Inflation: More Transitory than Expected

By John Mauldin 


If the inflation numbers leave you scratching your head, join the club. 

The August data was especially perplexing. 

The Producer Price Index came in hot, up 8.3% in the last year, inviting 1970s comparisons. 

Obviously, our current situation is different in many ways. 

But so were the 1970s, at first.

That was last Friday. 

On Tuesday the August Consumer Price Index data surprised in the opposite way, coming in lower than expected—but by no means “low.” 

Headline inflation rose 5.3% in the last 12 months.


Source: BLS


The pace may be slowing, though. 

The monthly CPI changes show an uptrend from January-June of this year, followed by two successively weaker months. 

But even 0.3% is higher than pre-COVID monthly inflation. 

If that pace continues, a year from now we will have experienced about 3.7% annual CPI growth.

That should be enough to meet the Fed’s inflation target and let it normalize policy. 

Whether it will do so or not, no one knows—not even the FOMC members. 

Today we’ll take another walk through the inflation debate. 

Is it still transitory or should we expect a light-1970s inflation going forward? 

The answer is critically important.

Measurement Problems

First a little history. 

Last May, Stephen Roach wrote a very important essay on inflation in the 1970s. 

He noted that Federal Reserve Chairman Arthur Burns (Roach had just started his career at the Fed during that time) would claim that every inflationary impulse was simply transitory. 

By the mid-70s Burns was calling 65% of the CPI “transitory.” 

Then he gave us this paragraph:

But the biggest parallel may be another policy blunder. 

The Fed poured fuel on the Great Inflation by allowing real interest rates to plunge into negative territory in the 1970s. 

Today, the federal funds rate is currently more than 2.5 percentage points below the inflation rate. 

Now, add open-ended quantitative easing—some $120 billion per month injected into frothy financial markets—and the largest fiscal stimulus in post-World War II history. 

All of this is occurring precisely when a post-pandemic boom is absorbing slack.

When he wrote this, real interest rates were -2.5%. 

Today they are below -5%. 

The parallels are becoming even more eerie, as the Federal Reserve appears to be claiming all the inflation they see is transitory.

Thus for good reason, inflation has been the topic du jour this year for everyone who follows economics. 

Jerome Powell has maintained the pressure we see isn’t because Fed policy is too loose. 

But that’s kind of what you would expect him to say.

Here in the real world, “transitory” doesn’t mean “inconsequential.” 

The Fed’s 2% inflation target, if actually achieved over time, would compound into 22% higher prices over 10 years, with no guarantee wages would rise to match it. 

Not to mention the loss of purchasing power for those on fixed incomes.

This is why measurement problems are so consequential. 

Policymakers flying blind is a recipe for disaster. 

They may think inflation is a problem when it’s not. 

Or, more likely, they may think it’s not a problem when it really is.

It’s not just policymakers, though. 

We all feel inflation differently based on our spending patterns, lifestyle, location, and more. 

The benchmarks like CPI and PCE are generalizations. 

Your mileage may vary. 

In fact, your mileage will vary.

Six months ago, I described (see Inflation Is Broken) how the inflation benchmarks don’t properly reflect housing costs. 

They rely heavily on a concept called “Owner’s Equivalent Rent.”

Homeowners are asked to estimate how much they would demand to rent their home to someone else, whether they intend to do so or not. 

Of course, the answers are all over the board, and bear little resemblance to what people actually pay.

In that March letter, I showed how OER disconnected from home prices around the year 2000, helping distort inflation since then. 

This new chart from Real Investment Advice demonstrates clearly that OER has no connection to home prices:


Source: RealInvestmentAdvice


Now we have a shorter-term distortion. 

Consider just the last two years. 

If you live in a home you purchased in 2019 or before, your monthly housing inflation has probably been running close to zero. 

Your payments may even have dropped if you refinanced at a lower rate.

Not so for many renters. 

Apartment rents have been surging. 

Here’s a map from Apartment List showing 12-month changes as of August.  


Source: Apartment List


All those reddish areas are places where average apartment rent is up 20% or more in the last year. 

The same is true for rental houses and condos. 

People who, for whatever reason, can’t buy a home are paying far more for housing in most areas. 

Yet the “Rent of Primary Residence” CPI component was up only 2.1% in this same period. 

Owner’s Equivalent Rent went up only 2.6%.

