Q3 Market Update & Commentary

November 11, 2021

Welcome to fall. We’ve had a splendid autumn here in the Boulder / Denver area. Whereas we usually transition directly from wearing shorts to donning parkas, this season has been full of lovely 60-degree days filled with sunshine.

While most have been rejoicing not only about the weather but also their stock portfolios, the investment team at BSW has been looking through the euphoria and is none too excited about what we see lying beneath the surface. We see this market as being driven by an unprecedented flood of money that will likely start reversing course this month. This cascade of money has had other knock-on effects as well. Read on to see what’s got us ready to unfurl the umbrella – despite these sunny days.

As we’ve highlighted in the past, the Fed’s balance sheet absolutely ballooned during the pandemic. It added $4 trillion to the economy. Other central banks around the globe were all doing the same – resulting in global central bank balance sheets swelling to $100 trillion. These types of numbers have been bandied about so much recently, that for many people they’ve lost their imposing magnitude. Reality check: A trillion dollars equates to printing $1 every second of every day for 31,710 years! While economic stimulus was likely warranted during the depths of the pandemic, it seems the Fed has continued on a crash course even as the economy has recovered.

Knock-on effect 1:


Inflation, once a thing of the past (or was it?), is now front and center. Oil is up 13%, natural gas is up 52%, and eggs are up 12%…SINCE THE LAST BSW MARKET UPDATE POST in mid-July of this year. The official headline October CPI number hit 6.2% on a year over year basis. This is the highest reading since 1990.

Most of the stimulus cash has landed in people’s bank accounts, temporarily driving up savings rates and no surprise, spending. Although are we truly better off if everything costs so much more?

Much of recent inflation is due to the stimulus-induced-demand clashing with supply chains that were not built to handle such a sudden surge. Some of these supply chain logjams should fix themselves over time – but likely not any time soon. Case in point, it takes time to build more semiconductor chip factories and better infrastructure to handle the flow of imports and energy across the country takes years to get shovel ready.

Not only is current inflation high, but after digging into how the actual CPI number has been calculated over time, I ran across this interesting chart at shadowstats.com:

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Since its inception in 1913, the methodology by which CPI has been calculated has continuously morphed. The chart above compares the way CPI used to be calculated back in 1990 (blue line) with the way it is calculated today (red line). Based on the 1990 methodology, CPI has been running closer to 5-6%/year as opposed to the more reasonable 2%/ year using today’s methodology. The main difference has to do with what is called Owner’s Equivalent Rent, or OER, which replaced more traditional housing costs in 1999. OER is what a homeowner would theoretically be paying to rent their own home. The U.S. Bureau of Labor Statistics does not consider any expenditure going into owning your home as “consumption or shelter” rather they consider it “investment.” Crazy? Yes. Convenient for them? Maybe.

Other changes along the way have also resulted in lower inflation numbers being reported. The adoption of “chained” CPI in 2002 resulted in the reweighting of goods in the CPI basket that were going up most in price. This was ostensibly to account for people buying less of those goods as prices rise and substituting for lower cost replacements. Hospital prices have been rejiggered to focus less on healthcare inputs and more on a single line item for a treatment-oriented item definition. It seems that nearly every change  resulted in a marginally lower inflation reading over time.

You get the picture. However, this is not a BLS witch hunt. Let’s face it; boiling down inflation to one number is not easy. And if measuring inflation is hard, try managing it. The Fed thinks they have their inflation playbook set, but more evidence is coming out highlighting that inflation is more than simply too much money chasing too few goods. Many believe it is as much a psychological and societal phenomenon as it is financial. That may also be why the Fed is talking down inflation. Simple expectations of future inflation can further drive inflationary behavior.

Knock-on effect 2:

Flood of Money into Stocks and Real Estate

BSW is also closely monitoring another of the intended consequences of this flood of money, namely the swift ascent of asset prices and especially those of stocks and property. Homes are up an average of 19% over last years’ prices and we are watching the stock market make new highs every day. The Fed wanted this to happen. By keeping interest rates so low, they have encouraged investors to take more risk to try and get some return. This has resulted in asset owners feeling wealthier. Importantly, it has also led to those not owning assets to be worse off. Over 46% of Americans do not own one stock, not even through company retirement plans! Those at the bottom are feeling the full brunt of inflation without any of the benefits of partaking in the upside.

But is it really upside? Are assets really getting that much better, or could it be that the mighty U.S. dollar is getting progressively less valuable? The charts below speak volumes.

Here is a chart of the S&P 500 (log scale) priced in USD:

Here is a chart of the S&P 500 priced in gold (log scale):


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Here is a chart of the S&P 500 relative to the Fed’s balance sheet:

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If we denominate the S&P 500 in gold (chart 2 above) it is essentially flat since the early 1970s. If we denominate it in relation to the Fed’s balance sheet (chart 3 above) it has gone nowhere since 2008 (meaning the majority of gains in the S&P 500 can be explained by the increase in the Fed’s balance sheet).

This is what the neoclassical economist Irving Fisher called Money Illusion. Money Illusion is the inflating of asset prices by deflating the currency in which it is denominated. I don’t think houses became 19% better this year and I know the gas I put in my vehicle didn’t get any better. How does the deflating of a currency happen? By printing more and more of it.

The Fed can indeed control the money spigot, but they cannot control where that money flows. Following the river of money, it appears as if most of it has pooled right into the S&P 500. This has resulted in the top 8 stocks within the S&P 500 ballooning in value. As a group, these eight stocks – Microsoft, Apple, Amazon, Tesla, Alphabet (Google both share classes), Facebook (now Meta) and Nvidia – now make up almost 27% of the entire index. When $1 is directed to the S&P 500, 27 cents of it buys these top stocks – no matter what. Not only that, but each of their forward P/E ratios are above the S&P 500 overall forward P/E ratio of 22x (recent historic average is closer to 15x). The priciest of the bunch, Tesla, sports a 147x forward P/E and is worth as much as the other top 10 car companies combined!

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Tesla vs. Next 10 Automakers – wolfstreet.com

Steps we are taking:

BSW will be trimming exposure to U.S. large cap stocks over the next few weeks. The run in these stocks may not be over, but we don’t believe in trying to call the top.

The BSW investment group is also conducting deep due diligence on assets that might act contrary to the debasing of the U.S. dollar and further inflation. The risk, in our view, is underestimating how much of a hidden drag these two forces can have on an investment portfolio – especially over longer periods of time due to the insidious effects of compounding.

Most of us spent way too much time on treadmills, stationary bikes, and other forms of hamster wheels during 2019/2020.  We are done with static. Making good returns on investment assets only to have prices increase at the same level is akin to walking the wrong way on a moving sidewalk. Moving forward and seeing goals get closer, not farther away, is part of how we help Make Life Better for our clients. Stay tuned for more details on how we intend to help clients navigate this slippery slope.

Thanks for reading.

Craig Seidler

BSW Director of Public Investments