Here Comes Trumpflation… But Not the Way You Think

The consensus view on Wall Street is that PEOTUS is about to bring $1 trillion in stimulus to the United States – this spending is expected to increase the prices of things, aka inflation; aka Trumpflation. Trumpflation is expected to be benign, gently lifting prices like an old man from a warm bath. But what if its not? What if there was something else lurking that could bring a more sinister type of inflation – the type that eats into profit margins and reduces consumer spending power?

BK is here to tell you that there is something more sinister and it steaming toward the US on a Ultra Large Container Vessel (ULCV).

Factory gate inflation (PPI) is soaring in China – the most recent reading released overnight suggests that the cost of producing in China has climbed by 5.5% on a year over year basis. This is the fastest rise since 2011 and the fourth straight month of increases. If it wasn’t clear already, the era of cheap Chinese production is over.

As you can see from the chart above, Chinese PPI is closely tied to US CPI. This means that the price of things we buy in the US is going up. It also means that companies with supply chains that stretch to China will have to raise prices…if they can.

For some US companies raising prices is unlikely to be a problem, but for others, low priced imported goods are the business model. Let’s take the two most obvious examples, Wal-Mart and Apple. Apple manufactures the iPhone in China via Foxconn – since the cost of doing business in China is rising Foxconn is likely to raise its prices to Apple. Thanks to the cult-like status of the iPhone and the potential for subsidies from mobile phone carriers, the price increase could go unnoticed. But low cost retailers like Wal-Mart face an entirely different challenge. The Wal-Mart business model is to sell low priced goods sourced from China. Promotions like “roll-backs” and price matching are integral to the perception that Wal-Mart is the place to get a deal. Customers are programmed to think that Wal-Mart will always have low prices. But what if that is no longer a valid belief? Wal-Mart (and many of the “dollar stores”) will either need to absorb the prices increases, thus reducing margins, or pass the increase on to customers breaking its implied contract with its patrons. There is no alternative.

On a broader perspective, more expensive imports means that the bond market is probably mispricing the risk of higher inflation. The 5 Year Breakeven inflation rate is pricing about 2% inflation, roughly the same expectation that has prevailed since 2009.


But if the cost of imports are increasing at the fastest pace since 2011 and that increase is expected to be sustained, then the bond market is wrong about 2% inflation. As is typical, BK is early on this view. There are others talking about it, but not enough for it to have an immediate impact on securities prices today. That being said, rising inflation (the bad kind) is one of BK’s themes for 2017.

Bitcoin and Yuan Break Up… For Now

The bitcoin and yuan relationship was made in financial tabloid heaven – two plucky upstarts traded hand in hand and the establishment hated it. The mainstream rejection served to make the relationship even steamier and the public demanded more juicy tidbits. Each time the Chinese government would try to separate the pair, the public demanded more bitcoin creating an ever stronger relationship. Bitcoin and Yuan traded together since 2015, but the relationship ended abruptly in the last 48 hours when the Yuan had its biggest ever two day gain (yes, gain), while at the same time bitcoin climbed well above $1100 to the highest level since 2013.

This is all a belabored way of saying that since 2015 as the Yuan weakened Chinese citizens bought bitcoin.


But yesterday, something different happened – as the Chinese government intervened to push USDCNY and USDCNH down (aka stronger Yuan) bitcoin kept rising. The euphoria over the rise in bitcoin appears to have clouded investors view that a primary driver of the bitcoin bull market just changed. If the Yuan has stopped weakening then there is not as much a need for Chinese citizens to buy bitcoin. Further, the Chinese government action implies that much stricter capital controls will be forthcoming. This threatens the bitcoin rally.

As much as BK hearts bitcoin, he is also cognizant that the digital currency is subject to the same human emotions as all markets – fear, greed, euphoria, and depression are the catalysts that drive human action to buy or sell – and it appears to BK that bitcoin investors may be blinded my euphoria.

