflation is running well above the Fed’s target, the FOMC today showed no signs of panic. Instead, they hinted that the current tapering of Treasury purchases is now likely to be accelerated modestly, and that might bring forward by a few months the first hike in rates (late summer ’22?). In my view, a true tightening of monetary policy (i.e., a draining of reserves, a hike in real short-term interest rates, and an inversion of the yield curve) is still far in the future. Meanwhile, corporate profits have set new all-time highs, both nominally and relative to GDP (third quarter profits were released today in the first revision to third quarter GDP numbers). With a profits boom and a gentle Fed as a backdrop, the downside risk to equities of a Fed tightening is minimal and far enough in the future to ignore for now.

Chart #1
Chart #1 tells us that the bond market is not unaware of the fact that inflation is rising. 5-yr inflation expectations (green line) have jumped from 0.2% in March of last year (when deflation and depression fears were rampant) to now 3.07%. The Fed has been telling us they want to see the CPI over 2% for at least a few years, and now the bond market sees the CPI averaging over 3% for the next 5 years. The Fed’s inflation-boosting efforts have thus been more than accomplished. If I were running the Fed I’d be pushing for—at the very least—an immediate end to bond purchases. I think they are way too easy at this point.
Chart #2
Chart #2 is a reminder of what true Fed tightening looks like. Every recession in the past 50+ years (with the exception of last year’s recession) has been preceded by a sustained tightening of monetary policy which takes the form of high real interest rates (blue line) and a flat or inverted yield curve (red line). Today we have just the opposite. Furthermore, to judge by the level of real short-term interest rates, monetary policy has never been so easy.
Chart #3
Chart #3 shows how Treasury yields tend to track inflation fundamentals. But today, yields are far below the current level of inflation. Yes, yields have jumped from the lows of last year, but they are still far below where they should be given the current level of inflation. I predict the red line will be rising for at least the next few years.
Chart #4
Chart #4 is one of the MOST IMPORTANT charts that the world is apparently still blissfully unaware of today. This is the elephant in the living room; the 800-lb gorilla that nobody sees. Inflation is up beyond all prior expectations because the money supply has exploded in the wake of the Covid lockdowns. By my estimates, there is an extra $4 trillion sitting in bank accounts held by the public, relative to what we would have expected to see in a normal environment. Don’t just take my word for it: check out John Cochrane’s discussion of this issue here. Briefly, he says that the Fed has done a massive “helicopter drop” of money, and that is the source of the inflation that is staring us in the face. It’s not transitory, it’s going to be with us for awhile, and it is going to be significant. (John Cochrane is one of my favorite economists.) You can read more about this in many of my prior posts.
Chart #5
Chart #6
Fortunately, there is plenty of good news these days to offset the bad. Chart #5 shows corporate profits compared to nominal GDP. (This measure of profits is the best measure of true economic profits that exists, and it has been consistently calculated in the GDP accounts since the late 1940s.) Both are at all time highs. Chart #6 shows that profits relative to GDP are also at an all-time high.
The economy is growing and corporate profits are on the moon. What’s not to like?
Chart #7 
Chart #7 compares corporate profits as calculated in the GDP accounts (red line) and trailing 12-month earnings per share (profits from continuing operations) as calculated by Bloomberg (blue line). Not surprisingly, both tend to track each other over time. But since the red line is a quarterly number, it tends to lead the blue line. This suggests that reported corporate profits are going to be very impressive for the foreseeable future.
Chart #8
Chart #8 is my calculation of a PE ratio for the S&P 500 that uses NIPA profits (the red line in Chart #7) as the E in a standard PE calculation. I’ve normalized the result so that the long term average of PE ratios for both series are the same. Yes, PE ratios are elevated today, but they are much lower than they were in the “bubble” that formed in the late 1990s. They are also elevated because the market is expecting trailing 12-month earnings to rise over the next year. Relative to forward expectations, today’s S&P 500 PE ratio is a relatively modest 21.
That’s all for now. My attention now turns to making some of the ingredients for our family Thanksgiving gathering tomorrow; my sister is hosting 36 of us! 









Economics

Economics in One Lesson

Connecticut State Representative Kimberly Fiorello released the 1-hour video of my discussion with her and her constituents about Henry Hazlitt’s 1946…

Connecticut State Representative Kimberly Fiorello released the 1-hour video of my discussion with her and her constituents about Henry Hazlitt’s 1946 book, Economics in One Lesson.

