Central Banks Are Between a Rock and a Hard Place

Inflation is plunging... Is deflation the bigger risk today?... Central banks are between a rock and a hard place... JPMorgan's Dimon warns the Fed... Have we reached 'peak retail bearishness'?...

Inflation is plunging...

For months, the Federal Reserve has been assuring us that consumer prices – how it officially measures "inflation" – are headed higher soon.

If you've been reading us for long, you know we're skeptical about that claim.

The big pickup in consumer prices that began last year now appears to be stalling. The latest data show inflation in both the U.S. and Europe continues to slow after hitting multiyear highs in February.

But new research from investment-advisory firm Kessler Investment Advisors suggests the slowdown could be even more severe than we originally believed.

The following charts show the two official measures of U.S. "core" inflation, which exclude more volatile food and energy prices.

First is core personal consumption expenditures ("PCE") inflation, which is the Fed's preferred measure...

And second is core consumer price index ("CPI") inflation...

The charts include the usual "year over year" inflation numbers you typically see. But they also include three- and six-month annualized rates. Comparing the three can show us not only the trend, but whether inflation is accelerating or decelerating in that trend.

These charts suggest two things...

First, inflation has decelerated dramatically in recent months. In both measures, three-month inflation is significantly below both the six- and 12-month rates.

Second (and more concerning), three-month inflation is getting dangerously close to 0% for the first time since the financial crisis. This suggests another bout of deflation – not inflation – could be the bigger risk today.

By definition, shorter-term measures have more "noise"... so this is no reason to panic. But if this trend continues, the Fed will have no choice but to give up its "tightening" cycle or risk triggering another crisis.

In short, we believe the Fed and other central banks are between a rock and a hard place...

If they don't try to tighten now, they'll have no room to "ease" when the next downturn comes. But simply unwinding their massive stimulus programs could hasten its arrival.

But apparently, we're not alone in that opinion. JPMorgan Chase CEO Jamie Dimon – one of the most-respected members of the banking "elite" – also thinks the Fed's tightening plans could have unexpected consequences. As Bloomberg reported earlier this week...

"We've never have had QE like this before, we've never had unwinding like this before," Dimon said at a conference in Paris Tuesday. "Obviously that should say something to you about the risk that might mean, because we've never lived with it before"...

"When that happens of size or substance, it could be a little more disruptive than people think," Dimon said. "We act like we know exactly how it's going to happen and we don't"...

"That is a very different world you have to operate in, that's a big change in the tide," Dimon said. All the main buyers of sovereign debt over the last 10 years – financial institutions, central banks, foreign exchange managers – will become net sellers now, he said. Central banks would like to provide certainty but "you cannot make things certain that are uncertain."

Now, you could argue Dimon is simply "talking his book." After all, he and his firm have undoubtedly benefited from the Fed's easy-money policies. But we wouldn't dismiss his comments entirely...

Dimon also stands to benefit as these policies are unwound and interest rates rise (assuming the economy is actually strengthening as the Fed implies). And there's a reason folks of Dimon's stature don't often criticize the "establishment." Surely, these comments do him no favors with his friends at the central banks.

Have we reached 'peak retail bearishness'?

Longtime readers know we're contrarians at heart...

We believe the best investment opportunities are often those that are hated, ignored, or ridiculed by the crowd. On the other hand, those that are popular or celebrated are often far riskier than most folks believe.

So we were intrigued to read that Wall Street is now launching a raft of new ways to short the retail sector. Soon it will be even easier for individual investors to bet on the "death" of traditional retailers. As Bloomberg reported on Monday (emphasis added)...

A trio of new [exchange-traded funds] proposed by ProShare Advisors take positions against retailers that are most likely to suffer from the dominance of internet shopping, "bricks and mortar" companies that rely on a physical store to sell their wares, regulatory filings show.

Two of the funds will use leverage to boost the returns on their bets against the industry, while the other will short traditional retailers and go long firms that stand to benefit most from the boom in electronic commerce, according to the documents.

Until now, equity investors looking to play the future of retailing could do so through single stocks, real estate investment trusts or a handful of existing ETFs that lump together physical and online retailers. Or they could plunge into the complex world of commercial mortgage-backed debt. But both routes have become well-trodden and expensive, leaving investors keen for a more focused alternative.