Bitcoin is now trading at 5 (yes F-I-V-E) standard deviations above its trend!!!!!


This extreme move coupled with one of the key drivers breaking suggests the ride might be over…for now. In the long run, BK is quite bullish on bitcoin, but in the near term he must wait until investor depression sets in before he can think about adding new positions.

Twas the Night of Fast Money

Twas the day before the night before Christmas, when all through Wall Street
Not a creature was stirring, not even Preet;

The stocks were hung at the highs of the year,
In hopes that St. Stimulus soon would be there;

The Millenials were nestled all smug in their beds;
While visions of sharing danced in their heads;

And Dan in his ‘kerchief, and BK in his Bear Suit,
Were still looking for a bull thesis they could shoot,

When out on the Street there arose such a clatter,
Traders sprang from their screens to see what was the matter.

Away to the pits they flew like a flash,
And put on a tail hedge, preparing for a crash.

The sun on the breast of a perky little show,
Gave a lustre to the midtown to objects below,

When what to their wondering eyes did appear,
But a miniature sleigh and eight tiny rein-deer,

With a smart little driver quick and lively she be,
They knew in a moment he must be MLee.

More rapid than eagles her coursers they came,
And she whistled, and shouted, and called them by name:

“Now, Guy! now, Tim! now Seaburg and Karen!
On, Grasso! on, Pete! on, BK and Dan!

At the top of the hour! I’m talking to you all!
Let’s keep it lively and fun so ratings don’t fall!

So out to the NASDAQ the coursers they flew
With the sleigh full of trades, and Melissa Lee too—

And then, in a twinkling, upon the roof
The prancing and pawing of each little hoof.

As the clock was making the 5pm round,
Down the chimney the FM gang came with a bound.

Tim was dressed all in suede, from his head to his foot,
And BK’s Bear Suit was tarnished with ashes and soot;

A bundle of value Karen flung on her back,
And Guy looked like a trader from the way-back.

Dave Seaburg’s eyes—how they twinkled! his stock picks, how cherry!
While Pete’s picks were like roses, his options how merry!

Dan’s droll little mouth was drawn up like a bow,
And the options on his blotter were in the green as we now;

Steve Grasso held the stump of a pipe tight in his teeth,
While the profits, they circled his head like a wreath;

They had a broad audience that made other shows jelly
Which made them shake and laugh, like a bowl full of jelly.

They were bright and funny, right jolly old elfs,
And people laughed when they saw them, in spite of themselves;

A wink of M Lee’s eye and a twist of her head
Let them all know she was the one to dread;

She spoke not a word, but went straight to her work,
And turned around and called Guy a jerk,

And laying a finger aside of her nose,
And giving a nod, up the chimney they rose;

She sprang to the sleigh, to her team gave a whistle,
And away they all flew like the down of a thistle.

But I heard them exclaim, as they drove out of sight—

“Happy Christmas to all, and to all a Fast Money night!

BK: Bitcoin is Now Bigger Than Twitter… and Growing

The best performing asset class continues to do just that…perform. Bitcoin is up 85% YTD and boasts a bigger market cap than Twitter. In fact, it now has a bigger market cap than other notable assets like US Steel and so-called “unicorn” Twilio.


As BK has written, this massive out-performance has been accompanied by lower volatility than the S&P 500, Gold and Bonds.

The proximate cause of the bitcoin rally is demand from countries that are either devaluing their currency (China) or demonetizing (India, Australia and Venezuela). This trend should carry over into 2017. Moreover, as new use cases for bitcoin come on-line in 2017 the price should continue to have support.

So is it too late to buy bitcoin? Nope.

While an 85% rally might be the type a thing a skeptical trader would fade, when viewed in the light of past moves it appears this rally is just getting started. The following chart is a log chart of bitcoin since it started trading on exchanges in 2011 – this chart adjusts for percentage moves rather than just absolute price.


