The dominant narrative of the 2020 financial markets is that the U.S. Federal Reserve is printing the U.S. dollar into oblivion. After having expanded its balance sheet by roughly $3 trillion between March and May 2020 (during the worst of the pandemic lockdown), the Federal Reserve has actually shrunk its balance sheet by $220 billion since then. But this hasn’t stopped financial pundits from breathlessly speculating about how close the U.S. dollar is to collapsing into hyperinflation.
A great example of this conventional wisdom can be found in an article I recently discovered on the financial blog Adventures in Capitalism. This blog is run by Harris Kupperman (aka Kuppy), founder of the hedge fund Praetorian Capital. This guy is a market pro with over two decades of investing experience.
Kuppy penned an article titled “Did The Market Actually Recover From COVID-19…???” It posits that even though the broad equity markets are either near (the Dow and S&P 500) or at (the NASDAQ) all time highs in nominal terms, in reality they are grinding along very low levels in valuation terms. This means that equities are a buy – a strong buy! Only an idiot wouldn’t be long this market!
The way he achieves this valuation sleight of hand is by arguing that the U.S. financial authorities are engaged in what he calls “Project Zimbabwe” – in other words, hyperinflation. During hyperinflations, stock markets shoot to the moon in nominal terms, even as the economy disintegrates around them. This has happened in every country that has 1) experienced hyperinflation and 2) had a freely-trading stock market at the time of its hyperinflation.
The two latest examples of this unfortunate situation are Zimbabwe and Venezuela. The Zimbabwe Industrial Index is up 654% for the YTD period through July 2020 while the Venezuela Stock Exchange General Index is up 280% over the same time. So just invest in stocks and we’ll all be rich, rich as Nazis!
Or maybe not.
Inflation in Zimbabwe is running somewhere close to 800% on an annual basis while Venezuelan inflation is maybe around 2,000% (hyperinflation rates are notoriously difficult to track, so all these figures are approximate). So equity investors in these countries might actually be losing money in real terms as inflation threatens to outpace any gains they make in the markets. Suddenly, those hockey stick equity market charts don’t look nearly so appealing.
But Kuppy will not be deterred.
He produces a chart that shows the ratio between the S&P 500 ETF (SPY) and the Federal Reserve’s balance sheet. The implication is that in a “true” bull market the S&P 500 will rise in relation to the Fed’s balance sheet, while in a bear market it will fall. The chart then shows this in action, with the market ratio rising (the green line below) for most of the 2010s only to get unceremoniously knocked back down by the 2020 global pandemic.
SPY to Fed Balance Sheet Ratio
But I find Kuppy’s accompanying commentary to be an intriguing window into the hyperinflation-obsessed thought process of professional money managers everywhere. I have excerpted a paragraph from his article below:
“What I find stunning is that after the COVID-19 crash, we’ve barely even bounced off the lows. In fact, we gave back a decade of retained earnings, financial engineering and everything else. We’re actually all the way back at 2010 levels. That’s stunning right? It’s literally been a wasted decade in the financial markets when indexed to the Fed’s balance sheet. That’s your COVID-19 crash and it’s as severe as you’d expect it to be.”
So Kuppy thinks the downtrend in the S&P 500/Fed balance sheet ratio will stop and reverse higher as the Fed’s money printing continues unabated.
Hyperinflation Ho! Zimbabwe here we come! Save us Dow! Save us S&P 500! Save us NASDAQ!
The hyperinflation narrative is perhaps best represented by the catchy slogan “money printer go brrr”, which implies that Fed governors are busy manning the printing presses in the basement of the Eccles Building in a nefarious attempt to destroy our collective monetary future. Here is an absurdly entertaining YouTube meme that encapsulates everything the mainstream investment community currently believes about the Fed’s money printing.
Kuppy, like many money managers in the world today, is suffering from Fed induced Hyperinflation Derangement Syndrome. Their thinking is that because gold is going up and stocks are going up and the Fed is printing, then it must mean that hyperinflation is right around the corner.
Except it’s not true. The Fed printing is really just plugging a giant sinkhole in the economy…barely.
As soon as I read Kuppy’s article I decided to prove it wrong. After about 45 minutes of work, I had my own chart showing the ratio of the Japanese Nikkei 225 Index to the Bank of Japan’s balance sheet. Remember, this is the same Bank of Japan that has been printing with wild abandon for years…years! They’ve printed so much that their balance sheet has now swelled to 118% of Japanese GDP. To put that into perspective, if the Fed just matched the BOJ, they would have to print an additional $16 trillion – enough to double the value of every dollar deposit account in the entire country!
