If it’s a bubble, unprecedented Fed flows have made it large, thick-walled, and able to shape shift at will….

In September of last year I wrote about inflation having jumped from consumer prices to secondary market assets, like equities and ‘protected’ bonds.

The reason was (and is) that the Fed has not throttled down its QE and Guarantee Infinity train to nowhere. That train’s probably headed in the direction of Japan, but the destination station (and timetable) is as yet unknown.

The effect has been a continuing increase in asset prices. No shock there.

This is what I proposed in September:

“………what if the QE/Guarantee pandemic bubble is no longer round? What if it is oblong instead and surrounds multiple asset classes all at once? In that case, it might just narrow and deflate in certain areas (like big tech at present) and change shape, but overall remain intact until the secondary markets catch up with the fundamentals of the real economy (i.e., the primary market).”

I’d like to suggest that (whatever it is) it’s still intact and tightening around some asset classes, while expanding and giving others breathing space.

But, the thickness of its walls (Guarantee Infinity), its size (QE Infinity) and its flexibility (rotation trading from instos, hedgies, Reddit army and mums and dads) might allow it to survive for a lot longer.

Today, I wanted to have a look to see how the bubble (if that’s what it is) has been expanding and contracting around certain assets.

I’ve looked at S&P500 findustrials and NASDAQ tech stocks, along with four ETFs for gold (as seen through miners), energy/oil (major oil/energy companies), materials (base metal miners) and emerging markets (predominantly China, Taiwan, India).

I don’t consider bonds here because we all know they have been on a 40 year rocket trajectory as yields have cratered. But more recently, mid-long end yields have started to rise and fall on competing inflation/reflation narratives with no clear direction just yet.

Recalibrate before vaccinate.

Around February 19, 2020 the technology focused NASDAQ index peaked (light blue line below).

The S&P 500 index (dark blue line) was trailing, but doing well.

Gold as seen through gold miners (purple line) was on the up, as a result of monetary debasement and very low real yields.

Flow was going into those sectors.

When the COVID lockdowns hit and the market tanked, oil/energy (gold line) hit its low. This was on 23 March 2020.

And then there was a reasonably quick 3 month melt up.

On June 10, NASDAQ reclaimed its peak and gold (purple) actually shot above its pre-lockdown peak, given the stimulus that was on its way (i.e., the effect of QE Infinity on fiat).

Equities continued to climb. NASDAQ and gold continued upwards, and between the beginning of the 2020 year (i.e., before COVID hit) and the announcement of the vaccines in November 2020, only these and emerging markets had recovered to pre-COVID levels.

At the same time as equities were recovering, bond yields had decreased further so there was still flow (or some hedging headway) in bonds.

Oil/energy was still sick - posting negative 50% returns as per the gold line above.

Take the shot kid!

And then on November 9, two efficacious vaccines were announced, and market behaviour started to change.

Investors started to rotate out of technology and into oil/energy and materials. As confidence started to return for a reopening, consumer price inflation caused by broken supply chains and additional demand from nascent activity pushed bond yields up, with real yields starting to materialise at the back end of the curve (i.e., that’s the part of the curve that the Fed has not yet interfered with).

The rise of real yields created a jet wash (real or not, we know perception is 99%) and that led to gold stalling mid-flight.

The chart below clearly shows the rotation trade into energy/oil stocks (gold line) and materials (yellow line) with gold (purple) tanking.

While tech stocks, industrials/financials and emerging markets (the blue lines) posted respectable 12% to 18% growth rates, they nonetheless paled in significance to energy’s 80% plus return in February, and the rise of materials (mineral commodities and mining stocks).

Conversely, you can see that gold printed a negative return as a result of growing real yields.

In fact, up until the beginning of March 2021, oil and materials had posted similar gains, so it’s only been over the last couple of weeks where oil has taken a breather as per the next chart.

This all comes at a time when investors are thinking about whether what they are seeing is really reflation (increasing real growth and increasing inflation) or just sporadic/pent-up supply constrained inflation.

I have felt for some time now that this has been sporadic (see my article “Hey Joe”) and curiously, I think the Fed agrees.

It sees a lot of labour slack still at work and a less than ideal vaccine runway. Employment prints are going to have to be compelling for successive months and quarters, before they move.

This could explain why the Fed has kept its QE Infinity train to nowhere going to nowhere (at a rate of $120 billion per month) even in the face of the recently passed $1.9 trillion support package.