(There’s another element to this. 

In the pandemic, eviction bans and court slowdowns taught landlords they might be stuck with non-paying tenants for extended periods. 

Many responded, understandably, by raising rents to cover that risk. 

But the higher rents hit everyone, not just those who might have to be evicted.)

Another index from Zillow shows how completely disconnected actual rent is from CPI.


Source: RealInvestmentAdvice


On Friday Zillow released data showing that rents went up 1.7% just in August. 

My good friend David Bahnsen wrote last night:

Today Bloomberg ran a piece about rents in NYC going up as much as 70% from pandemic lows. 

It was not even a year ago that the predominant story was whether or not NYC real estate would ever recover. 

Now, there are almost complaints circulating over how much it has recovered.

This matters to inflation because OER, which in no way reflects reality, has a huge CPI weighting. 

It’s a far outlier in this plot of August CPI change by weight.


Source: RSM


In most areas, both actual rents and an accurately measured OER would be much higher than CPI shows. 

Together, those are almost 30% of the index. 

CPI would be running much, much higher if it reflected true housing costs. 

A quick estimate says inflation would be at least 3% higher under the real-world measurements mentioned above. 

An 8% inflation number—which is entirely realistic—would certainly grab more attention. 

The Fed would have to deal with it sooner rather than later.

Stranded Ships

The generally rising prices that add up to broad inflation don’t come out of nowhere. 

Supply and demand factors cause them. 

As the COVID era drags on, adapting to the various changes it generated is increasingly difficult, and therefore increasingly expensive.

These changes aren’t crazy or complicated. 

Compared to 2019, Americans are eating more at home, buying more goods via e-commerce instead of in stores, fixing up their backyards instead of going on vacations, etc. 

Yet they add up to giant changes in the industrial supply chains in a relatively short time. 

This is causing problems.

For instance, the Financial Times reports shippers can’t find enough metal shipping containers to transport all the stuff we want to buy.

Chinese manufacturers are pumping out record volumes of freight containers after shippers ordered vast stacks of the steel boxes in an attempt to smooth out disruptions in the global supply chain…

The world’s biggest box manufacturers, China International Marine Containers (CIMC), Dongfang International Container and CXIC Group, are struggling to meet demand, even though production has been increased with workers’ hours extended.

“The factories are running pretty hard out,” said Brian Sondey, chief executive of Triton International, the world’s largest container leasing company, which rents boxes to shipping groups.

Even if the boxes can be found, they often arrive at US ports only to spend a week or more waiting for dock space to unload. 

Here’s a look at the Long Beach port last week. 

The green dots offshore are anchored container ships, each holding thousands of containers packed with stuff we need.


Source: Marine Traffic


As every investor knows, time has value. 

Extending the time it takes for goods to reach the buyer has a cost. 

Prices can rise while the new supply that might bring prices back down sits a few miles offshore. 

Multiply this millions of times over for many different products, and inflation is the result.

Nor is it just finished goods. 

Some of those ships have components US factories need to build other products. 

Lack of one key part can shut down an entire assembly line, idling its machinery and workers. 

That has costs, too.

The economy can adapt to all this, but not instantly. 

And it’s starting to look like the process will take longer than we thought a few months ago. 

That means inflation may be less “transitory” than we thought, too.

Walking the Tightrope

I’ve been on the “transitory” side of this year’s inflation debate. 

I still think we will avoid long-term sustained severe inflation, but I must admit it’s looking less transitory than expected, with inflation possibly running well above 2% for several years unless the Fed acts. 

The factors that are pushing home and other prices higher aren’t changing. 

Maybe they will, but they haven’t.

The other side of the argument, best articulated by Lacy Hunt, is that rising debt will cap inflation by holding back the velocity of money, thereby reducing GDP growth. 

This will reduce demand for housing and consumer goods, bringing prices back down. 

No more inflation.

Debt was already at crazy, unsustainable levels before the pandemic. 

I lack the words to describe what’s happened since then. 

Federal Reserve policy is both supporting government debt expansion and encouraging businesses and consumers to add leverage. 

Nor is it over. 

Congress is considering a pair of infrastructure bills that will add trillions more. 

Some of it will be productive debt, spent on public works projects we really do need (like better port facilities). 

But most will go to other, less productive programs. 

