Will Stagflation Be The Price We Pay For A 'Soft Landing'? | Cem Karsan
Adam Taggart | Thoughtful Money
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45.2K views
4 months ago
Core Parts
00:00:00
Structural change and volatile markets
00:10:22
Federal Reserve and Wealth Inequality
00:17:15
Secular Inflation and Populist Movement
00:23:47
Social Crisis and Political Uprising
00:30:29
Forces of Change and the Power Structure
00:36:50
The Rise of Derivatives in the 1970s
00:43:29
Volatility Compression and Structured Products
00:46:50
Structural Forces and Market Volatility
00:50:14
Artificially Compressing Volatility and Asset Valuations
00:53:22
Secular Inflation and Market Outlook
00:56:34
Recession, Inflation, and Investment Strategies
01:00:21
Bond Market Steepening and Fed Control Loss
01:02:02
Investing in Community and the Greater Good
Summary
1. The Regime Change and Structural Shift in the Market
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The current market environment is undergoing a regime change and a big structural change.
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Populism has taken hold in the last decade, leading to a different structural environment.
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The cyclical reaction function is being used to manage the structural changes, but it may not be the right approach.
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There is a push and pull between structural inflationary pressures and cyclical measures to combat them.
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The market is currently in a volatile state, with sumo market forces creating pressure.
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Volatility is closely monitored by the firm, as macro pressures can cause dramatic shifts.
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The low volatility ratings seen recently may be deceiving, as there are underlying macro pressures.
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The global economy is experiencing a secular regime change, with a focus on equity and fairness.
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The current cycle is driven by populism and a desire for equality and justice.
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The response to this has been massive fiscal spending and protectionism.
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The younger generation is driving the populist movement, as they have underperformed compared to previous generations.
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The shift towards prioritizing median outcomes over mean outcomes is inflationary.
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The current regime change is a political decision and may result in less efficiency but more fairness.
2. The Impact of Economic Inequality and Limited Opportunities on Social Unrest
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The current economic situation is causing social unrest, particularly among younger generations who are facing economic inequality and limited opportunities.
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The concentration of wealth and opportunity at the top is creating a sense of despair and frustration among millennials.
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Corporations are incentivized to replace human capital with automation, which further limits job opportunities for younger generations.
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This economic inequality and lack of opportunities may lead to a social movement demanding a more equitable distribution of wealth and power.
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Government intervention is often seen as the only way to address these issues, as it has the power to make necessary changes and rebalance the system.
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Crisis and political uprising are often necessary to rejuvenate and rebalance the system, as they bring people together and lead to necessary changes.
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The current power structure is resistant to change and will do everything to maintain the status quo.
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The current period of stability may be prolonged, but eventually, a crisis will occur that will break the current power structure and lead to a new future.
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The market is influenced by positioning and supply and demand imbalances, which can lead to extreme outcomes.
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The market tends to go against conventional perception and surprise people when it shifts.
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Crisis brings people together and leads to necessary changes.
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The current system has delayed necessary changes, and crisis is needed to rebalance the system.
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The path to change is uncertain and can take 10 to 15 years.
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It is important to consider both the secular and cyclical realities when making investment decisions.
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The market tends to be early in reacting to crises, and reflexivity plays a role in prolonging the cycle.
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Policy makers also play a role in delaying necessary changes through their actions.
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Eventually, the weighing machine will catch up, and it is important to wait for opportunities when people are off sides of the thesis.
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The outlook for the market in the coming year is uncertain, but it is important to consider macro factors and unfolding developments.
3. The Compression of Volatility and its Risks
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Derivatives were developed in the 1970s as a way to provide exposure without the need for upfront capital, which was expensive at the time due to high inflation.
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Derivatives became more prominent in the 1980s and are now a significant part of the financial system, especially in a market environment with higher interest rates.
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Structured products, such as ETFs, have seen a massive growth in issuance, allowing investors to stack returns on top of risk-free assets like treasury bills.
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This has led to a compression of volatility, as banks and dealers are laden with structured products and are long on implied volatility, resulting in a supply of volatility being pushed onto the market.
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The compression of volatility has created a feedback loop where structural forces buy back the market on a daily basis, leading to a continuous climb in the stock market.
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One way to observe the compression of volatility is through the trade called dispersion, which measures the performance of individual stocks relative to the index.
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Dispersion has shown historic three standard deviation outcomes, indicating that while the index is pinned and volatility is compressed, individual stocks continue to move in line with their historical averages.
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While compressing volatility can extend market cycles and create short-term stability, it also builds up risk in the system, which can lead to a more violent and dangerous reaction when volatility eventually increases.
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Artificially compressing volatility allows speculators and entities to take on more risk, creating a buildup of risk in the system.
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The longer volatility is compressed, the greater the risk of a rupture in the financial market.
4. The Impact of Liquidity and Fiscal Policies on Asset Valuations
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The magnitude of corporate buybacks and passive flows into certain assets is much higher than in previous generations, leading to increased liquidity in the market.
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This liquidity, combined with fiscal monies still in the pipeline, is pushing asset valuations up.
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However, this trend of pulling tomorrow's prosperity into today's asset prices may lead to a period in the future where asset valuations need to be adjusted below their historic averages.
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Historical data from 1968 to 1982 shows that during a period of low interest rates and inflation, top markets went nowhere in nominal terms and lost 70% of their value in real terms.
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Valuations are ultimately a function of interest rates, which are influenced by inflation. If interest rates normalize, valuations will be brought back into line.
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Higher inflation will eventually lead to higher interest rates, as artificially suppressing interest rates can create inflationary hyperinflation and pull forward demand.
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The Fed cannot allow interest rates and inflation to go in opposite directions, as it would create bigger problems.
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Looking ahead to 2020-2024, the market is expected to continue its secular trend, with opportunities arising when people deviate from the secular view.
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Soft landing and Goldilocks scenarios indicate that stagflation may be on the horizon.
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Recessionary pressures from cyclical reactions to secular forces are already being seen.
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Inflation will come back worse if cyclically stimulated again, as seen in the 1970s.
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Opportunities arise during recessionary slowdown periods when people overlook the inflationary picture.
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Quality and broad value assets are expected to outperform growth assets.
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Commodities, gold, and volatility are also expected to perform well.
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Interest rates coming down may loosen structured product issuance.
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During an election year, the reaction function of the government and the Federal Reserve will be quicker, leading to potential volatility in the market.
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Favoring assets that align with government spending priorities, such as defense, healthcare, energy, and housing, is recommended.
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Bonds may do okay in the near term, but once stagflation kicks in, it may be time to shift towards a reflation trade.
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Duration is a dangerous game to play in this secular environment, and being on the right side of the boat is important.
5. Investing in the Community and Making a Positive Impact
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The speaker encourages people to invest in their community and the people around them.
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He believes that too often people focus on their own financial outcome and neglect the bigger picture.
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Investing in the community and doing things that help for the greater good is the most important thing.
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The speaker is a student of history and broad philosophy, and he believes in thinking beyond oneself.
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He emphasizes the importance of education and making a positive impact on society.
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The speaker concludes by thanking the audience and expressing his excitement to do this again in the future.
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