Whitney Tilson
Wed, May 12, 2021|Whitney Tilson

Thoughts on inflation; The Fed Is Playing With Fire; Inflation Is Coming. Here's What To Do About It; A Shift in Market Leadership; Credit-Card Debt Keeps Falling

1) To achieve sustained investment success, I generally advise spending the great majority of your time on bottoms-up stock picking – focusing on developing in-depth (and ideally, differentiated) insights about a handful of companies and industries.

That said, it pays to at least keep an eye on big macro factors like economic growth, unemployment, inflation, interest rates, valuation levels across the entire market, fiscal and monetary stimulus, budget deficits, and so forth. If one or more of these things really gets out of whack, the effect on stocks can be substantial.

The macro factor I'm watching most closely these days is inflation. The sharp economic rebound (what I call "the mother of all economic booms"), unprecedented fiscal and monetary stimulus, and supply chain disruptions around the world are causing prices to soar in many sectors.

Here's a good overview from blogger Eric Rosen's recent missive:

Inflation Discussion

For the past couple months, I have been writing about my concerns about inflation and rising prices virtually everywhere. The markets have not seemed to mind too much and the all-knowing "experts," have not been concerned despite unprecedented stimulus and printing (1mm new $1,400 stimulus checks have been sent).

Well, Yellen came out Monday and suggested rates may have to rise to keep a lid on burgeoning economic growth brought on in part by trillions of stimulus spending. Markets sold off on the news. I would have thought they would have been harder hit. However, she is the Treasury Secretary, not the Fed Chair. Treasury Secretary Janet Yellen later said Tuesday afternoon she wasn't forecasting interest-rate increases to rein in any inflation spurred by President Joe Biden's proposed spending, clarifying comments that ruffled financial markets a few hours earlier.

Wow, that is not too confusing. Amateur hour. From my perspective, she 100% believes we need rate hikes.

I am a big fan of Sam Zell. The guy has the nickname the "Grave Dancer," as for decades he has been a buyer of distressed properties and made billions. According to this Bloomberg article, Sam Zell is seeing inflation everywhere, and has bought gold as a hedge – something he says he used to knock others for doing.

"Obviously one of the natural reactions is to buy gold," he said in a Bloomberg Television interview. "It feels very funny because I've spent my career talking about why would you want to own gold? It has no income, it costs to store. And yet, when you see the debasement of the currency, you say, what am I going to hold on to?"

Zell, 79, said he's concerned not only about the U.S. dollar but other countries printing money as well, and questioned whether inflation will be transitory, as Federal Reserve Chairman Jerome Powell indicated last week. "Oh boy, we're seeing it all over the place," Zell said of inflation. "You read about lumber prices, but we're seeing it in all of our businesses. The obvious bottlenecks in the supply chain arena are pushing up prices. It's very reminiscent of the '70s."

"We are seeing very substantial inflation," Warren Buffett said at the conglomerate's annual shareholder meeting Saturday. "We are raising prices. People are raising prices to us and it's being accepted."

I was wrong before on this topic. I, like many others, thought that the would lead to inflationary pressures with all the stimulus, but inflation never materialized. I wrongly believed the "Taper Tantrum" of the spring of 2013 was the move towards higher rates.

I struggle to agree with Jay Powell that inflation is transitory, but again, I am not a macro economist. I am just observing my surroundings and looking at the stimulus coming and it is hard for me to fathom more inflation is not on the way. You can't find a house or an employee (Montana ending extra unemployment pay due to worker shortage), you pay more for everything you use (food, consumer goods, oil, gas, plastic, logistics, services, education, healthcare, rental cars, fitness equipment, golf clubs, toys, cars, chips, lumber, services...).

The semiconductor shortage has now hit Ford Bronco, SUV, and pickup truck production. KFC is looking to fill 20,000 part and full time positions and are struggling to find workers.

What have I done? I have more assets in gold, crypto, r/e, art and hard assets as partial hedge. Truth be told, I am under hedged if we had any real inflation. We have Buffett, Zell and others seeing "substantial" inflation. This [Wall Street Journal] article is entitled, "Everything Screams Inflation: Investors are woefully unprepared for what me a once-in-a-generation shift in the market."