Some highlights follow.

0:00 to about 1:30: Intro from Kimberly.

From about 1:30 to about 12:00: My opening remarks. I cover labor unions, minimum wages, and tariffs.

14:00: How absence of the minimum wage helped Hazlitt early in his career.

16:00: Hazlitt’s answer on why it’s so hard for people to understand economics.

24:20: FEMA.

26:20: Answering Andy’s question about time horizons.

29:40: Andy’s suggestion for required courses in high school.

30:10: Wendy’s question.

32:40: One strategy for persuasion. Persuasion as therapy.

34:45: Taxes.

39:00: Inflation.

42:10: Interaction between inflation and marginal tax rates.

45:20: Scotty Post on trying to persuade on rent control and minimum wages.

48:55: Bracket creep in Connecticut.

49:50: Ramya on climate change.

52:30: Effect of cheap immigrant labor.

54:50: David Card and Nobel Prize.

57:50: Andy on handicapping Thomas Sowell for the Nobel Prize.

1:00:36: My ending comments on why Hazlitt’s book is still relevant: the issues don’t go away.

 

 

 

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Economics

China’s zero-Covid policy – Timing, benefits, costs and impact

As more countries opt for ‘living with Covid’, China is sticking with a ‘zero Covid’ policy (ZCP) that has brought significant benefits, although…

As more countries opt
for ‘living with Covid’, China is sticking with a ‘zero Covid’ policy (ZCP)
that has brought significant benefits, although not without costs. China may
soon be approaching a turning point where the costs outweigh the benefits. Why
is Beijing still pursuing this policy? Is it going to make any changes soon?
And what are the effects on China and the global economy?

Why ZCP?

The policy has brought significant human and economic
benefits. Despite their highly advanced medical technology, G7 countries have
registered many more Covid deaths than China [1]. Impressively, China only
recorded four Covid deaths between mid-April and October this year.

China’s robust export growth since mid-2020 (Exhibit 1) has
been a direct result of ZCP containing the spread of the virus. This has
allowed China’s production to normalise quickly and enabled it to cater for the
world’s demand, especially for personal protection equipment and work-from-home
products, at a time when the rest of the world’s production was hamstrung.
Those strong exports, in turn, have boosted China’s manufacturing and capital
expenditure.

Politically, ZCP has highlighted the institutional strength
of the Communist Party to rally resources to manage the unprecedented health
crisis. This has allowed the government to laud the success of the Chinese
model.

Abandoning the policy now could be seen as an admission that
it did not work. This could be extremely sensitive in the run-up to the 20th
Party Congress in late 2022 when plans for a reshuffling of top party officials
will be considered. As leaders compete for key posts during this once-in-a-decade
leadership overhaul, they will want to minimise any potential policy mistakes.
So the best option would now seem to be to keep the ZCP and minimise the risk
of another outbreak.

Rising costs, diminishing benefits

However, with almost 80% of the population now fully
vaccinated, the human benefit of ZCP – contributing to saving lives – is likely
declining. The economic benefit of robust export growth could also diminish as
and when production starts to normalise in the rest of the world, shifting foreign
consumption from goods to services and thus reducing demand for Chinese goods.

The ZCP has also cut China’s services trade deficit sharply,
boosting its current account balances, its balance of payments surplus and the
renminbi exchange rate. The strength of the renminbi will likely become a drag
on Chinese exports as global goods demand moderates.

Meanwhile, the costs of this approach are rising. As the
other countries choose to live with Covid and their economies re-open, ZCP
leaves China out of the global services trade such as tourism and business
travel. Chinese people are increasingly feeling the pinch as rounds of
lockdowns and travel bans across the country under the ZCP have hit the
services and consumption sectors, increasing unemployment and draining savings.

Significant fiscal spending on fighting Covid-19 will likely
reduce Beijing’s investment in other productive areas. The prolonged closure of
the international border will likely become an obstacle for foreign direct
investment and knowledge flows to China. This could affect its ambition to
climb the value-added ladder and develop its high-tech industry.

How long will China hold on to ZCP?

Theoretically, the answer depends mostly on medical factors
including the effectiveness of vaccines to control the virus, the mortality
risk of new variants and the development of effective anti-Covid drugs. In
practice, the timing of these factors is uncertain. Barring any swift
development of antidotes, political considerations may shape Beijing’s decision
on ZCP.

