We rarely republish old essays but given its importance we felt the need to do so in this case. In April 2019, BusinessWeek published a cover story asking “Is Inflation Dead” with a picture of a dead dinosaur – the implication being that inflation was not only dead but extinct.
Contrarians are (by definition) rare, but it is a key part of who we are and what we do at G&R. We saw the 2019 BusinessWeek cover as a natural bookend to the infamous “Death of Equities” cover story, which appeared in August 1979. In a point we have made multiple times, we observed that it can take up to three years before a published cover story is proven wrong—often abruptly. In the case of the 1979 “Death of Equities” cover story, it was published almost exactly three years before equity markets literally “blew-off” the bottom in August 1982 --which we know was the start to one of the greatest bull markets in history. Therefore, we argued that three years after the April 2019 published cover story, that inflation should stage a major acceleration and become a huge problem.
What follows is an essay on contrarian thinking and consensus expectations.
We were often asked what the catalyst would be to end the deflationary regime (in place since 1980) and usher in a new period of inflation. Publicly we would talk about money printing, credit creation and profligate spending.
Privately, we speculated that it would be a “Black Swan” event. The root causes of market shifts are usually predictable (albeit often overlooked) while the catalyst tends to come out of nowhere. In many ways, it seems as though everything since mid-2019 has been a nothing but a series of “Black Swan Events.”
Please position yourselves accordingly.
The Bell Has Been Rung
(reprinted from our Q1 2019 Commentary)
BusinessWeek has done it again. In an echo of the historic, oh-so-wrong- cover piece of August 1979, “Death of Equities,” the April 2019 cover of Bloomberg/BusinessWeek proclaims “The Death of Inflation”. If that’s not a screaming warning of inflation’s return, and buy signal for inflation sensitive assets, we don’t know what is.
Magazine covers have a long history of proclaiming erroneous predictions at critical turning points in financial markets. Sometimes it takes decades, but bullish or bearish trends often persist long enough to convince everyone, even the most senior and wizened editors of well-respected business magazines, to publish ill-conceived cover stories arguing that well-established trends will continue forever.
One of the most famous examples of contrarian messaging on a magazine cover occurred back in August 1979 when BusinessWeek published its “Death of Equities” cover story. Written after stocks had posted 20 years of substandard returns (including four bear markets -- one of which saw the market decline by almost 50%), the August 13th cover story explained how future equity returns would remain substandard for the foreseeable future. Although not quite the bottom in stocks (the bear market didn’t end until August 1982), investors should have used the strong contrarian signal issued by the BusinessWeek cover to literally “back-up-the truck” and invest as much as they could. If an investor had bought the Dow Jones Industrial Average then (with the index at 870) and held it until today (with the index now at 26,500), he would have compounded his money by 12.3% per year over 40 years - by far the longest and strongest bull market surge in U.S. history.
What made the editors of BusinessWeek so bearish on stocks? While everyone remembers the cover, few people recall the subtitle: “How inflation is destroying the stock market.” By the late 1970s, intractable inflation, which was distorting the returns of almost all investments, had become a universally accepted problems by all investors. The cover story related the firmly entrenched consensus investment opinion:
“The masses long ago switched from stocks to investments having high yields and more protection from inflation. Now the pension funds - the market’s last hope - have won permission to quit stocks and bonds for real estate, futures, gold, and even diamonds. The death of equities looks like an almost permanent condition –reversable someday, but not soon.”
Everyone including the editors of BusinessWeek believed future equity returns would be severely and permanently impaired by inflationary problems that would only get worse. For investors without gray hair, it is hard to believe how different the investment landscape looked 40 years ago and how bearish investors had become. Ever-rising inflationary expectations had convinced investors that neither bonds nor stocks should be bought at any price. The U.S. inflation rate hit 14% in the summer of 1980 while the Fed Funds rate peaked in the summer of 1981 at over 22% and 30-year U.S. Treasury yields peaked in October at 15.2%. By 1980 bonds, dubbed “certificates of confiscation,” had replaced stocks as the most hated financial investment. By the late 1970’s, hard assets had become the most popular and recommended investment class. It is not surprising that precious metals, the best performing asset class of the preceding decade, had become the asset with “must-own” status. Cocktail party banter often centered around how many Krugerrands “smart investors” had stuffed into their safe-deposit boxes. By late 1979, oil hit $25 per barrel; an eight-fold increase in 10 years. After two energy crises, everyone firmly believed we were running out. OPEC would continue to control world oil markets and it was only a matter of time before oil breached $100 per barrel, or so went conventional wisdom.
The Dow Jones Industrial Average hit 1,000 for the first time in 1966. 13 years later, in the summer of 1979, the index traded as low as 850. At these levels, the Dow yielded over 6% and traded at a slight discount to its book value. Surging inflationary expectations and collapsing bond prices had produced the cheapest stock market in over 45 years. Despite its radical undervaluation, few investors outside of Warren Buffett owned it. No wonder BusinessWeek decided to published its now infamous “Death of Equities” cover.
In retrospect, we know how wrong BusinessWeek’s prediction was. A contrarian investor would have spotted huge changes in Federal Reserve monetary policy by 1979 which monumentally altered the investment landscape almost overnight. The commodity bull market broke in January 1980 when silver (the best 1970s best performing asset), spiked briefly to $50 per ounce and then promptly crashed, taking the Hunt Brothers with it. Inflation, as measured by the Consumer Price Index, spiked six months later and interest rates peaked in the summer of 1981.
