IS GLOBAL STAGFLATION HERE TO STAY?

Conclusion: Today’s action in the Hang Seng Index lends support to a theory we’ve been pondering for the past few weeks: global inflation is likely to shift beyond mere commodity reflation born out of US dollar debasement into the dreaded “core” inflation readings that will incrementally stymie global consumption growth.

 

Recent Positions: Short Emerging Market Equities (EEM, EWZ, IFN, ESR); Short Consumer Companies w/ multinational sales and/or global supply chains (MCD, TGT, JNY, VFC, XLP, XLY); Short US Treasuries (SHY); Short Developed Nation Equities where sentiment is misaligned with the fundamentals (EWJ, SPY, XLI); Long Crude Oil and Oil Producers (OIL; PBR); Long Commodity Currencies (FXC).

One question we’ve been wrestling with lately is: “Where do we go from here?” – particularly as it relates to the US Dollar-debased commodity inflation you’ve been seeing on your screens for the last 3-6 months. On this morning’s Daily Macro Call, Keith mentioned he’d get more constructive on equities as an asset class (particularly US equities) if the US dollar were to stabilize above its TREND line of resistance at $78.98.

IS GLOBAL STAGFLATION HERE TO STAY? - 1

Playing devil’s advocate, one could make a compelling case that the boat has left the dock with regards to global inflation trends. As we’ve seen with accelerating “Core” CPI readings, particularly in Asian economies like China, Indonesia, and Thailand, companies globally are taking advantage of recent robust global growth trends and bullish growth forecasts to pass through COGS increases to consumers.

The US, China, Japan, India, Brazil are just a few major economies where consensus growth forecasts for 2011 are much, much too high relative to our models and the current Global Macro backdrop of accelerating inflation and higher interest rates.

Irrespective of the tired argument between the importance of “Core” vs. “Headline” CPI, the key takeaway here is that even if commodities start to back off their current highs (i.e. if MENA conflict stopped today and crude oil went back down to the $80-$85 range), there is a very high and underappreciated possibility that global inflation readings will continue to accelerate for two main reasons: 

  1. Corporations  – particularly public companies with FIFO accounting – will look to overly bullish global growth estimates as justification to pass through the last two quarters of COGS inflation through the supply chain to end-consumers in an attempt to protect both margins and earnings; and
  2. The recent global uptrend in public officials caving in to populist pressure to increase subsidies, transfer payments, and wages will continue to add to the demand-side inflationary pressure and exacerbate the current supply/demand imbalances of many commodities in the near term. Longer term, this artificial support of consumer demand is likely to result in additional price pass-through to end-consumers, which is likely to stymie consumption growth over the intermediate term. 

Since we all know where consensus is at regarding the current lofty global growth assumptions, we’ll just skip right to addressing point #2. A few specific examples of the recent global trend of increasing subsidies, transfer payments, and wages include: 

  • China: As the gov’t moves to rebalance the economy towards a greater reliance on domestic consumption, minimum wage hikes are anticipated in all 31 provinces for the second consecutive year, with key populations such as Guangdong, Beijing, and Shanghai are at the forefront of gains;
  • Indonesia: Plans to remove longstanding subsidies for fuel in March have been scrapped. In the past, the removal of such subsidies have led to protests which brought down Indonesian governments, such as the Suharto regime in the late ‘90’s;
  • MENA: Speaking of protests, Jordan, Algeria, Morocco, Yemen, Libya, and, perhaps most importantly, Saudi Arabia have flooded their economies with transfer payments to ward off current and future protesters (see: “Day of Rage” planned in the Saudi Kingdom on 3/11). Specifically, the Saudi royal family just announced a $37B benefits package last week in what may turn out to be a moot effort to prevent a domestic social upheaval;
  • India: In its latest budget (released Monday) the gov’t is attempting to boost incomes through greater income tax exemptions. Moreover, it is increasing subsidies for housing loans and allocating $1.44 TRILLION rupees for food and fuel subsidies. Additional subsidies are expected to be announced in the coming weeks.
  • Thailand: The gov’t just recently extended a program that provides free electricity and public transportation for the poor.
  • Brazil: President Rousseff just announced a R$2.1B ($1.3B) increase in funding for Brazil’s Bolsa Familia transfer program which will allow even more families to receive benefits. 

Perhaps more so than the other countries, Hong Kong’s capitulation on this front last night revealed an interesting takeaway as it relates this trend with respect to developing vs. developed economies. Given that most regard Hong Kong as a reasonably developed economy, it was interesting to see the Hong Kong gov’t give in populist demands for additional handouts because it lets us know that this trend may no longer be contained to largely-indigent developing nations like those of the MENA region, India, and China.

After Chief Executive Donald Tsang (the highest ranking H.K. official) was assaulted amid a wave of public protest yesterday, Financial Secretary John Tsang agreed to hand out cash, tax rebates, pension injections to the tune of HK$6,000 in each instance. This is in addition to his decision last week to wave public housing rents for two months and provide subsidies for electricity bills while talking up the dangerous inflationary pressures of providing cash handouts.

Addressing the media overnight, Tsang had this to say: “We find this is the best way to respond to demands from residents…”

We at Hedgeye also find this to be among the best ways to support our call for Global Inflation Accelerating. Perhaps that’s why the Hang Seng backed off its TRADE line of resistance hard overnight, closing down (-1.5%).

IS GLOBAL STAGFLATION HERE TO STAY? - 2

All told, we’ve been beating the table on Global Stagflation since October. Now that consensus has figured out the inflation component as oil trades above $100/bbl., our task is to figure out how to time consensus’ uncovering of the bearish growth factor on the short side of equities. If 2008 is any guide, they will kick, scream, and buy every dip on the way down – provided we’re headed there; ultimately, time and space will tell.

Darius Dale

Analyst