Biden’s upcoming infrastructure stimulus deal (est. $2 trillion fiscal package) will also affect markets and there is a chance that Janet Yellen might start to usurp some of Jay Powell’s pump priming. We shall see.

That said, the Fed doesn’t have much of a choice of railway tracks to travel down given the debt servicing wobbles that would occur if middle and long rates were to get too high.

Also, the fall in energy and materials of late seems to be supporting the argument.

Other elements in support of the sporadic inflation argument is a rise in gold (as real yields have started to fall) and a recovery in technology stocks, with iron ore, some metals and emerging markets taking a breather.

Rotate to reflate, or inflate?

So, what we appear to be seeing is a rotation from pre-vaccine to post-vaccine stocks, with a big question mark over whether real yields will kick up again on confirmation of a reflation, or down if recent price moves are likely to be sporadic inflation that is not sustainable.

These are the two key schools of thought. The jury is still out.

But, back to gold for a moment.

Gold started to stall more recently as a result of increasing real yields, but this was not the only reason.

It also stalled because of the attention that Bitcoin (a store of value and substitute for gold in some quarters) has been receiving from corporate and institutional adoption since last year’s halving (i.e., the halving of block rewards to miners which occurs ~ each 4 years).

Not unsurprisingly, with calls for higher inflation and some variability in the ‘real yields ’ trade, gold staged a bit of a comeback as of last week but with the jury still out on whether real economic growth will accompany inflation (and turn into reflation) it’s too early to form a view.

If inflation is sporadic/pent-up demand from broken supply chains, China trade and materials posturing, then what we might find on the other side of the vaccines is still a net-disinflationary Amazonian world. We will have to wait and see.

For the moment, and for a bit of fun, here’s bitcoin compared to industrial/financial and tech stocks, gold miners, base metal miners, energy/oil companies and emerging market companies - I’m sure you can guess which line is bitcoin without looking at the legend…..

Since just before COVID, Bitcoin has outperformed the next highest performing class by 13x. It’s crushed bonds, all equities, and all currencies.

But I say for fun, because while those returns make my head snap off, Bitcoin is still a relatively small asset class of $1.4 trillion, compared to global shares and bonds where we are talking $200-$300 trillion.

Also, Bitcoin’s daily trading volume of ~$12 billion is less than 10% of the trading volumes for each of gold, bonds and shares.

Still, if adoption across the full bank, payment gatekeeper, institutional, hedgie and retail investor spectrum continues, its 14,285% 5 year return will continue to converge further away from Gold’s 36.26% return.

Here’s a final chart. There are two lines on it - can you see the second line? Clue - they diverged in July 2016.

Jay’s train to nowhere makes the bubble a lot more robust, until it doesn’t.

While Jerome Powell continues with his hand on the throttle of the QE Infinity train, money will remain invested in financial assets and secondary markets.

Flows in and out of each will ebb and flow but should remain contained within the bubble, which is large, thick-walled and subject to expansions and contractions depending on the changing narratives.

Taking investment funds out and going to cash on the sidelines seems to not be an option at present given interest rates and the massive debasement in the USD. Instead, it has for the most part remained invested, rolling around in and out of sectors, classes and niches as the bubble rotates, like a massive ball mill that continually turns.

It will also be stoked further in the next few weeks as the next round of US stimulus cheques are deployed into trading apps, so get ready for some eye popping vals, still to come, both ways.

And the answer to todays question? Yes. If what we are in is a bubble, bubbles do rotate.

Last week Jerome Powell said again that he’s not increasing interest rates. And that will remain 100% accurate, until it’s not. Sounds stupid right?

Unfortunately, we’ve seen him backflip before, and that’s why we will probably see more volatility occurring as investors buy insurance to retain the upside of lower rates for longer, but protect the downside of a Powell pirouette and backflip.

Indeed, if interest rates see some sustained growth and we get into a reflationary environment, the proverbial stake in the heart of equities and bonds may make an appearance.

In the meantime, the party goes on with investors and traders waiting for expansions and contractions of the bubble membrane, and always at the ready to arbitrage a dip, rotation or peak.

Eyes will be pealed for the next value creation story to step off the QE Infinity train as it makes its way to its destination, somewhere in the mist.

I’ll look for you in the fog!

Best, Mike.