Can famed investors Paul Tudor Jones and Stan Druckenmiller, who recently proclaimed they are short bonds, thus betting on higher yields, be wrong? Instead of mindlessly assuming such legendary investors are correct, let’s do some homework.
First, though, let’s remind ourselves that Paul Tudor Jones and Stanley Druckenmiller are known for their aggressive trading styles. Therefore, we don’t know whether their bets are short term trades for a quick profit, or longer-term bets on significantly higher yields. Moreover, maybe their negative bond commentary is just “talking their books” to get traders and investors to follow them and boost their profits. Such a proven strategy by famous traders can be a recipe for losses by those who try to mimic their trades.
The recent 50-basis point increase in longer-term yields started the day after the Fed cut rates by 50 basis points. Some bond bears claim the Fed will rekindle inflation by cutting rates while the economy remains strong. Others fear that fiscal deficits are out of control, leading to inflation. An emerging group of bond bears, led by Paul Tudor Jones and Stanley Druckenmiller, worry that a Donald Trump Presidency and Republican control of Congress will ramp up deficits, resulting in high inflation.
Let’s address the market narratives and assess their credibility. Doing so will help us decide if following Paul Tudor Jones and Stanley Druckenmiller is a good idea.
Is Another Round Of Higher Inflation Likely?
Below is a review of some possible causes of inflation bandied about by the inflationist crowd.
Will High Inflation Reemerge
At its core, inflation is a function of supply and demand. The 2022-2023 bout of high inflation occurred because demand was grossly elevated by pandemic-related stimulus and unusual consumer behaviors. At the same time, the supply of many goods was significantly curtailed by global lockdowns and crippled supply lines.
Both demand and supply have since normalized. If inflation rises, it will not be for the same causes as the last round of inflation.
A Repeat Of the 1970s Is In the Cards
Some investors argue that consecutive rounds of the 1970s-like inflation are inevitable.
That era and this era are very different, as we recently wrote in a four-part series. Instead of requoting from those articles, we share the links (ONE, TWO, THREE, and FOUR).
“The 2020s aren’t the 1970s by any stretch of the imagination!” – Part Four
Government Spending Will Boost Inflation
Paul Tudor Jones and many others warn that uncontrollable federal deficits will boost inflation. We will also address this topic in the Debunking Deficits section, but before doing so, it’s worth a quick lesson on an economic term called the negative multiplier. To do so, we share a section from our article Stimulus Today Costs Dearly Tomorrow:
As we note, debt increasing faster than economic growth proves that borrowing and spending are unproductive. Unproductive government debt or private sector debt also results in a negative economic multiplier. Essentially, the ultimate expense of the debt outstrips its benefits over the long run.
Economists define the multiplier effect as the change in income divided by the change in spending. Over an extended period, if the change in spending is more significant than the change in income, the effect of said spending is negative. Replace GDP for income and government debt for spending to compute the government’s spending multiplier.
Multiplier = Change Income / Change Spending
Government Multiplier = Change GDP / Change Debt Outstanding
Bottom line: government debt stimulates the economy. However, the debt detracts from growth over time, more than offsetting the initial benefits. If you think the government is suddenly spending productively, then inflation may have an upward bias. However, assuming the government continues to spend unproductively, higher deficits are deflationary and weigh on economic growth.
The U.S. Will Import Inflation
Some say we will import inflation. The first graph below shows that inflation in the Eurozone, China, and the U.K., three of our largest trading partners, is falling alongside that of the United States. China’s inflation is near zero. Japan, not shown, has seen meager inflation with bouts of deflation for the last 25 years.
We also ran a multiple regression to forecast U.S. inflation based on the inflation of China, the U.K., and the Eurozone. The second graph shows a significant correlation, with an r-squared of .86. Moreover, the model states that U.S. CPI needs to fall by 0.3% to align with the historical relationship.
Both charts lead to the question of who we will import inflation from.
Debunking Deficits
Before we put context to the recent deficit spending, it’s important to caveat that we believe, and have written on many occasions, that the nation’s consistent deficit spending and accumulating debt are a considerable headwind to economic growth. We, in no way, condone the recent deficit spending or the excessive spending for most of the last forty years. We are also well aware that countries with debt-to-GDP ratios above 1.0 have not fared well.
That said, considering bond returns for the next year or two, we must assess the situation for what it is today and not let the narratives and hyperbole surrounding the market sway our decision-making.
We now review a few popular arguments claiming that the trajectory of deficits has changed considerably, and the change is inflationary.
