What is Inflation?

The market has become used to seeing higher inflation prints

Inflation is measured usually by comparing current prices of a basket of goods against the prices of the same goods some period of time ago (usually a year ago or a month ago).

The expected headline inflation as measured by the US Consumer Price Index (CPI) is that prices of this basket of goods as measured in December 2021 changed by 7% when compared to the prices of these same goods as measured in December 2020.

For inflation to continue even stay at the same level, prices will need to continue to rise at the same pace. Prices of goods collapsed in 2020 during the Covid lockdowns, and that’s why inflation over the course of 2021 rose as the economy recovered, leading to higher prices and also because these higher prices were compared to the collapsed prices of 2020.

The base effect will come into play soon as prices in 2021 were trending higher, and it will become increasingly difficult to have inflation print higher over the course of 2022.

The market has become used to seeing higher inflation prints and a lower-than-expected print will be a boost to market sentiment as that would mean that the Federal Reserve does not need to go into panic mode and start hiking interest rates aggressively.

The inflation data today will be closely watched, as the financial press are all poised to harp on 7% inflation and a disappointment for them on this front will be good for risk assets.

The Fed’s previously held argument of transitory inflation is largely based on this base effect and their expectations of recovery of supply chains as the economy reopens. They could finally be right, just when they’ve given up on talking about “transitory”.

TRADING TIP

Trade the Long term trends

Yes, we know trading the long term trend does not sound as cool as being able to trade every single move in general. After all, trading every single move of the market means that you must get most of your trades right and that itself is where the difficulty lies.

Most professional traders who are honest will tell you that they have a success rate that is around 50% and their profits usually come from the asymmetry of the payoff they get on their trades. Asymmetric payoffs are difficult to attain when you are attempting to trade every single move, essentially trying to trade the randomness and noise of the market.

On the other hand, a long term trend implies a bigger move over a longer period of time, and although there will still be randomness and noise in the shorter timeframes, you are trying to look past short term volatility to capture the move that is powered by “fundamentals”.

DAY AHEAD

US Inflation numbers (Consumer Price Index) will be released today and the market expects the headline number to show prices rising 7% on the year, an acceleration from the last month’s rise of 6.8%

TRADING PLAN

1. Currencies:
Keep short USD against CNH. Stay short.

2. Commodities: Uranium & Energy — Stay long.

3. Equities:

Equity Index: Long Nasdaq futures. Stay long.

Single Stocks: The tech stocks we have in our TrackRecord Model Portfolio remain on the defensive but the storm should be over soon. Stay invested but caution is warranted.

Key risks: US inflation data, and news of the Omicron strain remain a focus too.

WHAT HAPPENED YESTERDAY

Market Movement As of New York Close 11 Jan 2022

In his testimony before the Congress, Federal Reserve Chair Powell didn’t say anything particularly new, reaffirming that he thinks the Fed will end asset purchases in March, hike rates over the course of the year, and allow the balance sheet to run off this year. The reaction in the Treasury market was perhaps more consequential for risk-assets. The 2-yr yield quickly backed down from the intraday high of 0.94% and settled 2 basis points power at 0.90% while the 10-yr yield drifted lower by 3 basis points to 1.75%. The U.S. Dollar Index fell -0.38% to 95.62.
S&P 500 gained +0.92% on Tuesday in a continuation of dip-buying efforts. The Nasdaq (+1.47%) and Russell 2000 (+1.1%) outperformed with gains over 1.0% while the Dow Jones Industrial Average (+0.51%) rose more modestly.
From a technical perspective, the ability for the S&P 500 to reclaim its 50-day moving average (4678) was seen as another good development for dip-buying activity.
The crypto markets saw a recovery as well. Bitcoin rose 2.1% to 42,275 while Ether extended further by 4.9% to 3,237.

HEADLINES & MARKET IMPACT

Intel deletes reference to Xinjiang after backlash in China

Notable Snippet: U.S. chipmaker Intel has deleted references to Xinjiang from an annual letter to suppliers after the company faced a backlash in China for asking suppliers to avoid the sanctions-hit region.