A few crucial events will take place between early 2022 and
early 2023. So, do not expect any ZCP changes before the National People’s
Congress (NPC) in March 2022, which comes right after the Winter Olympics (from
4 to 20 February). Leaders will want to avoid any Covid problems before these
important gatherings. They may even double down on the policy in the run-up to
the Winter Olympics.

In late 2022, most likely in November, the central
government will hold its 20th Community Party Congress when top
positions will be determined. Risk aversion will likely dominate during this
major leadership change. The practical option for senior leaders seems to be status quo. The leadership change will
be completed at the NPC in March 2023 when the president, premier and senior
ministers will be appointed.

All this suggests that Beijing would likely stick with ZCP
until early 2023. Depending on the development of anti-Covid drugs and
infections, Beijing may relax the policy somewhat between March 2022 and March
2023, for example, by allowing some business and personal travel and easing the
quarantine requirements.

What impact has the zero-Covid policy had?

ZCP mobility restrictions are clearly disrupting the
consumption and services sectors. They are the key reason why China’s
consumption recovery has significantly lagged that of the production side of
the economy since last year.

The policy has also contributed to supply-chain disruptions,
leading to longer delivery time and bottleneck conditions. The international
impact is, arguably, more serious: delivery delays have been much longer in the
West than in China (Exhibit 2). This underscores the continued importance of
China in global supply chains despite concerns about China decoupling from the
world system.

All this is affecting inflationary expectations, prompting
some investors to expect inflation to remain higher for longer and to worry
about the emergence of stagflation.

[1] https://edition.cnn.com/interactive/2020/health/coronavirus-maps-and-cases/ 


Any views expressed here
are those of the author as of the date of publication, are based on available
information, and are subject to change without notice. Individual portfolio
management teams may hold different views and may take different investment
decisions for different clients. The views expressed in this podcast do not in
any way constitute investment advice.

The value of
investments and the income they generate may go down as well as up and it is
possible that investors will not recover their initial outlay. Past performance
is no guarantee for future returns.

Investing in emerging
markets, or specialised or restricted sectors is likely to be subject to a
higher-than-average volatility due to a high degree of concentration, greater
uncertainty because less information is available, there is less liquidity or
due to greater sensitivity to changes in market conditions (social, political
and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.  

Writen by Chi Lo. The post China’s zero-Covid policy – Timing, benefits, costs and impact appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management, the sustainable investor for a changing world.





Author: Chi Lo

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Economics

Stocks, Bonds, & The Dollar Bid As Fed Admits Stagflation Fears

Stocks, Bonds, & The Dollar Bid As Fed Admits Stagflation Fears

The Fed came clean about its big fear today in the FOMC Minutes:

"The…

Stocks, Bonds, & The Dollar Bid As Fed Admits Stagflation Fears

The Fed came clean about its big fear today in the FOMC Minutes:

“The staff continued to judge that the risks to the baseline projection for economic activity were skewed to the downside and that the risks around the inflation projection were skewed to the upside.”

Weaker growth, stronger inflation – the definition of stagflation…

Source: Bloomberg

A 25bps rate-hike is now fully priced-in for June next year…

Source: Bloomberg

Stocks were mixed on the day. Nasdaq outperformed, The Dow lagged, scrambling to hold unch…

Growth stocks were hit at the open again today but found a bid for the rest of the day to close green (still notably underperforming Value on the week)…

Source: Bloomberg

Bonds were also mixed with the short-end underperforming (2Y +3bps, 30Y -6bps)

Source: Bloomberg

30Y Yields tumbled back below 2.00%…

Source: Bloomberg

As the yield curve (2s30s) flattened to new cycle lows (its flattest since Sept 2020)…

Source: Bloomberg

Real yields double-topped and slipped back lower…

Source: Bloomberg

The Dollar rose for the 4th straight day, with the same pattern playing out – bid during the European session only…

Source: Bloomberg

The dollar broke above the Sept 2020 high and is now at its highest since July 2020…

Source: Bloomberg

Bitcoin was choppy today, but ended back above $57,000…

Source: Bloomberg

Gold ended the day marginally higher, holding above the FOMC Statement level…

Oil prices held on to yesterday’s post-SPR-Release gains…

Was this how Biden felt as he announced the SPR release?

Finally, for a sense of the difference between the “real” and the “fake” economy, there’s this…

h/t @MichaelAArouet

Let’s all give thanks for The Fed’s matrix-creation.

Tyler Durden
Wed, 11/24/2021 – 16:00




Author: Tyler Durden

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