The bear market in stocks ended in spectacular fashion. By August 1982, the U.S. stock market literally blew off the bottom and proceeded to surge almost 40% in the next four months alone. The August 1979 BusinessWeek cover did nothing more than express an opinion that had been cemented by trends that persisted for decades: inflation problems would never be solved, hard assets and commodities were the great beneficiaries of an inflation problem that could only get worse, and bonds and stocks should not be bought at any price. The 1979 BusinessWeek cover gave investors the strongest sign imaginable that inflation was about to significantly slow, that commodities would become terrible investments, and that financial assets were the buy of a lifetime.
How different the investment landscape looks today. The expectations of rising inflationary 40 years ago have been replaced by a strongly-held belief that inflation will continue to fall -- a trend that has been in place now for nearly two generations. Because of lingering fears from the 2008 global financial panic, investors continue to favor “risk-off” investments in general and bonds in particular. After experiencing a massive 38-year bull market, investors clamor for bonds: the riskier the credit and longer the maturity, the greater the demand. Even more absurd, nearly $10 trillion of government bonds now trade with negative yields – a first in 3,000 years of financial history. Even though governments continue to set new records for peacetime indebtedness, investor demand for their debt remains unwavering. Japan and Argentina are poster children for this absurdity. Japanese government bonds are issued by a country which has racked up debt approaching 250% of GDP, a level never seen in peacetime by any industrialized country. Argentina, one of the world’s great “serial defaulters,” issued a 100-year bond only one year after its most recent default. Demand for the bond was extremely strong and the issue quickly traded above par.
In the stock market, investors continue to clamor for high-quality technology growth stocks (the so-called “FAANG” stocks), several of which command near trillion-dollar market capitalizations. Investor interest in “risky” hard assets, commodities, and their related equities has approached zero, even though all three have never been cheaper relative to financial assets.
The reversal in investor preferences from hard assets to financial assets has been extreme. The trend started 40 years ago and has continued up to today with few interruptions. Despite its persistence, we believe this trend is nearing its completion and is about to reverse again in favor of hard assets. Why do we think this? Back in 1979, the “Death of Equities” BusinessWeek cover gave investors ample warning that inflation-sensitive hard assets (the most popular asset class at the time) had become radically over-owned and overvalued and, conversely, that financial assets (the asset class that no one wanted) had become radically undervalued and offered phenomenal returns.
What if investors are as wrong today about the pricing of “risk-off” assets as they were about the pricing of hard assets in 1979? Certainly much of the outperformance of “risk-off” assets over the last 10 years has been the result of falling inflationary expectations. What if the bet on constantly slowing inflation is about to be reversed and inflation begins to rapidly and unexpectedly accelerate over the next several years? Since 2008, the US, European, and Japanese central banks have conjured trillions of dollars of bank credit through quantitative easing. Despite this massive new credit creation, investors (in a fit of extreme trend-following) have become more convinced than ever that inflationary expectations will continue to fall. Even talk of introducing a new, radical monetary policy such as Modern Monetary Theory (MMT) has been met with a continued rally in bond prices.
Back in 1979 , with gold soon to spike to $850 per ounce and bond prices collapsing, investors bet that inflation would follow its 30-year trend and continue to accelerate while financial assets would remain depressed. Today, investors have made a completely different bet: in 1979 everyone believed inflation would never end, whereas today no one believes inflation will ever return.
Given the historical significance of BusinessWeek covers, we believe the April 22, 2019 Bloomberg/BusinessWeek cover, “Is Inflation Dead,” will turn out to be as historic as the 1979 cover. Just as the earlier cover predicted inflationary problems would never go away, today’s Bloomberg/BusinessWeek cover story tells investors that inflation will never be a problem again. The article explains how the danger facing investors is not inflation but rather deflation. It has taken 40 years to vanquish the inflation monster (as depicted on the cover), but we have now come full circle regarding inflationary expectations. The inflationary monster is now dead.
With the publication of this current Bloomberg/BusinessWeek cover story, we believe investors have once again been given an extremely strong contrarian indicator: inflation (which everyone thinks is now dead) is about to reemerge as a huge problem. Investors today have crowded into trades that are heavily dependent on inflation staying low. “Risk-off” financial assets have been the only source of market outperformance and profit. Tens of trillions of dollars worth of government bonds now sport negative interest rates and four tech companies command equity valuations approaching $ 1 trillion each. Gold has languished with little interest and there is even talk that oil will eventually trade toward “worthlessness,” according to a widely-followed newsletter writer.
Although investors forget, the long-inflation/short-financial asset trade that BusinessWeek recommended in 1979 began to unravel shortly after the publication of its cover story. Although it took three years for the bull market in equities to begin, the commodity bull-market bubble (driven by ever-rising inflationary expectations) broke in spectacular fashion soon after the cover story was published. Silver prices (which led the commodity bull market and were the subject of a speculative craze) crashed five months after the BusinessWeek cover story, bankrupting two famous brothers in the process. Today, with investors crowded into tech stocks, bonds, and other “risk-off” assets, we are looking for signs that these trades are about to become seriously stressed. Conversely, the asset class that absolutely no one has wanted to own —commodities, natural resource equites, and related “risk-on” assets - should reverse as well. This new Bloomberg/BusinessWeek cover signals to us that the 40-year trend of declining inflationary expectations is now fully incorporated in everyone’s portfolio, and at risk of coming undone.
The unexpected return of inflation will have monumental effects on “risk-off” and “risk-on” asset classes. Investors have made the bet that inflation will stay low; few are positioned for its return. This month’s Bloomberg/BusinessWeek cover gives a strong warning that everyone has made the wrong bet and yet no one is paying attention. The fat lady has come on stage, she is singing, and bells are ringing. Readers, we beg you to seriously listen and position yourself accordingly.
Intrigued? Please revisit our entire Q1 2019 letter and follow that up with our recently released Q4 2021 letter. Better yet – register for our mailing list and receive each letter as soon as it is released.