By Graham Summers, MBA
Yesterday, I outlined how the markets are likely at a very critical point regarding inflation.
By quick way of review:
1) Stocks initially love inflation because it boosts results (companies don’t report inflation-adjusted returns, so any increase in product pricing due to inflation is instead reflected as “growth”).
2) This love relationship eventually turns to hatred as inflation leads to higher operating costs, which squeeze profit margins.
In yesterday’s article, I illustrated how this played out during the last major bout of inflation in the 1970s.
At that time, stocks initially roared higher as inflation initially boosted corporate results. However, by the time 1974 rolled around and inflation (as measured by the consumer price index or CPI) hit 11%, stocks began to crash, eventually losing ~50%.
I mention all of this because it is highly likely that something similar is about to manifest in the markets today.
Stocks have erupted higher on the back of inflation, courtesy of $11 trillion in Fed QE/ fiscal stimulus from the Federal Government between March 2020 and today.
However, inflation is now taking a turn for the worse. And, as usual, the signs are showing up in the currency markets first.
The Fed is in the process of ending its QE program. Fed officials have also signaled that they intend to raise rates three or four times this year. All of this should be highly U.S. dollar positive.
And yet… the $USD is breaking down.
The greenback has taken out key support (green line in the chart below). Even worse, it’s also broken its bull market trendline (blue line in the chart below).
This is a MAJOR signal that the Fed’s actions are not enough. Put another way, the Fed is behind the curve on inflation! This is extremely negative for stocks as it means inflation is getting out of control (just like in 1974).
So, what would a similar, 1970s-style crisis look like today? The market is warning us, though few have noticed.
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