The Ghost of Rasputin, Inflation and a Bond Bear Market

Despite the global prevalence of electric cars and the green revolution, the reality of production has finally set in. The long-term bond bear market, now entering its sixth month, will likely persist for the foreseeable future.

Putin will follow Rasputin’s path. The Russians will turn against their despot because that is where history always leads them. The comparisons between Putin and Rasputin (both evil and dangerous characters) are obvious as Putin’s invasion of Ukraine, a madness of historic proportions, will bring chaos and ultimate revolt to a country that spans eleven time zones. .

Bold predictions? On the verge of surrealism? Perhaps. But mainstream thinking is rarely right. Leptokurtic distributions are statistical distributions resulting in a greater probability of extreme positive or negative events. Most of us know it as big cocks. We have already had more than one this century. So when we talk about a 4% cash flow over 10 years and a mortgage rate of 6% or even 8% (this year), it might be a good idea to add this possibility to your Monte Carlo simulations.

I started to think about what higher rates meant to me, other than going back to a more “normalized” yield curve (with positive real yields) and bringing back more of the American family savers who were excluded all these years. In 1978 my father, an immigrant, took out a $48,000 mortgage for his second home in Cleveland, Ohio. It sported an 8.5% coupon, and I remember him telling me he felt both proud and lucky to have had it. That, alongside his 5-year-old 12% CD a few years later, worked well for him. We didn’t have to pay for Wi-Fi, internet, cell phone bills, Netflix, Hulu, or the fancy $6 lattes. The only debt in our house was the mortgage, and it was manageable. Credit cards weren’t allowed, there was no third car, and we were cooking at home with occasional trips to McDonalds or At Mama Santa’s on Mayfield Road for special occasions.

Today we have some similarities to the late 1970s – when inflation hit double digit levels, followed by the deepest recession since World War II. Then there were disruptions in the world’s oil supply caused by the Iranian revolution. The Russian invasion of Ukraine is the world’s oil disruptor today. The downturn then ended 16 months later, and in November 1982, the longest bull market in history began its 40-year run. We are at the start of a long-term bear bond market precipitated by a once-in-a-lifetime pandemic entering its third year and creating immense pent-up demand, and a politicized Federal Reserve holding rates too low for too long, keeping Big, stupid, happy Wall Street.


Previous long-term bond bear markets were 1899 to 1920 and 1946 to 1981 – not a short period of time – and there isn’t an economic expert who even dreams of something like that now because most of their clients are “embedded” – defined as “the natural tendency of investors to attach their opinions to irrelevant, outdated or incomplete information in making investment decisions”. What does your wealth manager tell you? Buy the dip? Thinking long term? The Fed controls?

In his weekly Flow Show report, Michael Hartnett, chief investment strategist at Bank of America, astutely stated that the big picture was one of “deflation to inflation, globalization to isolationism, from monetary excess to budgetary excess, from capitalism to populism, from inequality to inclusion and from the United States. depreciation of the dollar. He said long-term returns would top 4% by 2024. An overly conservative prediction most likely tempered by not wanting C-Suite bosses.

We have warned of both the rapid acceleration in commodity prices and the extraordinary increase in workers’ bargaining power over the past six months. Labor has already begun the long-term struggle to keep up with inflation and make up for fifty years of lost wages that have mostly benefited investors.

Jason Furman and Wilson Powell, writing for the Peterson Institute of International Economics, noted “that inflation-adjusted wages fell 2.1% in 2021, compared to the previous year, and accelerated their decline in the last quarter. Looking only at the last three months of 2021 – when inflation was breaking records – inflation-adjusted wages fell at an annualized rate of 4.3%. No wonder Labor rose from the dead like a heavenly god. Look at the thousands of Southern California grocers who voted overwhelmingly to allow a strike if supermarkets don’t meet their wage demands. Equally important, a grassroots campaign to create the first-ever union in an Amazon factory (Staten Island) was successful.