The part that isn’t debt-financed will be paid for with tax increases which, depending on exactly who and what is taxed, may also depress growth.

All this goes into the mix as the Federal Open Market Committee decides if and when to start tapering its asset purchases. 

The bond purchases and low rates are effectively subsidizing government debt. 

Servicing government debt is actually costing the economy much less than it used to as old higher-rate bonds roll off and are replaced with lower-rate ones.


Source: Bloomberg


Note the blue projection bars assume current law, and don’t yet account for what may soon be added. 

If inflation takes hold, the new debt will be issued at higher rates than CBO presently projects, driving interest costs higher.

On the other hand, inflation is historically the debtor’s friend. 

Borrowers can repay their debts in currency whose purchasing power is lower than it was when they received the loan. 

Is that thought somewhere in Jerome Powell’s head? 

A little inflation may be welcome if you are in charge of the world’s largest debtor, as Powell’s White House and Capitol Hill bosses are.

Powell and the FOMC may think they can walk this tightrope, keeping the free-spending politicians happy while also avoiding economic calamity for everyone else. 

I’m not sure they can. 

More moderate inflation numbers could actually be problematic if they encourage the Fed to further delay tapering. 

They may wait too long and find they have to step on the brakes hard and fast.

My friend Peter Boockvar ended his CPI analysis with a haunting note.

I remain strongly in the belief that sticky and persistent inflation will continue, that we have entered a stagflationary environment and we are not going back to a pre-Covid trend for a while to come. 

Wages are moving higher thankfully but unfortunately inflation is running faster for many.

However…

We don’t need to have inflation stay at the current elevated levels to remain an issue. 

All they have to do is moderate to a 3-4% trend as a world of negative and zero interest rates, negative real rates, drum-tight credit spreads, high equity valuations and an enormous amount of global debt is not positioned for that.

The real danger isn’t a return to something like the 1970s inflation. 

Given where the economy is now, we could have big problems long before it reaches that point.

My friend Karen Harris and her team at Bain’s Macro Trends Group are worried about slower trend growth. 

In a recent presentation they noted the decelerating US recovery leaves the economy at a crossroads.


Source: Bain’s Macro Trends Group


While they acknowledge that it is possible the economy catches up to previous trend line growth, given other factors it is more likely that we begin to moderate to 2% growth from where we will be in a few months. 

For me that would be the best-case scenario. 

Why? 

Their next graph shows the reason:


Source: Bain’s Macro Trends Group


GDP has already recovered back to 2019 in nominal terms. 

But inflation has skyrocketed and will become a drag.

Workers will eventually come back, mostly to different jobs, and the supply/demand problems will settle out. 

That is how the economy works.

Bain asks a very good question: “Why does the US economy ‘all of a sudden’ need approximately 8 million fewer workers to achieve the same level of economic activity? 

Is it a structural gap in GDP and the number of workers needed?” 

This leads me to ask if we would see a GDP boom if 3 to 4 million workers come back.  

We are in such uncharted territory that you can easily make a very bullish or very bearish case, looking at the same data. 

That assumes the Fed begins to deal with the problems of inflation. 

If they do nothing or wait too long, we get back into a mini-70s-type problem as the Fed will be forced to remove QE faster and raise rates more quickly, likely triggering recession. 

That’s the last thing they want, but waiting too long will force the issue.

I believe this is why you are seeing more FOMC members talk about tapering sooner. 

It won’t surprise me if they start tapering as soon as Biden reappoints Powell. 

If he chooses Brainard or another monetary dove, we could easily find ourselves in the latter scenario. 

Shades of Chairman Arthur Burns, part two.

Remember my sandpile story

The fingers of instability are growing and eventually one grain of inflationary sand will hit the sandpile and trigger an avalanche. 

It doesn’t really matter which one does it. 

Barring another pandemic (the chance of which is hopefully decreasing), nearly all the problematic grains of sand come from the government and/or central banks. 

We don’t have to predict the exact disaster to know one is coming. 

And like the ‘70s, those fingers of instability lead to recessions and market volatility. 

This is a worldwide phenomenon, not just a US problem.

I said last week we are in danger of stagflation. 

That won’t be great if it happens. 

But if stagflation is all that happens, we should be grateful. 

Eventually this will all settle down but getting there could be very bumpy.

New Opportunities in Technology and Transformation

I have an ask. 