From 2011 to 2013 bitcoin moved from below $2 to over $1100 a stunning 58,000% increase!!! This meteoric rise happened when it was very difficult for the general public to buy bitcoin and few major corporations understood the potential of the technology. Since 2013 easy on-ramps have been built by companies like Coinbase which offers anyone with a credit card the ability to instantly buy bitcoin. As well, most financial institutions dismissed bitcoin in 2013, most notably Jamie Dimon of JP Morgan calling it a “terrible store of value.” Just yesterday, JP Morgan announced it would be a lead investor in the $20m financing round for a blockchain start-up called Axoni. Additionally in early 2016, JP Morgan was a lead investor in the $60m financing round of Digital Asset Holdings.

As more companies begin to explore the use of bitcoin and blockchain, the demand for this asset should rise at the same time that supply is severely constricted. The total supply of bitcoin is capped at 21 million coins, currently 16 million coins are traded freely leaving only 5 million coins in additionally supply. The remaining 5 million coins will be metered out by the bitcoin software over the next 100 years…yes a century.

One does not nee a PhD in economics to understand that when increasing demand meets decreasing supply the price goes up. So no, its not too late to buy bitcoin.

China – Airpocalypse Now

Gray Swan Alert

BK was struck by this story from the FT today –> China’s ‘airpocalypse’ hits half a billion people – not because of the brilliant title and not because the financial markets are slowing down into year end – but because man-made pollution is so bad that it shuts schools and airports and has the potential to be an economic shock.

The proximate cause of the ‘airpocalypse’ is coal fired steel and electricity plants that have been running at full tilt due to the government stimulus plan. As well, during the winter the general population turns on their heat in a ‘crazy’ attempt to stay warm.

Think about this air pollution as having the same economic effect as a major snow storm or a very cold winter in the US – plenty of companies blame poor earnings on weather events – now imagine these weather events being a permanent fixture. The long run solution is for China to require factories to clean up emissions like US factories are required. Of course this takes time and money. Moreover, this will add cost that will accelerate the rate of factory gate inflation.

In the short term the solution is to simply shut the factories down so that the general public can breathe. This solution would be an economic shock at the exact time that China needs GDP growth to prevent a massive deleveraging similar to what the US experienced in 2008. To be clear, BK is not calling for a 2008 style meltdown in China…yet…just that a highly leveraged economy that experiences slow growth is very vulnerable.

Is the Bond Bull Dead-Dead?

For 30 years US stocks have enjoyed the balmy trade winds of falling interest rates. In fact, T.I.N.A (There is no alternative) and the “Hunt for Yield” are not just kitschy constructs of the post-GFC markets – they have been operating in the background for three decades. This behind the scenes dynamic could be changing as many of the driving forces are in flux. Low wages from Asia (think Foxconn) are quickly becoming an historic anomaly adding to global inflationary pressures; inflows into China have reversed resulting in Chinese selling of US bonds; and the promise of a yuuuuge fiscal stimulus in the US are all contributing to the demise of the 30 year bond bull market.

While the bond bull market may be mostly-dead, but it’s not dead-dead.

The interest rate on the 10 year US Treasury note has yet to breach the 30 year down-trend line, which means there is still time to bellow air into the aging bovine.

Many have asked – via the Twitter machine – whether BK is still long TLT (the position he initiated before the FOMC meeting). The answer is yes. BK is long of the 20+ Year US Treasury ETF (TLT) as a way to trade an extended market that is approaching a major technical level – this is not to say BK is a raging bond bull. The truth is, BK doesn’t really know about the long term prospects interest rates. To BK’s mind the arguments for and against rising rates have equal merit – therefore he is obliged to fade the exuberance for a short term move.

While BK awaits the outcome of this short-term trade he will continue to try and answer THE question for 2017 – is the bond bull dead-dead?