Recent Spending Is Obscene
A common argument from the emerging bond bears is that recent deficits are obscene compared to past ones. Accordingly, bond bears think these increased deficits will be inflationary and require higher yields to satisfy Treasury investors.
While that may be true, the argument lacks context. They fail to mention that the economy has grown significantly over the last few years.
The economy is about $8 trillion, or 33%, larger than it was on the eve of the Pandemic. Therefore, it’s not surprising the amount of debt has grown commensurate with that amount.
The graph below shows the debt-to-GDP ratio and its trend line since 1980. After the ratio jumped higher on massive COVID-related spending, it settled down slightly above where it was before the Pandemic. Furthermore, it has been flat for the last two years.
Now, let’s take the analysis one step further and theoretically calculate what the current debt growth would look like had the Pandemic never occurred. We admit that this is not a traditional way to assess debt, but it does provide unique context on the debt outstanding compared to GDP.
To do this, we reduce the debt by the estimated $5.6 trillion spent on COVID relief. Furthermore, we assume the interest expense of the Treasury debt would have stayed on the pre-inflation trend. For perspective, this cuts approximately $500 billion of added interest expense in the past year.
The graph below shows the revised debt to GDP in orange. Might it be fair to say that without the Pandemic, current debt issuance would be on par with pre-pandemic debt to GDP levels given the economy’s size? Furthermore, despite the pandemic, spending, debt, and GDP growth have primarily been aligned for the last two years.
Deficit Spending Increases The Money Supply
Money is lent into existence. Such is a fact; therefore, larger deficits (borrowing) increase the money supply. However, as the graph below shows, the money supply (M2) is on the pre-COVID trend. More importantly, M2 as a ratio of GDP, a better measure of money supply, is decently below the pre-COVID trend.
Also, for consideration, the supply of money is only part of the inflation equation. The other significant half is the velocity of money, or how often it is spent. Currently, the velocity of M2 is at the same level as at the start of 2020.
The supply and velocity of money have erased the pandemic-related anomalies and are similar to where they stood in late 2019. At that time, inflation was consistently running at 2%. The current supply and velocity of money should not lead one to believe that inflation is set to increase. If anything, the figures argue that inflation will return to the Fed’s 2% target.
We Are Following Japan’s Path
Paul Tudor Jones mentions a similarity between our fiscal situation and Japan’s. He refers to Japan’s excessive government debt and its central bank, which keeps interest rates extraordinarily low to help service the debt.
Japan has a debt-to-GDP ratio of 263%, more than twice that of the U.S. Its central bank has set interest rates at or below zero and relied on massive amounts of Q.E. for the last 20 years. The result is longer-term bond yields, as shown below, of 2% or less and sub-1 % inflation with prolonged periods of deflation.
Following Japan’s path seems awfully bullish strictly from a bond holder’s perspective.
More From Jones
Paul Tudor Jones also believes that inflating away the debt is the only way to resolve the issue without taking strict fiscal steps. Maybe he knows something we don’t, but Japan proves that is not necessarily the case, at least not yet.
Jones also comments that we need to “get to the point where we stabilize debt to GDP to where it is right now.” As we showed earlier, the debt to GDP is stable and not rising.
Donald Trump and a Republican Sweep
Paul Tudor Jones and Stanley Druckenmiller voice concern over inflation and bond yields if Donald Trump becomes the President and the Republicans sweep Congress.
Let’s take their assumption a bold step further and assume Donald Trump immediately attempts to cut taxes, spend like crazy, and rack up massive deficits. Even so, he must contend with Democrats, who will still have nearly 50% of the votes in Congress, and the Republican Freedom Caucus, which wants to curtail government spending and balance budgets. The Caucus and Democrats could be strange bedfellows in that circumstance.
Summary
The bearish arguments we discuss in this article have merit. However, when taken in proper context, we believe some of them are not as worrying as the headlines may seem. Further, as we see in Japan, there is quite likely more monetary policy runway before problems escalate.
We believe the slowing economic growth and lower inflation trends that persisted before the Pandemic are reasserting themselves. It may sound ridiculous today, but we wouldn’t be shocked if investors and the Fed were again worried about deflation in the coming years.
The post Can Paul Tudor Jones and Stanley Druckenmiller Be Wrong? appeared first on RIA.
Full story here Are you the author?You Might Also Like
Election Outcome Presents Opportunity For Investors
2024-10-04
As the November 2024 election draws near, the election outcome will profoundly affect the financial markets. Whether Donald Trump or Kamala Harris wins the presidency, each administration will bring distinct policies creating investment opportunities and potential risks for investors.