I would like to establish a strategic relationship with a small handful of larger professional investors; be you a hedge fund, mutual fund, pension fund, insurance fund, family office, or a large non-US funds manager. 

My objective is to share a select few transformational ideas that have, in my opinion, excellent potential investment profiles. 

I say a small number of professional investor relationships due to availability capacity in deal sizes and realistic time management.

More frequently than you might imagine, because of my connectivity, I am introduced to transformational technology companies that really do have the ability to creatively and positively disrupt our world. 

I see a number of opportunities; however, only a select few interest me. 

Often the companies are private so regulators require certain net worth thresholds before I can share them. 

And for a number of reasons, there are even fewer that I am able to invest in with my own and client capital.

This is not a solicitation for a specific offering.

I want to start at the relationship level and move forward. 

If you are a large institutional investor you can contact me at john@2000wave.com

Please give me your contact information and I’ll be in touch.

If you are interested in learning more, please know I will be working with you through my firm Mauldin Securities, LLC, where I am president and a registered representative, member FINRA and SIPC and Amera Securities, LLC, member FINRA and SIPC (where I am co-registered and a registered representative).

New York, Dallas, and Booster Shots

My next scheduled trip is to Dallas for Thanksgiving. 

We will get there a few days early to see some friends and then Thanksgiving with the family out at Lake Granbury (south of Fort Worth). 

I hope to get my booster shot in a few weeks and then plan more regular trips to New York and other cities for presentations and dinners.

I did a video podcast with Bill Walton in DC a few weeks ago and it is out. 

This is the second part, where we get a little more optimistic. 

It was a fun conversation.

I do appreciate it when you forward this letter and especially when you encourage your friends to subscribe. 

And don’t forget to follow me on Twitter

Now I will hit the send button and wish you a great week!

Your hopeful that we stumble through together analyst,


 

John Mauldin
Co-Founder, Mauldin Economics

Banks to become landlords in growing ‘build-to-rent’ sector

Big companies pile into housing market that has proved resilient throughout the pandemic

George Hammond 

Investors are betting that build-to-rent blocks will be a source of steady returns over the long term © ?


Tenants moving into a pair of Wembley tower blocks in 2016 were told by their landlord Tipi that they were on the frontline of a “rental rebellion”.

Tipi was among the first “build-to-rent” companies in the UK, operating a portfolio of residential flats built specifically to let out. 

The model, common in the US, Germany and elsewhere in continental Europe, was then novel in the UK.

“When we started Tipi, people didn’t know what build-to-rent was,” said James Saunders, chief executive of the business that has since rebranded as Quintain Living.

But now big companies are piling into the sector, which has proved resilient throughout the Covid-19 pandemic and is a beneficiary of a chronic housing shortage and growing urban populations in the UK.

Lloyds Banking Group is the latest to enter, with aspirations to become a landlord to 50,000 homes within the next decade, according to internal documents.

Overseas investors including US property group Greystar and Goldman Sachs are also making inroads. Australian bank Macquarie launched its own platform, Goodstone Living, in June this year and announced plans to pour £1bn into the sector. 

“There’s a large addressable market, growing tenant demand and constrained supply . . . It’s a big market, and there’s so much white space in it,” said Dana Gibson, senior managing director at Macquarie and non-executive director of Goodstone.


Having barely existed in the UK a decade ago, investment into build-to-rent hit £3.5bn last year, a peak despite the pandemic, according to estate agency, Savills. 

Growth has gradually accelerated since a government-commissioned report threw its support behind the sector in 2012.

About 40,000 units are in development across the UK, adding to an existing market of 62,000.

In place of the scruffy decor, poor regulation and absentee landlords that are the hallmarks of the worst kind of privately rented properties, build-to-rent operators promise high levels of service, no hidden fees, clubhouses and a calendar of events put on by the landlord.

The proposition has been a hit with renters, thousands of whom have been willing to pay a premium to live in purpose-built, corporately managed blocks. 

Increasingly, it is attracting serious money too.


Lloyds has set up its own private home rental brand, Citra Living, and laid out aggressive growth plans. 

A portfolio of 50,000 homes — Lloyds’ target for 2030 and a number equivalent to about 1 per cent of the UK’s rental housing stock, according to Savills — would make it by far the biggest rental landlord in the UK.