Finally, the United Food and Commercial Workers announced that 95% of voters in seven local unions had approved a potential strike. This is the tip of the work iceberg.

Things are similar in the EU, where wages were expected to catch up with inflation. Yet the economic fallout from Russia’s invasion of Ukraine is leaving many EU workers facing even bigger pay cuts in real terms, according to union officials. Eurozone inflation rose to 7.5% in March, hitting a new record high. As mentioned in previous months, labor will continue to re-emerge as an important force in this country and in Europe.

Western companies have cut costs over the past 40 years by outsourcing much of their production using cheap labor (often children). This has helped keep price pressures low, allowed central banks to keep interest rates low, bizarrely compensated mediocre corporate CEOs with dodgy options, and created massive investment in risky assets. Those days are over.

U.S. jobless claims hit their lowest level in more than five decades a few weeks ago as the scorching labor market showed few signs of cooling in the near term. In addition, the number of unemployed workers for March was once again strong. On April 1, the Labor Department reported that US employers added 431,000 jobs in March (unemployment at 3.6%), beating expectations and keeping pace with the average gain in recent months. So why isn’t the Fed more aggressive? Surely they understand that we are a long way from a real recession, given the buoyant labor market and ever-increasing pent-up demand?

According to a study by the Federal Reserve Bank of San Francisco, we know that the inversion of the yield curve has preceded each recession since 1955. (Currently, the 2-year Treasury yield is higher than the 10-year rate). There’s no doubt that higher rates are sure to cause problems in the housing market, but the tax breaks available to investors for buying and renting single-family homes will keep the boom going, but not at breakneck speed. of the last two years. Investor purchases (hedge funds and private equity) of single-family homes accounted for 21% of sales in many regional markets. These regional markets also saw strong corporate buying.

Significantly higher rates encourage existing homeowners to hang on to their current, cheap mortgages. It could also further limit the supply of existing homes despite the massive cranes that litter the skyline of nearly every large and medium-sized city.

There can be no reliable progress against inflation without a substantial increase in real interest rates, which could temporarily increase unemployment. But going from an unemployment rate of 3.6% to 4.5% is not a killer for the economy. Real short-term interest rates are currently lower than they have been in decades. They will probably have to reach levels of at least 4 or 5% for inflation to be brought under control. With inflation above 8%, mortgage rates could also reach 8% again, which market “experts” currently consider almost unimaginable. True positive returns are where the demons of the Fed lurk. They know they cannot allow inflation to continue to erode the wealth of most Americans.

People notice when they pay more for groceries, rent, gas, pet food, and diapers. It is painful and destabilizing. Inflation affects a wider range of people than a change in the unemployment rate.

Finally, an unprecedented level of sanctions has been imposed on Russia, which will prove painful for it and for the rest of the world. Ukraine and Russia are massive suppliers of things the world needs. To name a few: nickel (more than 11% of global production) used in technology and batteries, fertilizers, energy, neon gas used in chip manufacturing and a large amount wheat.

The cost of food on the table is the highest in 40 years. The biggest increases in food prices are in meats, with pork and beef up 14% to 20% from a year ago. No wonder vegetarianism is on the rise!

For those old enough to remember the movie Wall Street and its most famous line, “Greed is good,” what Gordon Gecco said to end his speech to the Teldar board of directors is even more important. He noted that the “other faulty company” was called the United States. He also said, “The most valuable asset I know is information.” Well, you should have all the information you need to see the Fed panicking behind closed doors and smelling the ghost of Paul Volker in every dark hallway of this neoclassical Beaux-Arts building.

This has been established:

The Federal Reserve will fail to control inflation if it only raises rates by six-quarters of a point this year, as markets expect.

With Putin showing no signs that he is ready to withdraw his troops, and the United States and Europe promising to arm Ukrainian forces and wage unlimited economic warfare against Russia, there is no end in sight to the nascent duel between the West and Russia.

George Lucaci is Global Head of Distribution at FolioBeyond.

Garland K. Long