"Clearly people want to short it so they're giving them that, and then also mom and pop are talking about this – you read every week in the newspaper about Amazon and the death of the mall," said Eric Balchunas, an ETF analyst for Bloomberg Intelligence. "This is a story that's going to play out for the next decade at least, and everybody can understand it."

Said another way, Wall Street is now making it easy for even novice investors to bet against retailers – with leverage, no less. Meanwhile, a two-year bear market has already erased 60% or more off the share prices of many retail stocks.

What could possibly go wrong?

Now, to be clear, we aren't suddenly turning bullish on the broad 'brick and mortar' retail sector...

As we've discussed many times, we expect the shift to online shopping will continue. While there will be exceptions, we expect many companies – particularly those tied to shopping malls – will continue to struggle. Many will not survive.

But no trend moves in a straight line forever. And even the worst bear markets are broken up with vicious rallies when sentiment becomes too extreme. We suspect we could soon see one of these rallies in retail stocks.

Again, this isn't a recommendation to buy the broad retail sector. But it could be a great time to put select retail stocks on your watch list. And if you're shorting these stocks, be sure to keep an eye on your trailing stops.

New 52-week highs (as of 7/12/17): Allianz (AZSEY), Boeing (BA), Alibaba (BABA), Becton Dickinson (BDX), iShares MSCI BRIC Fund (BKF), Global X China Financials Fund (CHIX), WisdomTree Emerging Markets High Dividend Fund (DEM), Euronet Worldwide (EEFT), iShares MSCI Italy Capped Fund (EWI), iShares MSCI South Korea Capped Fund (EWY), Facebook (FB), First Trust Emerging Markets Small Cap AlphaDEX Fund (FEMS), National Beverage (FIZZ), iShares China Large-Cap Fund (FXI), Global X MSCI Greece Fund (GREK), PureFunds ISE Mobile Payments Fund (IPAY), iShares U.S. Aerospace and Defense Fund (ITA), KraneShares Bosera MSCI China A Share Fund (KBA), McDonald's (MCD), iShares MSCI China Index Fund (MCHI), Naspers (NPSNY), Nvidia (NVDA), Paysafe (PAYS.L), Stanley Black & Decker (SWK), U.S. Concrete (USCR), Verisign (VRSN), Weight Watchers (WTW), ProShares Ultra FTSE China 50 Fund (XPP), and Direxion Daily FTSE China Bull 3X Fund (YINN).

In today's mailbag, praise from a new Stansberry Alliance member, and two subscribers share their results with Steve Sjuggerud's China research. Send your notes to feedback@stansberryresearch.com. Good or bad, we read them all.

"Hi there Porter and gang, I am an Alliance member that has been with you for 18 months. I have special thanks to Porter, Steve, and Doc. You guys are spot on, I am very happy with your service. I wondered when I spent a lot of money to become a lifetime member, but I am so glad I did. I know you guys get complaints from others and I really don't know why. I have been in the markets for over 30 years and you guys are the best. Keep up the good work and I look forward to the future with you. Oh by the way, this past December I bought a two year subscription to TradeStops and I plan on being a lifetime member with them as well. The best to all." – Paid-up Alliance member Bill L.

"I have been slow to invest in the Chinese market... Never been there, don't have confidence understanding the market and driving culture. That's where you guys have really been awesome. The research, education and recommendations are well beyond what I have attained elsewhere. Two years ago, I purchased [my first China recommendation] and that position is up 43%. On May 26th, I purchased [my second] and it's up 5%. I want to stress that Stansberry did the research and made both recommendations before they became popular in the market. That's really important to me, because this is my future retirement!" – Paid-up subscriber Mark Hamby

"Just a note to let you know, on Sept 16 last year I invested in 13 of your [True Wealth China Opportunities] recommendations. As of today, they are up an average of 15.6%. The highest at 56.3% and only one in the red at -0.10%. I don't understand anyone complaining about results like that, especially as you said right up front, this was a 5 to 7-year play. Please keep up the good work and I'm looking forward to doing as well in the oil patch. Thanks!" – Paid-up subscriber Gail Clark

Regards,

Justin Brill
Baltimore, Maryland
July 13, 2017