By Now, Pay Later

Being negative on this market has been easy - and wrong. Just as inflation fears exploded higher, corporate earnings were expected to have supply chain-induced potholes. Fed tapering was supposed to threaten the bond market. Washington's perennial policy dysfunctions (debt ceiling, passing legislation) have been on full display. Add to that, the ESG-driven spending moratorium that has generated the current commodity surge and you can see how a 60/40 interest-sensitive tilted strategy, embraced by many conservative investors, is now under an existential threat.

Risk has a different meaning to the Boomer/Geezer crowd than it does to the alphabet generations that have succeeded them. Preservation of capital has been a one-way bet over the inexorable 40-year decline in interest rates since the last inflation peak in 1981. The wind was at your back if you were long coupons and short growth and hard assets. Now the worm has turned. The risk of higher rates to the value of income-producing assets is all too real. Time to get me some 'future'.

Tesla, the poster child for growth leadership, is a perfect example. Yesterday, Hertz announced a purchase of $4 Bn of cars from Elon Musk's company that generated a $118 Bn Pavlovian response in the stock - a 30X multiple of sales. The message is clear: investors want to look to the future as fast as they can. They are buying into a dream-like world of low-carbon gadgets designed to seamlessly solve the climate crisis. Don't bother me with worrisome details like valuation, competition, or execution. Buy now and pay later! Musk's net worth now surpasses the entire market cap of Exxon Mobile - but given the outlook for the climate, maybe it should.

It is little wonder that Fintech buy-now, pay-later start-ups like Affirm, Klarna, and Afterpay are catering to younger consumers. Gen X,Y, and Z consumers are income short but optimism long. They are not willing to use their recent paycheck bumps to pay off debt. More likely, we see them stretching for expensive gadgets or bigger houses. Low interests rates are embedded in their psyche. Debt aversion is not in their lexicon, unlike their parents. It makes sense given that the Central banks are in the business of social engineering. Their suppression of rates has hermetically sealed risk-takers from all perceived harm.

The secular rise in rates and inflation expectations that began in 2018, randomly hijacked by a pothole/speed-bump pandemic crisis, has recommenced. The 'temporary' inflation scare has now morphed into a more persistent feature of the financial narrative. Although the once-dominant secular deflation stemming from technology and demographics is still alive and well, it has been subsumed by the powerful cyclical forces of labour and raw material shortages only partly due to supply chain effects. The new hike in expected inflation is demonstrated in the chart below. It has emerged from the pandemic depths like a Kraken from the deep and is swallowing up bond investors with a vengeance.

Inflation Expectation ETF

Increasingly, the supply response that normally flows from rising price signals has now broken down. I got this spectacularly wrong when I opined earlier this year that 'there is plenty of $60 oil'. Geologically true, but operationally inaccurate. The surprisingly disciplined stewardship of the oil market from the Saudis, and the failure of the green power system to consistently supply European energy needs, meant that we were suddenly vulnerable to a 1974-style energy crisis. The climate crisis has generated a chronic under-investment in resources that will have lasting effects for much of this decade. For every barrel of oil, mcf of gas, or pound of copper produced, there is less than half as much being discovered and brought to market versus prior cycles.

Copper is both a beneficiary of supply curtailments and green investment demand increases. Unlike oil gas and coal, it is not a sunset industry, unless a credible alternative transmission mechanism for electricity is found. And forget aluminum as a threat. The white metal is pure electricity in solid form - hardly a green solution. The next few months in the copper market are likely to see some degree of volatility. China's current growth deceleration and a speculation-driven surge in the 'front month' of the curve are risks to the near-term price. The supply situation will actually improve next year as mines conceived in the last cycle come on stream. But ominously for copper consumers - (Tesla and EV players take note), the latter part of the decade portends an enormous shortfall. That's where it gets interesting for miners.

Copper Supply/Demand

Source: Freeport McMoran

We can also question the validity of this scenario when looking at the above chart. The shape of the demand curve looks suspiciously flat as compared to past history. Should the nascent backup of interest rates stemming from the current inflationary surge ultimately become disorderly, an economic recession would quickly ensue due to the highly indebted nature of the system. It only took a 3% two-year yield to crater the high yield market in 2018. China's clumsy policy shift towards 'common prosperity' that threatens to dampen housing investment demand is even a bigger threat. Watch copper/gold carefully over the next few weeks for clues.

Bull markets are never to be confused with brains and this one is no different. When too much money is chasing too few things, prices go up. The stock market was first to reflect this fact last year. Now it's the goods economy that is experiencing rapid price increases. Soon it will be the service economy's turn. That means one more surge in inflationary expectations as the cost of travel, entertainment and everything from haircuts to gym memberships will soar. At that point, inflation won't seem so transitory.

Should China right the Evergrande ship - however temporarily- we could see the potential for a monster seasonal move for commodities into the first half of next year. It looks increasingly likely that the Democrats in Washington will stop self-flagellating long enough to pass an infrastructure bill, further fanning the flames of the copper mania. Investors will gleefully pay higher prices for 'hard asset' stocks, in an attempt to hedge the fixed income bear market. Enjoy it while it lasts. Buy now, but remember, eventually the bond market will make investors pay later.

Risk Model: 3/5 - Risk On

As I expected, the AAII reading kicked in to 'buy' last week (chart below). It removes my nagging feeling that investors were on a buyers strike. Given the talking-head euphoria on CNBC and Bloomberg TV, that ship has sailed.

This doesn't mean that we can start chowing down on stocks willy-nilly though.

The RSI is well over 70 and the market stands fully 10% above the 200 dma.

3 Month Volatility and Copper/Gold are confirming the recent move. Looks like some 'sell on news' choppiness will develop this week as earnings come through better than expected. The Fed is on tap for next week so some caution will creep back in soon.