If we were to see inflation going back to levels expected by the Fed (2-3% I suppose?) how would that change your forecast?
Great question. So my view is that there could be a few potential triggers for a sell-off cascade (via some combination of margin calls and panic selling), leading to a large drop. There’s also a few triggers for increasing interest rates, not just inflation: The Fed doesn’t have a monopoly on rates. When they buy fewer bonds, they shift the demand curve left, decreasing the price, leading to higher effective interest rates. I’m kind of baffled that they speak about “tapering” as if it’s possible to do so without increasing interest rates.
The particular problem with persistent inflation is that the Fed is less able to increase the cash supply in the event of a large crash. So while I think that inflation isn’t necessary for a 30 percent drop (I’d say it’s over half of my credence), I expect it to magnify the downside if it is higher than normal right before a crash.
When you wrote “The main thing I’m worried about is increased savings” did you mean what you described in the previous paragraph (e.g. zero-NPV assets investing and alike), or was it something else?
When I say zero-NPV assets, I mean anything that doesn’t pay out future cash flows to investors, like gold, silver, bitcoin, and NTFs. Certain stocks are being traded as if they were these assets too (AMC, GameStop). I think investment in these things is indicative of mania.
I’m worried that the Fed has flooded the market with so much cash that the new normal for the CAPE ratio and PS ratio are close to what they are now. If it is, then margin-debt-to-GDP isn’t the relevant ratio anymore, margin-debt-to-total-market-cap is, which is not at as high of a level as margin-to-GDP. Basically, supposing we have a smooth exponential curve for the S&P 500, I’m worried about a one-off discontinuity in the graph. I’m also worried about people investing more of their income and net worth, which would have the same effect.
Great question. So my view is that there could be a few potential triggers for a sell-off cascade (via some combination of margin calls and panic selling), leading to a large drop. There’s also a few triggers for increasing interest rates, not just inflation: The Fed doesn’t have a monopoly on rates. When they buy fewer bonds, they shift the demand curve left, decreasing the price, leading to higher effective interest rates. I’m kind of baffled that they speak about “tapering” as if it’s possible to do so without increasing interest rates.
The particular problem with persistent inflation is that the Fed is less able to increase the cash supply in the event of a large crash. So while I think that inflation isn’t necessary for a 30 percent drop (I’d say it’s over half of my credence), I expect it to magnify the downside if it is higher than normal right before a crash.
Interestingly, the Fed itself was (and probably still is) concerned about the current high valuations.
When I say zero-NPV assets, I mean anything that doesn’t pay out future cash flows to investors, like gold, silver, bitcoin, and NTFs. Certain stocks are being traded as if they were these assets too (AMC, GameStop). I think investment in these things is indicative of mania.
I’m worried that the Fed has flooded the market with so much cash that the new normal for the CAPE ratio and PS ratio are close to what they are now. If it is, then margin-debt-to-GDP isn’t the relevant ratio anymore, margin-debt-to-total-market-cap is, which is not at as high of a level as margin-to-GDP. Basically, supposing we have a smooth exponential curve for the S&P 500, I’m worried about a one-off discontinuity in the graph. I’m also worried about people investing more of their income and net worth, which would have the same effect.