“The challenge for Citra is that this is not a sector where you can just wade in and buy 50,000 homes. 

Investors in just about any other sector would be buying portfolios or platforms, but here they have had to come in and build it themselves,” said Lawrence Bowles, a senior analyst at Savills focusing on build-to-rent.

Developers are hoping to steal a march on private landlords in what is a hugely fragmented market. 

The 4.4m households in England’s private rented sector are owned by 2.3m landlords, according to the Ministry of Housing, Communities and Local Government. 

By most estimates, build-to-rent stock only accounts for just 2 per cent to 3 per cent of the UK’s pool of rental housing.

Investors are betting that build-to-rent blocks will be a source of steady returns over the long term and that interest from renters will continue to grow. 

Yields of 3 per cent to 5 per cent are unspectacular but nonetheless attractive in a low interest rate environment in which bond yields have hovered around historic lows.

Rents from tenants of new-build flats have also proved more reliable than those from other commercial property sectors during the coronavirus pandemic.

“Investors are seeing resilient cash flows during the pandemic, predictable income and an ability to maintain occupancy, all of which other real estate asset classes have suffered with,” said Mark Allnutt, who is responsible for expanding Greystar’s presence in Europe.

For Lloyds, the foray into rental housing is a way of trimming its reliance on traditional sources of income such as lending.

But some of the biggest players in the space say that making a success of build-to-rent requires significant investment, skills and scale.

“There are bound to be winners and losers,” said Rick De Blaby, chief executive of Get Living, which owns and manages the former Olympic Village in east London and is backed by Dutch pension fund asset manager APG and property developer Qatari Diar.

“With build cost inflation and high demands around ESG, architectural quality and affordable housing, you have to be pretty skilful and agile . . . 

When a lot of capital is getting deployed, inevitably people will make some fairly optimistic assumptions in order to win the land,” he added.

Lloyds’ foray into rental housing is a way of trimming its reliance on traditional sources of income such as lending © Tolga Akmen/AFP via Getty


As well as a competitive investment market and operational hurdles, build-to-rent developers and operators are likely to face more scrutiny from politicians than those putting money into less public-facing sectors.

“Residential real estate is hard because it’s in the public sphere. 

There is a need for more housing in the market, social housing needs to be addressed. 

What is our role in that? 

That gets political,” said Gibson.

In Germany, where corporate landlords are far more prevalent, there has been pushback from tenants disgruntled at what they see as sharp practice and high rents. 

In Berlin, a campaign to expropriate 240,000 properties from Germany’s biggest publicly listed residential landlords is under way.

In the UK, the complaint from existing build-to-rent landlords is not that they are too much in the public consciousness, but that they are off the radar. 

Operators talk of 10,000 units being the level at which economies of scale kick in, but none have yet attained that in the UK.

“This is a sector where we’re still writing the manual,” said De Blaby.

Commodities: the Chinese real estate exposure

What might the fallout from Evergrande mean for demand?

Jamie Powell

© REUTERS


In markets, being right early is the same as being wrong. 

Fortunately for FT Alphaville, the same rule doesn’t apply to journalism.

Back in 2018, FT Alphaville took a look at Evergrande -- China’s largest property developer -- and its ballooning balance sheet, which included 408,000 car parking spaces, a land bank the size of Malta, and a curiously low yield on its rental properties.

Three short years later, Evergrande is facing a liquidity crisis. 

In a normal economy, this wouldn’t be such a big deal. 

But in China, where real estate is estimated to account for up to a quarter of GDP, this is slightly more of a concern. 

It doesn’t help that the property developer also has some $300bn of outstanding obligations to pay. 

And it’s crunch time: two interest payments on its long-suffering bonds are due Thursday.

So the question now is: how contagious would an Evergrande default be for the global economy? 

Chinese property stocks have started the week by already taking a battering, with Hong Kong listing Sinic Holdings crashing 87 per cent during trading on Monday, and the bonds of other developers sinking to distressed levels. 

Via UBS:


European equities this morning are also showing signs of suddern concern, with the FTSE 100 falling 1.6 per cent, and the Stoxx 600 off 1.8 per cent in midday trading. 

The basic materials sector is leading the charge, with the sector in the UK off 4.5 per cent, led by Anglo American’s fall of 8.6 per cent. 

