Why Isn't Inflation Falling? (EP.279)

Episode Summary

Executive Summary: The episode centers on the 2022 market selloff, arguing that extreme volatility, inflation, Fed tightening, and bearish sentiment make bottom-picking nearly impossible. Michael and Ben debate whether bad economic news is needed to end inflation, how corporations and banks are benefiting from higher rates, why housing is likely the next major weak spot, and why consumer balance sheets remain unusually strong. They also touch on flows into ARK, Treasury ETFs, venture capital, and a range of pop-culture riffs and recommendations.

Main Topics: Market volatility and bottom-calling (Priority: 5/5): The hosts emphasize that the year’s market losses have been driven by a handful of extreme down days and that bottoms are only recognizable in hindsight. They argue that price action, not fundamentals, is the only useful signal, but even then bear-market rallies can mislead investors. Inflation, wages, and who bears responsibility (Priority: 5/5): They debate the causes of inflation and push back on the idea that workers alone should absorb the pain. The conversation argues that corporations, banks, and policy choices have also contributed, especially as margins and spreads remain elevated. Federal Reserve credibility and tightening cycle (Priority: 5/5): The hosts question the Fed’s confidence and communication, noting repeated forecast misses and the risk that aggressive rate hikes will overshoot. They discuss whether the bond market may ultimately signal a pivot before the Fed does. Housing slowdown and lagged economic damage (Priority: 5/5): They argue that the biggest economic effects of higher rates may still be ahead, especially in housing-related jobs, construction, refinancing, and related investment. U.S. and Canadian housing markets are presented as vulnerable to delayed fallout from 7% mortgage rates. Consumer balance sheets and resilience (Priority: 4/5): A major theme is that consumers, including lower-income households, entered this period in unusually strong financial shape thanks to wage gains, stimulus, and prior deleveraging. The hosts argue this helps explain why spending remains resilient despite inflation. Flows, sentiment, and speculative behavior (Priority: 4/5): They highlight unusual investor behavior: heavy inflows into ARK, record Treasury ETF demand, and large retail put buying. These are framed as evidence of washed-out sentiment but not necessarily a tradable signal. Private markets and tech valuation reset (Priority: 3/5): A brief section reviews the venture capital slowdown, with funding and mega-round activity falling sharply from 2021 peaks. They use this as another example of frothy private-market valuations normalizing.

Key Arguments: Extreme market moves matter because a small number of days account for most of the year’s losses; this makes timing and bottom-calling nearly impossible. Fundamentals do not reliably identify market bottoms because stocks have bottomed under many different valuation, yield, and inflation regimes. A market bottom is only confirmed by price and trend, but investors usually dismiss the first rally as just another bear-market bounce. Inflation is not solely a wage story; corporations have maintained record profit margins and banks are widening net interest margins, indicating they are benefiting from the environment too. The Fed may be tightening too fast and too far, and bond markets could ultimately force or anticipate a pivot before the Fed admits one. Housing is likely to be one of the biggest lagged casualties of higher rates, with impacts on employment, construction, lending, and investment still building. Consumer balance sheets are unusually strong, especially relative to prior cycles, which helps explain continued spending and delayed recession effects. Retail investors are not uniformly ‘dumb money’; continued buying into ARK and Treasury ETFs may reflect discipline, tax-loss harvesting, or strategic allocation rather than pure panic. The current inflation episode was amplified by fiscal stimulus and policy choices, not just by labor-market tightness. If policymakers want to fight future inflation, taxing corporations could theoretically target excess margins without directly pushing workers out of jobs, though the hosts treat this as a provocative thought experiment.

Data Points: S&P 500 year-to-date decline: down over 23% - Nick Colas statistic cited in the discussion of how a few big down days account for nearly all losses. Number of days driving S&P loss: 9 single days - The hosts note that these nine days make up the entire year-to-date decline. S&P 500 if worst days excluded: up 9% YTD - Colas’ point that removing the nine worst days would leave the index positive. Extreme market reversal day: up about 3% after opening sharply lower - Used as an example of the wild intraday swings during the selloff. ARK peak outperformance vs S&P 500: more than 600% total outperformance at peak - Refers to ARK’s peak in February 2021 relative to the S&P 500. ARK performance since inception: underperforming by about 30% - Current position after the drawdown from peak. ARK fund drawdown: down 78% - ARK’s decline from peak referenced as evidence of speculative bust. ARK inflows: $1.2 billion year to date - Despite the drawdown, investors kept adding money to the fund. Treasury ETF inflows: $111 billion YTD - ETF flow data showing strong demand for Treasury exposure despite poor bond performance. Treasury ETF share of ETF flows: 26% of all ETF flows - Treasury ETFs are taking an outsized share of new money. Retail options activity: $19.9 billion in puts vs. $6.5 billion in calls - Jason Gempford’s data on retail traders’ bearish positioning last week. VIX level: around 31 - Discussed as elevated but not yet at extreme capitulation levels. UK gilt yield average: 4.5% - Deutsche Bank chart showing 10-year UK gilt yields reverting to long-run average after massive moves. 10-year Treasury yield streak: 11 consecutive weeks higher - Longest such streak since 1978. U.S. consumer wealth, bottom 50%: $4.4 trillion - Federal Reserve data showing the wealth of the bottom half of households in Q2. Bottom 50% wealth pre-pandemic: $2.0 trillion - Used as the comparison point for the recent surge in wealth. Bottom 50% wealth increase since end-2019: +$2.4 trillion - Hosts cite this as evidence that lower-income households are not uniformly worse off. Social Security COLA for 2023: 8.7% - Announced increase for retirees, highlighting inflation protection for beneficiaries. Average Social Security benefit increase: about $150/month - Retiree benefits rising to a little over $1,800/month. Exxon vs. Zoom market cap: Exxon is now almost 20x larger than Zoom - Illustrates the reversal in pandemic-era valuations. Venture funding projected 2022: $440 billion - CB Insights projection, down from a 2021 peak. Global venture funding 2022 so far: $329 billion - Actual funding through the period discussed. Global venture funding 2021: $630 billion - Prior-year peak used for comparison. Average global deal size: $18 million - Down from roughly $25 million as rounds get smaller. Mega-round funding: $29.6 billion - Funding from $100 million+ rounds fell sharply from prior peaks. National average wage index: $60,575 in 2021, up 9% - Cited as the largest wage increase since the early 1980s. Bank of America loans growth: up 12% YoY - Used to show consumer and lending activity remains strong. Bank of America net interest income: $13.8 billion, up 24% YoY - Evidence that banks are benefiting from higher rates. OpenDoor offer decline: from $830K to $590K - Listener example showing how sharply housing-related offers have fallen. Toronto market decline: down 25% - Commentary from a Toronto broker on Canadian housing weakness.

Pivotal Quotes: "The S&P is down over 23 percent year to date, but nine single days make up that entire decline." — Nick Colas (quoted by the hosts): Used to show how concentrated market losses have been in a few violent sessions. "We're never out of the woods. We're always in the woods." — Ben Carlson: Summarizing their view that the economy is always somewhere between boom and bust. "I think we're in an environment where it's kind of odd, which is very strong consumer spend." — Jamie Dimon (quoted by the hosts): Referenced while discussing consumer balance-sheet strength and bank earnings.

Implications: Listeners should expect more volatility, delayed housing damage, and continued policy uncertainty. The episode argues that strong consumers may cushion the slowdown, but inflation and Fed tightening are still likely to reshape markets and valuations.