Remember, in May of 2007, the Fed Chairman at the time, Ben Bernanke, said, "Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited." Wait. He was the Chairman of the Fed, went to Harvard undergrad and has a PhD from MIT, had access to all fathomable data and was a complete idiot on this topic and could not have been more wrong. My point is, just because Powell is comfortable that inflation is transitory, does not make it true.

Here are various other articles about rising inflation:

And here's a chart from the Financial Times:

2) So what should be done? Legendary investor Stanley Druckenmiller and his colleague Christian Broda, in this op-ed in yesterday's WSJ, The Fed Is Playing With Fire, called on the Federal Reserve to tighten monetary policy and raise interest rates. Excerpt:

With Covid uncertainty receding fast, and several quarters deep into the strongest recovery from any postwar recession, the Federal Reserve's guidance continues to be the most accommodative on record, by a mile. Keeping emergency settings after the emergency has passed carries bigger risks for the Fed than missing its inflation target by a few decimal points. It's time for a change.

The American economy is back to prerecession levels of gross domestic product and the unemployment rate has recovered 70% of the initial pandemic hit in only six months, four times as fast as in a typical recession.

Normally at this stage of a recovery, the Fed would be planning its first rate hike. This time the Fed is telling markets that the first hike will happen in 32 months, two and a half years later than normal. In addition, the Fed continues to buy $40 billion a month in mortgages even as housing is clearly running out of supply. And the central bank still isn't even thinking about ending $120 billion a month of bond purchases.

Not only is the recovery happening at record speed, excesses of fiscal policy are already visible. Consumers are spending like never before, construction is booming, and labor shortages are ubiquitous, thanks to direct government transfers. Two-thirds of all relief checks were sent after the vaccines were proved effective and the recovery was accelerating. Opportunistic politicians didn't let the pandemic go to waste. Especially after the Trump years, Congress has decided to satisfy its long list of unmet desires.

Isn't the Fed's independence supposed to act as a counterbalance to these political whims?

The emergency conditions are behind us. Inflation is already at historical averages. Serious economists soundly rejected price controls 40 years ago. Yet the Fed regularly distorts the most important price of all – long-term interest rates. This behavior is risky, for both the economy at large and the Fed itself.

3) As for what you should do to protect your portfolio, this WSJ article outlines some options: Inflation Is Coming. Here's What To Do About It. Excerpt:

Here are five approaches, along with their biggest risks:

  • Gold
  • Commodities
  • Stocks With Low Pricing Power
  • Treasury Inflation Protected Securities
  • Assets With Short Duration

Frankly, I don't like any of these options... So I'm playing a bit of defense by sitting on 22% cash and taking some profits among my biggest winners.

4) Investors are also rotating from growth into value, as this WSJ article notes: A Shift in Market Leadership Is Reassuring When Stocks Get Frothy. Excerpt:

Value stocks globally have just recorded their strongest short-term performance against growth stocks in over a decade. In a market riddled with signs of froth and euphoria, that's a healthy development.

The MSCI All Country World Value Index – heavy on less-expensive financial, healthcare and industrial stocks – is beating its growth-stocks equivalent by 11.3 percentage points over the past 12 weeks. That's its biggest advantage since mid-2009, when the equity market was climbing off the floor following the global financial crisis.

Of course, that follows last year's even-larger outperformance by richly valued growth stocks, the greatest since the heat of the dot-com bubble. In general, growth stocks – led not just by the U.S. FAANG set but also the emerging Chinese tech sector – have trounced their more staid peers globally over the last decade.

5) Another smart thing to do, especially if you're worried about a market pullback, is pay off high-cost debt – so it's good to see Americans doing exactly this: Credit-Card Debt Keeps Falling. Excerpt:

Americans are paying down their credit-card debt at levels not seen in years. That is good news for everyone but credit-card issuers.

Large card issuers that cater to borrowers ranging from the affluent to the subprime say that overall card balances – and thus the firms' interest income – are falling. To make up for it, issuers are spending more on marketing and loosening their underwriting standards.

Best regards,

Whitney

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