In Europe, it’s a similar story, with steel company ArcelorMittal, as one example, down 6 per cent. (European banks also seem to be taking a battering, we should add.)

But why commodities? 

Well, the obvious answer is that real estate tends to use a lot of them -- whether it’s steel for the structure or copper for wiring.

With that in mind, you might be wondering about just what level of exposure to the business of digging stuff out of the ground we are talking about here. 

Well, not to worry, because Tom Price at Liberum did a quick back-of-the-napkin estimate on what a Chinese real estate crunch might mean for commodities, and . . . it’s not too pretty.

Here’s the key blurb from his note this Monday morning:

bearish commodities? yes. 

looking narrowly at the direct/first-round impact on commodities, this event threatens a slowdown in China’s property sector – 1-of-2 very large, broad-based commodity-consuming sectors of this economy (i.e. the other = infra). 

it’s generally well known (among resources sector investors, at least) that China’s share of global commodities consumption = 40-70%. 

but what share of global consumption is China’s property sector? Of China’s total commodity supply, its property sector consumes: 

40% of steel flow (380Mtpa = 20% of global total); 

20% of copper (2.7Mtpa = 20% of global) 

15% of aluminium (6Mtpa = 9% of global) 

15% zinc (0.7Mtpa = 5% of global) 

10% nickel (0.2Mtpa = 8% of global)

ANSWER: China property = 5-20% of global commodity supply. - so yes, Evergrande’s potentially a big deal to Commodity World.

Yep, Chinese real estate accounts for a fifth of all global and copper steel supply. Blimey.

We don’t have a whole lot to add on top of those eye-opening stats, bar a passing thought that if you were an economy which depended on commodity sales for a large chunk of your output -- say, Australia -- you might be concerned that the fourth quarter is going to be a touch more difficult than expected.

The bull case on stocks

Robert Armstrong


The best reason to own lots of stocks is always the same. 

It is this: 

No alt provided


That is the S&P 500 price for the last 150 years, on a log scale (the data comes from Robert Shiller at Yale). 

US equities have been an unbelievably powerful wealth machine, and you should have a lot of your money in them a lot of the time. 

Own stocks! 

Most investors, it must be said, do not have an investment horizon of 150 years. 

What bears are worried about, therefore, is periods like this:

 No alt provided


That’s a 24-year round trip — not including dividends, but still. 

Here’s a more recent, 12-year round trip:

No alt provided


What is sickening about those two charts is that the first covers a period roughly equivalent to a normal person’s entire investment horizon; the second, about half of it. 

Even quite fortunate people only have, say, 25 years between the time when they have substantial assets to invest and the moment they retire. 

And it is legitimate to worry that 2021 is akin to 1929 or 2000, given valuations are uncomfortably near the 1929 and 2000 highs on some metrics, profit and economic growth are slowing, market leadership is getting thinner, and sentiment is turning. 

But we have to first make a distinction between the risk for the investor and risk for the person who manages investors’ money. 

Using Shiller’s data again, during that awful 1929 to 1954 round trip on price, investors’ real total return was 4 per cent annually (they clipped a nice dividend, in other words). 

That is an unspectacular but acceptable return, over the roughest quarter century in the market’s history, which included the depression and World War Two.

Dividends were not enough to provide a positive real return between the 2000 peak and early 2013, but if you bought at the 2000 peak — at the absolute worst time, in other words — and held on for 20 years, once again, you earned 4 per cent real annually. 

And those are the worst outcomes, remember. 

Buy stocks! 

Buy the dips, buy the peaks, but buy!

Things look slightly different, though, from the point of view of someone who works in money management. 

At some time point represented in the two charts above, they tend to get fired. 

This happened to me. 

Here’s the chart:

 No alt provided


The professional risks of having your clients mostly in stocks heading into a bear market are real (though they are exceeded by the risk of having clients underweight stocks and then watching the market rise). 

So the possibility that we are on the cusp of a bear market requires attention.

The best argument against the notion that we are living in a 1929 or 2000 style period has a name. 

It is Tina (for “there is no alternative”). 

Here is a chart from Shiller, showing what he calls the “excess Cape yield,” that is, the cyclically adjusted real earnings yield on stocks, minus the real 10 year bond yield. 

It is a proxy for your expected returns on stocks, over and above the expected return on bonds. 

