Ever since I wrote the piece “Save the Ponzis, Save the Plebs” (here), I’ve been in deep thought about the concept of Inflation and Policy Makers’ incentives (“What does Yellen want?” is the first and foremost existential question I try to answer!). In this piece I attempt to put out some of these thoughts on paper. The conclusion is really simple but it has profound implications on investing. So here it goes.
I simplified “Inflation” down to 2 types of inflation:
a) Wealth-flation: This is mostly asset price inflation, which would measure how quickly assets rise over time, therefore how wealth accumulates over time. Some real life examples would be real estate trends, private schools fees, the price of luxury items etc. But I want to make my life easy so I will be using $SPX as a proxy. It’s a rough guide but it’s an honest, real-time, mark-to-market index and I trust it more than Private Equity marks ;)
b) Pleb-flation: This is inflation related to the basic cost of living. This is the kind of inflation that 99.9% of people experience: cost of food, oil price, the cost of living etc. I will be using CPI as a proxy here. Again, it’s not perfect but it’s good enough (PS: If you are offended by the term “Pleb”, please don’t be: we are all Plebs at the end of the day!)
I then plotted the S&P YoY performance vs the CPI YoY since 1970. This is the result:
One can readily observe that for Policy Makers the “Optimal Pleb-flation” is between 0-4%: The “Plebs” are happy or at least not complaining much, while the rich are getting 0-30% gains per year through “Wealth-flation”! And when the rich get richer thanks to the Policy Makers, then the Rich can hire the Policy Makers as advisors to their Private Equity / Hedge Fund / Ponzi Corporation! Everyone’s a winner! (Well kinda. The Plebs just get by).
But once we cross >6% Pleb-flation then, oh boy, the Policy Makers know that the Plebs will be coming for them with Pitchforks. And then it’s not a tough choice between getting lynched or getting a cozy advisor role. So they take drastic action. That drastic action creates volatility in “Wealth-flation” and sometimes pretty darn nasty market corrections: We lived through 2022 but similar periods include 1973, 1974 and 1981.
The best way to visualize the Policy Maker reaction function is to introduce another character in the Shrubverse: “Tamagotchi Yellen” (“tamagotchis” are those virtual pets that you have to keep “happy” by feeding them just enough food and petting them once in a while).
As long as Pleb-flation is below <4%, Tamagotchi Yellen is happy and she can keep the Fiscal taps running and the Fed can keep monetary policy loose. Then the rich can experience “Wealth-flation” smoothly with low volatility. As if the game is rigged or something!
But when Pleb-flation rises >6%, then Tamagotchi Yellen has a problem. She gets angry and has a tantrum. She really wants to keep the Fiscal taps running and she probably still does. But with all her unholy powers she knows she can’t also get the Fed to keep monetary policy loose, otherwise the pitchforks are coming. So she and / or the Fed have to take action. And this is where volatility is introduced in “Wealth-flation” which can result in steep corrections.
Now you ask me, why does it matter in the current market setup?
It’s actually quite relevant: lately a lot of market participants were arguing that the market is “too high” so, even though Inflation is trending lower, the Fed and Tamagotchi Yellen would be prudent in their decisions and actions and they would keep monetary policy tight and coupon issuance strong, in order to prevent any future bubbles from forming.
But as we have just learned, Pleb-flation is different from Wealth-flation. The Fed and Tamagotchi Yellen have declared victory on Pleb-flation:
“Save the Ponzis, Save the Plebs!!! Mission accomplished”!
Do they care about Wealth-flation going rampant?
Well, they do know that asset price inflation can lead to Pleb-flation. But it’s an Election year dammit! So lets just worry about that later, ok?
Here’s where you say, “Shrub, I didn’t have you for a conspiracy theorist”.
To which I say: remember all those Trump videos boasting about the stock market performance? Well look at Biden’s twitter post last week here , where he cheers the new all-time-highs in the stonk market!
It’s all a bit like Animal Farm. Different leaders, same story. And I’m saying this purely from an investing perspective as an a-political, non-voter and with no offense to either candidate! They are just playing the game they were given!
So here’s the summary, for traders with ADHD:
The game is rigged. Shocking I know. BUT, it’s rigged as long as Pleb-flation is in check.
If Pleb-flation is in check, the policy makers will NOT care about “Wealth-flation”. It’s fundamentally wrong to be bearish because you assume that “they” care ! They don’t!!! They will party like it’s 1999, they will make new bubbles, they will then blow the bubbles and here we go again!
“Wealth-flation” is fun (and speaking of fun, have you watched Blackstone’s holiday video?). But Wealth-flation often does lead to Pleb-flation, with a lag. “They” know it. And sometimes “they” care. But none likes being a party-pooper, especially in an Election Year! So lets' worry about that later shall we?
To clarify: This isn’t a call for a new Bull or a new a Bubble. In fact, we can very well crash tomorrow for all I know!
The whole point of my analysis is to further my understanding of the “Game”. And to understand the “Game”, one needs to understand the “Actors” in the “Game” and their respective “Reaction Functions”. And a key actor in this Game is “Tamagotchi Yellen”. And now we understand her reaction function and what makes her “happy” and what makes her “angry”.
So Stay Safe and Position Accordingly!
Disclaimer:
This isn’t financial advice.
This is the trading blog of a shrub.
Don’t be Stupid.
One of your best Shrub. You did give away your age with that tamaguchi but fck it was worth the laugh 😆
Simple framework describing the "game" as it *is*, instead of as we would want it to be.