Let's Talk About This 'Mysterious' Market Factor

Are you 'cool' or 'uncool'?... What more stimulus could mean... Let's talk about this 'mysterious' market factor... How to protect your portfolio from inflation... Video: Dominic Frisby on bitcoin and taxes...

Are you 'cool' or 'uncool' with another stimulus package?

We're not making the question up...

It's essentially what Louisiana Sen. John Kennedy, a Republican, asked Jerome Powell earlier today during the Federal Reserve chairman's semiannual testimony before the Senate Banking Committee.

Powell, not in the business of opining the fiscal policy that Congress devises (at least not directly), declined to answer... which is kind of an answer in itself.

As we see it, and as we'll detail in today's Digest, more fiscal stimulus (like more stimulus checks) might make Powell's job leading the U.S. central bank harder in the years ahead and ultimately threaten the economy and markets.

Let me (Corey McLaughlin) be clear...

We're not saying people on Main Street couldn't use some more money in their pockets today. That's especially true for folks who've lost their jobs because of the COVID-19 pandemic and ensuing shutdowns... and need help to pay their bills until things get better.

But we also must address the long-term consequences of continued, unprecedented stimulus... with likely more on the way by next month. The next round of stimulus will only increase the debt in our already overburdened financial system.

And as a result, we see a threat that impacts anyone with money in the markets today...

We're talking about inflation...

Indeed, although Powell said again today that the Fed's broad measures of inflation remain below their target (now 2% and above), we are seeing "real world" inflation...

In the most recent issue of Income Intelligence, our colleague Dr. David "Doc" Eifrig discussed this topic, which directly impacts income investors looking for safe yield in an already low-rate world. As Doc wrote...

We're on record as watching for higher inflation. Oil, silver, copper, and corn all shot up this month, pushing commodities up around 50% on the year.

We're also seeing upticks in our Real-World Inflation indicators – including bread, which is up 14.4% on the year.

Elsewhere, Doc notes that milk prices are up 6.6% over the past 12 months, ground beef is up 5.1%, and the price of a standard bicycle has gone up 39.3% since a year ago.

(You may have your own examples of "real world" inflation to share. If you do, we'd be happy to hear them at feedback@stansberryresearch.com.)

Inflation, as a word, has a negative connotation – similar to 'taxes'...

It sounds like one of those things that nobody likes. But the right amount of inflation is actually good...

No inflation at all means economic growth isn't happening.

In February and March 2020, for example, "deflationary" forces struck the world economy by way of a pandemic. Supply and demand in various sectors took massive hits... The rally back since then has been described as "reflationary."

But too much inflation, or "hyperinflation" – prices rising and people not having more money, or money that isn't as valuable, to keep up – can be an economy-killer...

Nobody wants that, we don't think...

After all, if you're putting your money to work and looking for decent returns, you want it to work better for you than the federal government is at debasing dollars at its leisure... And as we've seen, government officials are really good at that.

In the past 12 months alone, the U.S. government has created many trillions of dollars that simply didn't exist previously – 25% more, in fact, as measured by the "M2" money supply.

As you might remember... M2 includes cash, checking and savings deposits, and money-market accounts and mutual funds. It's money available to the economy.

And the Fed quietly – when it comes to the headlines at least – continues to add $120 billion to its balance sheet each month to help fund government spending that reached a stunning $32 trillion at the end of 2020.

We don't believe this approach to money strikes anyone as "sound." And on a practical level, the concern goes like this...

For every new dollar created, the value of each brand-new and existing dollar goes down...

You can buy less for the same amount... and even less when prices go up. But monetary policy – like bond-buying and record low interest rates that the Fed sets – doesn't create inflation on its own...

In January, Doc dedicated an entire issue of Income Intelligence to the topic of inflation. And he explained in part...

If you wanted to point to three sources of inflation, you'd look to accommodative monetary policy, expansionary fiscal policy, and a strong economy. There's no question that we have the first two ingredients – and we think the third is about to kick in as well.

In yesterday's Digest, we mentioned the potential for an economic rebound in the year ahead as folks get COVID-19 vaccines in their arms... though that assumes enough people actually get them.

That's good for people who want to leave their homes and go back to restaurants or their physical workplaces one day without needing to wear a mask. But it also means a recipe for inflation. As Doc wrote last month...