Shiller plots it against the subsequent 10-year return for stocks (the dotted green line):

 No alt provided


The current excess yield on stocks does not scream “buy!” as it did, for example, in 2010 (when I was still psychologically frozen did not buy). 

But it does not shout “sell,” either. 

Similar levels of excess yield in the late 1980s, in 2008, and in 2011 were each followed by a decade of solid returns.

Tina is a real reason to stay with stocks. 

Low bond yields surely force many investors with target returns to buy stocks, and this must support stock prices. 

But it cannot be a sufficient reason. 

Consider, first, that rates are very low in Japan and Europe, too, but their stock markets have not had the smashing decade the US’s has. 

Second, remember that bull markets often end in panics, and in panics people do not sit around companying yields on various assets. 

They just want cash, immediately. 

So we need more reassurance than just excess yield on stocks. 

But there are three good sources of it:

Corporate profits are strong, and while their growth is slowing, it remains solid. 

Consensus estimates for S&P 500 earning growth in 2022 — after the pandemic effects have fallen out of the annual comparison — is 9.5 per cent, according to FactSet (and do you know what high profits fund? Buybacks).

GDP growth, similarly, is slowing but is still above trend. 

For the current quarter, according to the Atlanta Fed’s GDPNow real-time estimate, output is growing at 3.6 per cent. 

The estimate was for six per cent just a month or so ago, and one likes a slowdown, but if the Delta variant subsides, supply bottlenecks continue to clear, and more fiscal support is rolled out, growth could reaccelerate nicely next year. 

Five (ish) per cent growth in 2022 is not out of the question. 

The Fed is clearly determined to keep rates low until they see the whites of non-transitory inflation’s eyes. 

Given all this, and against the background of Tina, is it really time to take US equity risk off the table?

All bets are off, of course, if inflation gets out of control and the Fed has to push the economy into recession to stop it. 

Whether the above bull case convinces you will depend on the probability you place on that happening. 

But if you are sanguine about inflation, a little deceleration from abnormally high growth levels, and the accompanying shift in sentiment, seem like bad reasons to underweight the best asset class there ever was. 

Winter Worries

The Changing Virus

As winter approaches, experts are concerned that more contagious variants of the coronavirus could emerge. Measure to prevent the spread of the virus, they say, will be with us for a long time to come.

By Veronika Hackenbroch und Rafaela von Bredow

A vaccination event at a Hamburg concert hall: "The fourth wave may be devastating." Foto: Ulrich Perrey / dpa


A year ago, the world was almost optimistic. 

Disease experts had a pretty clear idea of how best to combat and possibly defeat the coronavirus.

"If we get a coronavirus vaccine that is 70 percent effective and we combine it with some elements of good public health practices, then I think we can get good control of this pandemic within a year or so," American immunologist Anthony Fauci told DER SPIEGEL in an interview in August 2020.

We now indeed do have highly effective vaccines, and they have come to the market much faster than hoped – and yet SARS-CoV-2 has nonetheless invalidated what turned out to be overly optimistic expectations. 

The virus has mutated far more than most experts expected, becoming more contagious and beginning to pose a challenge to the vaccines that are currently available.

With the Delta variant now dominant around the world, one infected person infects six to seven other people without containment measures in place – more than twice as many as were infected by the original wild type of the virus circulating in 2020. 

The vaccines that are currently available still provide good protection against a severe course of the disease, but less protection against infection with the virus than for the previous variants that had been prevalent.

A Difficult Winter

That's just one reason that hopes for herd immunity by this autumn have been dashed. The number of intensive care patients in German is once again rising significantly. 

"If we don’t manage to drastically increase vaccinations, the current fourth wave may be devastating," Lothar Wieler, the president of Germany’s center for disease control, the Robert Koch Institute (RKI), said last Wednesday.

It could well be that the second pandemic winter will be a difficult one. And no one dares to venture a guess at what will come after that. 

What happens next depends not only on vaccination, but also on how the virus might mutate.

Even for leading epidemiologists, like Emma Hodcroft of the University of Bern, making predictions is something of a fool's errand. 

As part of the Nextstrain project, Hodcroft is collecting SARS-CoV-2 genome sequences around the world. 

"I don’t think we understand SARS-CoV-2 well enough to be able to give a definite answer to the question of how the virus might evolve," Hodcroft told DER SPIEGEL. 