And despite all this BOJ printing, there is still no inflation in Japan. None. Zero. Nada. Zilch. The latest Japanese inflation reading in June 2020 was a microscopic 0.1% year-over-year.
Kuppy implicitly believes that the last 10 years of retained earnings and financial engineering in corporate America couldn’t have been for nothing. But it was. Outside of a handful of exceptions, corporations actually retained very little in the way of earnings over the past 10 years. Instead they spent it all on share buybacks and dividends. Financial engineering has likewise proven to be a curse for long-term shareholders. It has hollowed out many companies’ productive capacities, snuffing out their future viability.
Instead of arising like a phoenix to new highs, further Fed printing will only cause the S&P 500 to Fed balance sheet ratio to contract even more aggressively. One only has to look at the Nikkei to BOJ balance sheet chart below to realize that. Regardless of how many trillions of yen the BOJ has printed, the ratio has relentlessly sunk ever lower. In fact, you can still buy the Japanese Nikkei Index for the same (nominal) price it was back in 1987 – over 30 years ago!
Nikkei 225 Index to BOJ Balance Sheet Ratio
In the final analysis, there are two interpretations of what is happening in the market right now. The first is that we are in the nascent stages of hyperinflation – the money printer go brrr hypothesis. This is the glib, simplistic myth that just won’t die.
The other possibility is that traumatized investors are fully cognizant we have entered a modern-day Greater Depression. Consequently, they are retreating to the safest, most liquid and money-like financial instruments possible – things like Treasury bonds, Agency debt and cash, along with gold and silver bullion. In conjunction with that, we are also experiencing the end stages of the largest equity bubble in the history of mankind – the twilight of the dreaded Everything Bubble.
I think the latter explanation is far more compelling than the former.
Of course I don’t hate equities simply because they are equities. I hate them because they are so overpriced at the moment that their future returns will undoubtedly have a negative sign in front of them. If the valuations weren’t so obscene, my investment outlook would be more constructive.
As a parting gift, I will give you a little investing tip. You’ll often hear that you should invest in good, solid dividend paying stocks. And I would, if there were any domiciled in the United States. Alas, U.S. corporate management has mortgaged their shareholders’ future through accounting tricks and excessive leverage.
But I did stumble across a gem from overseas during my research. Coca-Cola Bottlers Japan Holdings Inc. is a company that controls 90% of the Japanese Coca-Cola beverage distribution market by sales volume. It administers the most important, most populous geographic areas in Japan, including Tokyo, Osaka and Kyoto. The company trades under the ticker “2579” on the Tokyo Stock Exchange or “CCOJY” as an over-the-counter ADR (American Depositary Receipt) in the U.S.
The firm has a market cap of around $3 billion, making CCOJY a mid-cap company. It also has an English language website, which makes gathering company information easier. The ADR (CCOJY) will probably be the most accessible security option for most U.S. investors.
I like CCOJY because it has a healthy dividend yield of between 2.5% and 3.0%, a low price-to-sales ratio of 0.35, and a reasonable debt to (tangible) equity ratio of only 55%. The company’s debt sports a solid AA-/A+ credit rating, which means that their debt servicing costs are negligible. The chances of this firm going bankrupt are nil.
Coca-Cola Bottlers Japan Holdings Inc. is the kind of company you buy today and stuff away in your retirement account for the next 10 years. You’ll earn a fair return on it (probably mid single digits annualized), which I understand isn’t stellar. But neither will you wake up one random morning to news that the company disintegrated overnight as its executives fled to Mars in the wake of an accounting scandal.
CCOJY has declined by about 45% (in dollar terms) from earlier this year due to the impact of COVID-19. But it is a consumer staple company and sales volumes are unlikely to drop significantly. Positive near-term catalysts include the (now delayed to 2021) Tokyo Summer Olympics and the potential for further consolidation with the remaining smaller Japanese Coca-Cola bottlers. CCOJY’s dollar price is currently near an all-time low, while its yen price is the same as it was back in 2013, 2009, 1995 and probably earlier as well (but that is as far back as I could get data).
In any case, please do yourself a favor by not falling for the hyperinflation myth. The U.S. dollar isn’t going to fall apart anytime soon. But even so, I think allocating some of your portfolio to gold or silver (or the rare undervalued stock) is a good idea. Otherwise, holding cash while you wait for better investment opportunities to come along is just fine.
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