How Much is Too Much of a Good Thing?

Stock indices closed the month of October having recovered all of the ground they ceded in September. For the month, the S&P 500 gained over 6.75%, the Nasdaq 100 added 7.47%, and the Russell 2000 gained just under 4%. Big tech names were the biggest winners this month. Tesla gained a whopping 41.7%, Nvidia gained over 23% and Microsoft added 17.12%. These are some rather significant moves for companies with extremely large market caps.

Long-term interest rates fell this month, causing TLT (iShares 20+year US Treasury Bond ETF) to gain over 2% this month. Most commodities continued to go up this month. Crude Oil futures gained over 10%, High-Grade Copper futures gained 6.8%, December Corn futures gained 6.3%, and December Cotton futures rose 10.3%. I highlight the rise in many commodity prices as an illustration of the rising inflation rate. Supply chain disruptions are being blamed for much of the rising costs. Whatever the cause, if we continue to witness inflation rates of 5+% year over year, interest rates are going to have to go up and go up fast. If the Federal Reserve refuses to address the elephant in the room, namely that everyday consumers are watching the purchasing power quickly evaporate, then the problem will begin to spiral out of control.

However, should the Fed have to slam on the breaks and raise rates you should expect asset markets to start to panic. I still believe, however, that the equity markets will continue to push higher in the short run. Early stages of inflation are similar to the beginning of a party, everybody is excited and enjoying the music. But, like binge drinking, the after-effects are extremely painful. Investing in this environment can get pretty tricky. Siting in cash is a certain loser if/when inflation is averaging 5%. A static bond allocation with rates below inflation is also a certain loser. Equities and commodities remain the sole salvation for anyone hoping to keep up with the cost of living, hence the tendency for stocks to remain en vogue during the early stages of inflation.

Ultimately, rising costs eat into demand. As demand suffers so to do corporate earnings, which should impact stock prices. For people seeking refuge from a deteriorating currency during times of stagnant growth and high inflation, gold has been the traditional life raft. However, for the better part of a year gold has been mired in a sideways price pattern. In fact, since August 2020, gold has declined by nearly 15%--hard to imagine given the rising cost of nearly everything else. My opinion is that gold is suffering at the hands of crypto currencies. Cash looking to exit the fiat currency game has turned to crypto rather than the 2000+ year solution of precious metals. It remains to be seen whether this trend will continue or not. Should the FOMO chasing crowd begin to get hurt elsewhere it seems conceivable that those effects could ripple into crypto. Which could leave gold the lone winner.  

Thanks for reading,

Zach and Dave

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