INTRO
This is a sequel to our recent missive called “Positioning for the Pivot”. We explore the possibility that we have entered “the suddenly part of the story”. Reminder – this is not a prediction, simply a thought experiment. Our favored lanes of risk and volatility require us to go down this dark and dirty road.
INFLATE OR DIE
We appear to be stuck in this “inflate or die” trap. Central banks inflated the supply of currency since the GFC (Great Financial Crisis) of 2008. Although the initial $700B TARP was an emergency response to the collapsing financial system, the central banks have maintained these operations since. In the fall of 2018, we received a glimpse of what the world would look like if/when the central banks do NOT inflate. At that time, The Federal Reserve had a documented plan to “normalize rates”. They decided to not only stop buying bonds, but they also became a net seller of bonds. This is called “quantitative tightening” (QT), where the Federal Reserve tried to reduce their balance sheet by selling bonds. It only took a couple of months and a 20% correction in the stock market for The Fed to tear-up this playbook. QT was the catalyst for the correction, and we cannot have that, since the markets are the hot-air balloon that lifts the economy basket.
THE POWELL PIVOT (#1)
This is referred to as the “Powell Pivot”: when James Powell, the head of the Federal Reserve, did a complete 180. Instead of selling bonds, they decided to keep buying. When the markets realized that The Fed was stuck in this inflate or die trap, they celebrated this Pivot. The year 2019 was a year of celebration and realization, as every asset class finished deep into the black with positive returns across the board.
ENTER COVID-19
As the Coronavirus shut down the planet, the central banks across the world engaged in the only thing they know – “moar”. The policy response was a predictable massive global-coordinated creation of currency units. Here in the states, our balance sheet doubled in a few short months from $3.7T to over $7T, sure to surpass $10T in short order, given all the new “ideas” being discussed in Washington. We intentionally put quotes around “ideas”, as most of their ideas and programs involve giveaways, bailouts, and moar printing. In addition, the projected annual deficit numbers continue to balloon. And keep in mind, all this inflation is taking place amongst a challenged and fragile economy.
HEREIN LIES THE RUB
Because we are ensnared in the inflate or die trap, we can now discuss two critical questions: when will we get the next reset, and what will it look like? Herbert Stein said it best, “If something cannot go on forever, it will stop.” Given the constant and massive injections of currency units globally, and then the awesomely fast reversal in rates, we have raised the bar to a foreseeable unsustainable path. We have also answered one of the two critical questions: we have entered the suddenly part of the story. We’ve solved the when, and now we have to try to figure out what it will look like.
SOLUTIONS
We took a swing at some solutions in our New Vol 4-part series, which redefined volatility from a market decline to a systemic failure (of sorts). We also advocated for an asset allocation strategy that can survive either extreme inflation or deflation (see multi-asset approach here). There is a lot of debate as to who wins this tug-o-war — inflation or deflation. Our new theory has us sleeping easier at night: we think we see both. Then the logical question becomes, “well, which one do we see first?”
We get our crayons back out to try to solve this new riddle. We again side with the detached solution of “it doesn’t matter”. The reason it does not matter is because the outcome of the two paths is the same. Stick around for the answer, and there is a good chance you can guess it, the way this table has been set.
