The best defense is a good offense

The local market fell from the open and then mainly traded aimlessly near the lows of the day. Investors are worried about inflation in the US - and the latest China inflation data only made it worse.

The inflation and producer price index data out of China clearly shows that China has started to export inflation out to the world in the last six to nine months. We are into the eighth consecutive week of trading without a single double-digit (i.e. over $10 billion) turnover day. 

Consumer staples was the only positive sector, while technology and energy were the most beaten up on a day that was mostly red. 

Locally, it's the Budget update tonight, where the Federal Government will be on "pork-barrel overload" into all the major voting bases, problem areas and big donor sectors. The government needs an election around September/October on rebound data. This is because structural problems in the economy will start to deteriorate and data will start to show that from Q4 onwards. 

All the handout plans into childcare, property and aged care will be a simple transfer to service provider profits as prices will move higher. It has all the hallmarks for government to claim that they are doing something, but in reality doing nothing much at all.

It is not the first time we had handouts in these sectors and each time it drove prices. Reform is too hard and hurts political donations. Industry bailouts with no limit to hide structural problems have been the failed strategy used by the Federal Government at every turn. From banks to casinos and aged care, even Royal Commissions are not delivering reform. Tax cuts for the top end will have no limits, but hand outs to those in middle to low income brackets will fade away faster than three word slogans like “Debt and Deficit”.

Like it or not, inflation is everywhere except in the price of asset bubbles. We have had a one-way trade for global markets that assumes the cost of borrowing will keep falling forever and that central banks will bail out asset bubbles with more stimulus forever. It is the assumption of the classic “Stimulus Super Cycle” with no end in sight. 

Sadly, everything has limits. The problem was always going to be with rising inflation and when the bond markets lose faith in central banks. Over the last three to six months, inflation has started to go wild and bond markets have lost faith. China is pouring petrol on the US inflation fire by exporting higher inflation, while protecting its own economy by strengthening the Yuan. 

The vaccine protectionism policies are further exacerbating the supply-side shocks and have driven commodity prices higher. The globalisation of labour forces means that cheap supply-side chains in Emerging Markets are going to continue to struggle in the pandemic waves. China remains the main post-pandemic stable economy, and it is seeing rising inflation. 

The US producer price index is at all-time highs and going higher. The inability of the US corporates to move away from China means that US input costs are going to keep seeing higher prices.

The latest US inflation data update will be out on Wednesday night and markets are worried. We are looking at the annual rate moving from high 2% to mid 3%. The next month is likely to see it move to a low 4% as the upward trend continues. The US Fed will be forced to expand its balance sheet to yield control like the last inflation data release. Its balance sheet expansion will inevitably drive further US-dollar debasement, which will in turn drive even higher inflation ahead.

Despite the obvious failure of the strategy, the Fed will be forced to curb the yield rise. How will the bond market react to this mess? Will it see through the problem and push up bond yields anyway? Or will it expand the balance sheet far enough to control yield rise and hence drive real yield even further into negative territory? Time will tell.

The inflation cycle is hitting growth stocks and asset prices in general. The sentiment has definitely turned, as it is very rare to see the NASDAQ and RUSSELL fall more than 2.5% overnight without any specific macro catalyst. 

If the US Fed burns more balance sheet for yield control and buys short term support, then Gold will run on the blow out in negative real yielding debt. Treasury inflation-protected securities are falling to bigger negative yields and are expected to drop further with the inflation update ahead. Do you have enough gold exposure as an inflation hedge? Given the relative value territory of most gold equities, I am guessing the answer is no.

China's annual inflation rate jumped to 0.9% in April 2021 from 0.4% a month earlier and compared with the market consensus of 1%. This was the highest reading since September 2020. amid a faster increase in cost of non-food goods (1.3% vs 0.7% in March), mainly driven by transportation and communication (4.9% versus 2.7%); clothing (0.2% versus 0.1%); rent, fuel and utilities (0.4% versus 0.2%);and household goods and services (0.4% versus flat reading). Meanwhile, food prices dropped 0.7%, the third straight fall, with pork prices declining faster (-21.4% versus -18.4%). On a monthly basis, consumer prices fell 0.3% in April, compared with forecasts of a 0.2% decline and after a 0.5% drop in March.

China's producer prices rose by 6.8% year-on-year in April 2021, accelerating from a 4.4% gain in the prior month and above market expectations of 6.5%. This was the fourth straight month of increase in factory gate prices and the steepest pace since October 2017, as growth in the economy continued to gather momentum. Prices of means of production rose much faster (9.1% vs 5.8% in March), boosted by extraction (24.9 vs 12.3%), processing (5.4% vs 3.4%), and raw materials (15.2 vs 10.1%). At the same time, prices of consumer goods went up faster (0.3% vs 0.1%), led by food productions (1.8% vs 2%), while prices of daily use goods picked up (0.3% vs flat reading), and both clothing (-0.6% vs -0.8%) and consumer durables (-0.9% vs -1.4%) fell less. On a monthly basis, producer prices went up 0.9%.

Comments on US market last close

The US market started positively on reopening and negative on reflation, before rolling over into solidly negative territory at the close. DOW -0.10%, S&P -1.04%, NASDAQ -2.55% and RUSSELL -2.59%. The market can't ignore inflation signals from economic data and corporate updates. We have US inflation data out tomorrow and expect 3-4% for April and that's heading to 4.5-5.5% in May. Bond yields and the US dollar were higher and that hit all commodities, while gold keeps climbing as the inflation hedge. Tech and retail lead the red sectors, while utilities and consumer staples were the best green sectors. 

The NASDAQ has broken 50- and 100-day moving averages for the second time post-pandemic, and it may be setting up for more pain with an inflation update due in a few days. 

The WHO has confirmed that India has a triple variant that spreads faster and evades some of the vaccine protections. The Indian variants have already spread to neighbouring Asian countries. It is time to get off the fence and protect against downside risk. Get some gold or Bear ETF protection against both market and inflation risk.

The full SUNSET STRIP report with the end of day market stats are available at the following link.

(VIEW LINK)

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