A set of measures known as "breakevens" evaluates how much inflation the market expects. In the depths of the crisis, markets saw five-year inflation at just 0.16%. But rather quickly, expectations have risen to crack 2%.

These breakevens tell us that right now, the market expects average inflation of 2.1% per year over the next 10 years and 2.09% over the next five.

As Doc has said many times over the years, his end conclusion is "inflation remains mysterious, poorly understood, and difficult to predict." But he also noted a few hallmarks...

We've covered in prior issues how an expanding money supply doesn't automatically mean inflation. Money growth in excess of money demand does. Yes, the money supply has grown dramatically... But since the financial crisis, banks have held extra reserves, and corporations have beefed up their balance sheets. The money hadn't made it out "into the system" so to speak.

So monetary policy alone didn't create inflation. But now the government has stepped in.

Now, based on his research, Doc says another stimulus package under President Joe Biden's administration "will push us past the sweet spot and over into the risk of inflation" that may run as high as 4%. More from the January issue of Income Intelligence...

Again, that's not to say it's right or wrong for a broader policy perspective. On the full spectrum of values, you may conclude that risking inflation to help those in need is the right thing to do.

But we do think that this stimulus will cause inflation to pick up in 2021 and beyond.

The point is...

When it comes to your portfolio, the inflation story matters maybe even more than you think...

As Doc explained in Income Intelligence...

The expectations for inflation will drive investment returns. When you expect inflation, you position yourself differently than you would if you expect deflation. And other investors doing the same thing will drive some investments to lead and others to lag.

Recently, Wall Street investors have been betting on higher inflation in the months ahead...

One way to gauge inflation expectations is to look at U.S. Treasury yields. We wrote in the January 12 Digest that the 10-year Treasury yield moved to more than 1% for the first time since March 2020. That got our attention...

For one, yields rise when bond prices fall. That means investors are selling bonds and moving into other assets, like stocks, to deliver a better return in the face of higher inflation expectations.

Said another way, investors on balance were starting to demand more yield for putting money to work in low-risk U.S. government bonds.

More narrowly, higher longer-term yields are also good for banks, which make money by borrowing at short-term rates – which have been largely dictated by Fed bond-buying practices (driving yields down) – and lending at long-term rates, which are more market-driven.

If things were going well for the hated, beaten-down banking sector, it told us the U.S. economy was improving. With this in mind, we wrote last month in the Digest...

We'll have to keep tracking this trend for longer than a week, but there's no doubt that the longer-term, market-controlled 10-year Treasury rate has been rising lately. Meanwhile, the two-year U.S. Treasury yield, which typically moves in sync with interest-rate expectations, is a miniscule 0.14% and has barely budged since May.

Since then, longer-term yields have kept rising... The 10-year Treasury yield closed yesterday at 1.4%, still relatively historically low but more than 25% higher than it was January 12 (up from 1.15%). Meanwhile, the two-year yield has actually decreased a little to 0.11%.

All in all, this means the "spread" – the difference between long- and short-term rates – has widened to its largest gap since January 2017.

Usually, higher inflation and longer-term yields lead the Fed to raise its benchmark interest rates to slow inflation. But that won't happen any time soon...

We saw a lot of nervous market observers ahead of Powell's testimony today, concerned that the central bank would allude to a rate hike sooner rather than later... or possibly tighten its "easy money" policies in other ways.

Instead, Powell said inflation was "soft" overall and the recovery has a long way to go. He said he thinks inflation will be volatile but doesn't expect pandemic-opening price hikes "will be large and persistent."

We'll see.

On Friday, we'll get a glimpse at the latest inflation numbers when the Fed's personal consumption expenditures ("PCE") rate comes out. This is the indicator that the central bank uses to gauge changes in prices.

So with that said, how do you protect your portfolio from higher levels of inflation?

In any case, it's wise to prepare for higher inflation this year and beyond...

We go back to Doc for some advice everyone can heed, especially those who are heavy into income investments. As Doc wrote in Income Intelligence last month...

For one, own stocks over bonds.

Fixed-income instruments pay just that: fixed incomes. And when inflation reduces the value of each dollar, those income streams are worth less.

Additionally, even with stocks at high valuations, they still look cheap relative to bonds. Yields are remarkably low – and with inflation coming, many bonds likely have negative real yields.

But don't just go buy any stocks...