Last month, Intel was slammed on Chinese social media for a letter to suppliers published on its website. The Dec. 23 letter said Intel had been “required to ensure that its supply chain does not use any labour or source goods or services from the Xinjiang region” following restrictions imposed by “multiple governments”.

Thematic Context: “The Chinese understand the use of “soft power” and as in Tai-Chi, use the opponent’s strength and weight against him (i.e. US hegemony). For the longest time, China has been using Dollars to buy up critical resources, finance mega infrastructure projects and build supply-chains; these real-assets ensure the Renminbi can eventually be a semi-hegemony. China did all these while running a record trade-surplus against the Americans, plunging America’s Net International Investment Position (NIIP) into deeply negative territory as the Chinese used USD profits to pillage the US’ domestic resources, effectively holding the American’s hostage to their own debt and hegemony .” — 25th May 2021

WHAT WE THINK: This realpolitik essentially boils down to the huge Negative Net International Investment Position (NIIP) of the US and one that Trump used to win the elections (i.e., Make America Great Again — as its manufacturing industry has been hollowed out). A large NIIP means that the US industry is being held hostage by foreign investors (ala China) and, in purely economic terms, may not be as “sovereign” as you think they are. This is why the NBA has to kowtow to China when players make snide remarks etc. We suspect that the US is cognizant of this fact and will do its best to regain and rebuild America’s industrial capacity, which is hugely dependent on accommodative fiscal policies (bullish for Energy & Industrials).

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Chinese cities tighten COVID-19 curbs as Tianjin battles Omicron outbreak

Notable Snippet: Cities across China are imposing tougher restrictions to try to control new outbreaks of COVID-19, with Tianjin battling the highly contagious Omicron variant which has been detected to have been transmitted locally in two other provinces.

A Tianjin official told a Tuesday press briefing that 49 domestically transmitted cases with confirmed symptoms have been detected during the latest outbreak. The city of 14 million people, around 100km (62 miles) from Beijing, is now implementing tough controls to stop the coronavirus from spreading, especially to neighbouring Beijing.

Thematic Context: “We suspect that we have seen “peak hawkishness” from the Fed and that the road from here should be easier to tread. China’s Covid zero policy will mean supply side destruction (we believe Omicron will also spread through parts of China if they fully reopen their borders) and the follow through effects cause more supply-chain problems for the US,, reminding them why “Build Back Better” is a good idea and that easier monetary policy is essential if the US want to keep its economy strong.” — 21st Dec 2021

WHAT WE THINK: China’s caution is an effective tightening on the West, as it will affect supply chains globally and increase prices for consumers everywhere. This will result in slower economic growth for the global economy.

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German trade body warns of huge supply chain disruption over Omicron

Notable Snippet: Germany’s BGA trade association warned on Wednesday of massive supply chain disruptions due to the rapid spread of the highly infectious Omicron variant of the coronarvirus, but said a long-term collapse of the supply chains was unlikely.

German industry has been hit by supply shortages of microchips and other components, while rising coronavirus cases are clouding the outlook for retailers at the start of 2022.

Thematic Context: “We are in an era of great power competition and no amount is too much as economic factions backed by sovereign printing presses are in it to win it. We haven’t even officially begun and commodity prices are already spiking on the back of supply chain issues. We believe that we will see much higher commodity prices in time to come and are invested accordingly.” — 14th June 2021

WHAT WE THINK: As Omicron dies down, we suspect that the West will embark on their own version of the “Marshall Plan,” where supply-chains will go from the current status of “adequacy” (as the Japanese put it, Just-In-Time manufacturing), as a result of globalization over the past decades, to a period of “excess capacity” due to splitting of economic factions, essentially de-globalization. In this outcome of a more fragmented world, massive amounts of material and energy will be needed to build excess capacities; as such, we remain invested and heavily positioned in Energy investments and commodities.

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