Tax Cuts – An Examination Of The 2017 TCJA Impact
2024-09-27
An analysis of Presidential Candidate Trump’s policy proposals recently suggests that tax cuts will increase the deficit. While the raw analysis is correct, as it subtracts the potential for reduced tax collections from the tariff revenue, it ignores the impact on economic growth.
There is much rhetoric about the impact of tax cuts, mostly centering around “only benefitting the rich.” While it may seem that “the rich” are the ones who benefit, there are two important points to consider. First, “the rich” already pay most of the taxes. The Tax Foundation shows that the top 10% of income earners paid 59.1% of taxes. The top 25% of income earners comprised nearly 70% of all tax revenue, with the top 50% paying 97% of all taxes.
Of course, such begs the question of those
Trump Or Harris: Corporate Tax Winners And Losers
2024-09-18
Not surprisingly, Donald Trump and Kamala Harris are taking opposite approaches to modifying the corporate tax code. If enacted, both proposals would significantly impact corporate profits and, thus, share prices.
Cash Cow Clues: Can Dividend Yields Forecast Interest Rates?
2024-09-11
We have written many articles and commentaries forecasting interest rates. The analysis has used prior and current inflation and economic activity. Additionally, we have looked at market data on inflation expectations, Fed Funds futures, and other factors that influence interest rates. Today, we add an unorthodox factor to the list: cash cows.
This article introduces a unique way to imply where dividend investors think interest rates will be in the future. The impetus for this article came from a recent SimpleVisor Friday Favorites article in which we reviewed the Campbell Soup Company (CPB). Friday Favorites typically analyzes a company’s fundamental and technical conditions and valuations.
This time, however, because the company was a cash cow, we took it further and studied its
Yield Curve Shifts Offer Signals For Stockholders
2024-08-28
The level of U.S. Treasury yields and the changing shape of the Treasury yield curve provide investors with critical feedback regarding the market’s expectations for economic growth, inflation, and monetary policy. Short- and long-term yields have recently fallen, with short-term maturities leading the charge. The changes result in what bond traders call a bull steepening yield curve shift. The shift is due to weakening economic conditions, moderating inflation, and the increasing likelihood that the Fed will lower rates.
Yield curves are essential indicators that bond investors closely follow. However, many stock investors do not track yield curves despite the importance of bond yields on stock returns. Therefore, in this two-part series, we start with an introductory discussion of
Overbought Conditions Set Up Short-Term Correction
2024-08-27
As noted in this past weekend’s newsletter, following the “Yen Carry Trade” blowup just three weeks ago, the market has quickly reverted to more extreme short-term overbought conditions.
Note: We wrote this article on Saturday, so all data and analysis is as of Friday’s market close.
For example, three weeks ago, the growth sectors of the market were highly oversold, while the previous lagging defensive sectors were overbought. That was not surprising, as the growth sectors of the market were the most exposed to the “Yen Carry Trade. “
We saw much the same in the Risk Range Analysis (Note: both sets of analysis presented are published weekly in the Bull Bear Report).
As explained in the weekly report:
Two critical points. First, three weeks ago, many sectors and
UBI – Tried, Tested And Failed As Expected
2024-08-09
A Universal Basic Income (UBI) sounds great in theory. According to a previous study by the Roosevelt Institute, it could permanently increase the U.S. economy by trillions of dollars. While such socialistic policies sound great in theory, history, and data, they aren’t the economic saviors they are touted to be.
What Is A Universal Basic Income (UBI)
To understand why the theory of universal basic income (UBI) is heavily flawed, we need to understand what UBI is.
“Basic income, also called universal basic income (UBI), is a public governmental program for a periodic payment delivered to all citizens of a given population without a means test or work requirement. Basic income can be implemented nationally, regionally, or locally, and is an unconditional income sufficient to meet
Confidence Is The Underappreciated Economic Engine
2024-08-07
Ask economists how they forecast economic activity. It’s likely they will mention productivity, demographics, debt, the Fed, interest rates, and a litany of other elements. Economic confidence is probably not at the top of the list for most economists. It is tricky to gauge as it can be inconsistent. However, confidence can sometimes change quickly and often with significant economic impacts.
Look at the two pictures below. Can you spot a difference between them?
The difference is subtle. The restaurant on the left has 54 diners. While the one on the right is missing the three diners in the front.
What if the three missing diners decided to eat at home that day due to waning confidence in the economy and, ultimately, concerns about the safety of their jobs and investments?
Tags: Featured,Investing,newsletter