"This virus keeps surprising us," agrees Mary Bushman, a mathematician and population biologist at Harvard University’s T.H. Chan School of Public Health. 

"No one expected such large jumps in contagiousness.”

This may may be because the Delta variant has the ability to replicate very quickly once the infection begins.

But even the genome sequence of a newly emerging variant tells us little about what properties the mutant will have. 

For example, variant C.1.2, which first emerged in South Africa in May, looked very threatening at first glance. 

It was "highly mutated" beyond any other variant in the world, South African researchers concluded in a preprint study. 

They found that is was "between 44-59 mutations away from the original Wuhan" virus.

However, it doesn’t currently appear that C.1.2 will be able to displace the Delta variant. 

"Delta has relatively few mutations," says Tulio de Oliveira, a bioinformatician at the University of KwaZulu-Natal in Durban, "but it apparently manages to keep C.1.2 at bay."

"We Will See Much More Dangerous Variants"

Still, that doesn’t necessarily mean that Delta will remain dominant forever. 

"I think it is very likely we will see much more dangerous variants than Delta because of the large number of unvaccinated people around the world," predicts politician Karl Lauterbach, who is the health policy point person for the center-left Social Democratic Party (SPD) and a leading German voice in the pandemic.

Harvard University's Bushman ran a model calculation in an attempt to gather at least some clues about which new variants researchers and public health officials should be keeping a close eye on and what precautions will be essential for winter. 

The model simulated the emergence of new virus variants.

According to her findings, variants that are even more contagious are likely to prevail over the Delta variant in the current phase. 

The so-called moderate escape variants, on the other hand, which at least partially cancel out the effectiveness of vaccines, don’t generally stand a chance according to Bushman’s model calculation – provided they aren’t also more infectious than Delta.

However, if a variant that has both characteristics at the same time emerges, it could become a nightmare. 

An escape variant more contagious than Delta could have "devastating consequences," Bushman says. 

She adds that the double effect would be far greater than the sum of the two individual effects. Only very strict coronavirus containment measures and a rapid vaccination campaign could mitigate the spread of that kind of variant.

"We are particularly concerned about the UK," says Tulio de Oliveira. 

"While vaccination rates are high there, behavior also plays an important role. 

And that has been problematic since the British declared 'Freedom Day’. 

Anything that emerges or is amplified there has the potential to spread extremely fast across Europe, North America and Africa given the connection of the country to the rest of the world."

There could also be negative consequences if corona measures like mask-wearing requirements are lifted too early. 

More contagious variants in particular were then able to spread more quickly in Bushman’s computer simulation. 

"Vaccinations alone," says Bushman, "may not be enough in these cases to keep the number of infections sufficiently under control, especially if the vaccination campaign progresses too slowly." 

At Germany’s Robert Koch Institute, officials believe that the coronavirus containment measures currently in place will have to be maintained for quite some time to come.

The extent to which SARS-CoV-2 can mutate and develop at all remains an open question for scientists. 

"There is probably an upper limit in terms of how much more infectious the virus can get," says Hodcroft. But it probably hasn’t been reached yet. 

"There could be a further increase in infectiousness," she adds.

It is even more difficult to predict how the virus will evolve to bypass immunity, she says. 

"With many viruses, this is a constant battle," says Hodcroft. 

"We gain a certain level of immunity, and the virus is then under pressure to escape that immunity."

 If a new escape variant were to spread, though, it wouldn't automatically mean "that we are back to square one with a highly dangerous virus," she says.

Theoretically, though, that remains a possibility. 

"There’s a widespread public perception that viruses become less dangerous over time because they evolve to avoid harming the hosts they rely on for transmission," says William Hanage, a professor of epidemiology at Harvard University’s T.H. Chan School of Public Health. 

But this is wrong, he says. 

The truth is that a virus can become more or less dangerous depending on the situation.

"And it could also be that variants develop that are by and large immune to our current vaccines," says politician Lauterbach. 

"If, for example, the coronavirus’ spike protein develops a cloak of invisibility like some cancer cells." 

But that is all still in the realm of speculation. 

He is more pessimistic about the fact that there is no effective treatment for COVID-19 patients. 

And the fact that there will still be serious illnesses because there are no vaccines that provide 100-percent protection. 

"This virus will be with us for years to come."