It's amazing how "high-quality, capital-efficient businesses" – the kind we love here at Stansberry Research – are often the answers to so many investing dilemmas.

Inflation threats are another reason why investors should own good businesses. These companies can react to higher prices by charging more and still see consistent demand, and continue to grow... As always, though, you want to heed your stop losses, too.

Another piece of general advice under inflation, according to Doc, is to own "hard assets." These are things like real estate, gold, and inflation-protected securities.

To this list, we will add assets like art and collectibles, or even bitcoin... which several of our other editors have suggested in these pages lately.

In the end, we want to make sure inflation doesn't catch you off guard. It's a factor that savvy investors, like Doc, always take into consideration and are keeping a close eye on today.

Right now, the Fed says it will let inflation run higher until employment numbers rebound fully... and more stimulus from Congress and a reopening economy on the heels of a COVID-19 vaccine rollout may be on the way to fuel it.

So this is a long way of saying, we'll keep watch on this critical trend in the months ahead.

In the meantime, if you don't already, be sure to give Doc's Income Intelligence newsletter a try for his latest insights on the income markets. You'll get access to Doc's Inflation Monitor indicators every month and much, much more. Click here right now to get started.

Why Inflation Is Taxation

Dominic Frisby, author of the new book Daylight Robbery, joins our colleague Daniela Cambone to talk about bitcoin and why taxes are at the heart of every significant financial revolution...

Click here to watch this video right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

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In today's mailbag, feedback on yesterday's Digest about a COVID-19 vaccine's influence on the economy... including Stansberry Venture Technology editor Dave Lashmet's take on the topic. What's on your mind? Tell us at feedback@stansberryresearch.com.

"Hello, Great info as always. In projecting herd immunity/vaccination totals and timelines, we need to exclude the 20 million Americans aged 16 and younger who will not be getting vaccinated anytime soon as there's no shot for young kids. Hence, you [could] trim almost a month off the anticipated point of total coverage, yes?" – Paid-up subscriber Anthony K.

Corey McLaughlin comment: Good point, Anthony. And it's one that our colleague and Stansberry Venture Technology editor Dave Lashmet raised to us as well...

Readers who've been with us over the past year know we've shared Dave's take here in the Digest many times on the science of COVID-19 and the pandemic in general... And he has been spot-on along the way.

Venture Technology subscribers know Dave's research is among the best in the world in the science and technology space. And the results back it up... He has made a handful of eye-popping stock picks with triple-digit returns over the past year or so.

Today, Dave is not as bullish on the potential for "herd immunity" that we described via analysis from Stansberry NewsWire editor C. Scott Garliss... or at least, not in the same time frame.

In short, Dave notes the hesitancy among many folks to get the vaccine. He says that unless people are vaccinated themselves, they will be vulnerable to getting COVID-19. And as a result, "the end" – if there is one – might come later than the optimistic estimates.

Here's more info from Dave...

There isn't going to be herd immunity until we vaccinate children. Children are more than 20% of the U.S. population – so you can't hit 80% without them.

Rather, very high vaccine compliance rates in nursing homes, and then in the military, and then among medical staff by the end of 2021 will bring "hyperlocal" control, or limited herd immunity.

But in areas where there's high opt-out rates, there's no localized control.

Throughout 2021, we will see people still getting sick, still passing the infection around, still ending up in the hospital, and still dying entirely dependent on social distancing, good filtered mask wearing, and personal vaccinations.

Maybe by 2022 we will have so many people vaccinated – 85% of seniors, 65% of adults, and 45% of children – that we will see 1% rates of infections, from peak. That might reflect herd immunity. But that's a good nine months out.

For fall of 2021, we will see an upsurge. Folks won't wear masks, they will crowd into indoor venues – especially bars and restaurants. And they will get infected, vector the infection to other people, and thousands more will die per week.

It's ironic, since this fatal infectious respiratory virus is entirely preventable by good masks and 95% effective (and 97.5% protective) vaccines. But if your buddy wears a bulletproof vest and you don't, guess who gets hit in the chest?

That's how vaccines work, too.

For more analysis from Dave on the COVID-19 pandemic, be sure to check out his Venture Technology newsletter. And here in the Digest, we'll continue to track the vaccine rollout and "re-opening" trends in the weeks and months ahead.

All the best,

Corey McLaughlin
Naples, Florida
February 23, 2021