This Investment Has Crushed All Contenders in 2016

If you think the strong dollar, the election rally, or bond bloodbath is the market story of the year then you haven’t been paying attention. Asset ‘X” is the best performing asset in 2016 – it is up +79% and has been less volatile than the S&P 500 (SPY), US Dollar (DXY) and Bonds (TLT).

Here is the breakdown:


And BTdubs: Asset ‘X’ is completely uncorrelated with any other major asset – not negatively correlated, completely and utterly correlation-less.


Correlation Matrix

If you haven’t guessed already, Asset ‘X” is bitcoin. Why has bitcoin had such a great year? BK is glad you asked…The sun shone on bitcoin in 2016 for two reasons that are likely to continue in 2017: capital controls and supply reduction.

Capital Controls

Controlling the flow of cash is no longer the domain of Greece and Cyprus; in 2016, China, India and Venezuela all restricted the free movement of currency in the name of economic stability…it hasn’t worked. Venezuela joined the rarefied hyperinflation club; India plunged into economic chaos after destroying 86% of it’s currency in circulation; and China has suffered some of the largest outflows on record. As governments cracked down, citizens flocked to bitcoin – the border-less medium of exchange and store of value.

Capital controls and the disdain for cash are likely to be the story of 2017 too. Australia has floated the idea of banning high denomination bills and Ken Rogoff has just started to market his book “The Curse of Cash” – which advocates for a cashless society.

Supply Reduction

This new love affair with a cashless economy has smashed head on with a reduction in the amount of bitcoin created. Bitcoin is programmed to have a maximum supply of 21 million bitcoin – currently there are 16 million bitcoin in circulation, which means there are only 5 million bitcoin left before maximum supply is reached. Unlike gold where higher prices result in a supply response from gold miners, the supply of bitcoin is fixed and the 5 million bitcoins remaining are scheduled to be drip-fed into the market at a rate of 12.5 bitcoin every 10 minutes – at this pace it will take over 100 years to reach maximum supply.

As we rip another page off the calendar, the demand for bitcoin looks set to rise while supply is permanently constrained. This is the perfect recipe for continued out-performance. If you are an investor looking for market beating returns with low volatility and no correlation then it behooves you to look at bitcoin in 2017.

Could a FED Induced Short Squeeze in Bonds be Good for Stocks?

The bond short squeeze meme is picking up steam. The Credit Writedowns blog has picked up the theme and has an excellent post on the extreme positioning in the bond market.

With everyone piled into a short position on safe assets, all we need is one crisis trigger to create the mother of all short-covering rallies back into safe assets, not just in the US but globally.

This extreme positioning coupled with a weak retail sales report gives the power to the FED to initiate the squeeze. Based on Commitment of Traders data (and anecdotal evidence), everyone and his brother’s uncle’s cousin’s dentist is short of bonds…expect BK 😉

This chart from Citi (via Jamie McGeever at Reuters) shows that the aggregate short position in the bond market is 5 standard deviations from the mean! BK is not a statistician…but even he can understand this is extreme!!


Given that positioning is the fuel for a short squeeze – a more dovish FED could be the catalyst. But would that be “bad” for stocks?

Not necessarily.

The rise in US interest rates has been relentless, prompting many to wonder how far is too far before it hurts the economic recovery. In fact,the so-called New Bond King – Jeff Gundlach – has declared a 3% yield on the 10 year bond would be detrimental to the US economy…and by extension US stocks. This fear has gripped most of the market coverage today (at least from what BK has read/watched), therefore any drop in yields could be met with relief. Imagine a scenario where the FED is willing to run a “high pressure” economy AND there is a promise of tax cuts with fiscal stimulus. Then add relief that rising interest rates will not be a headwind and you just might get a stock market rally based on short squeeze in the bond market.

Why is BK Long TLT?

Over the last fortnight, BK has harped on the “China is importing inflation” theme. He has suggested that buying gold (GLD) and Inflation Protected Bonds (TIP) was the prudent move in this environment. But last night on the television program Fast Money, BK argued that now was the time to BUY TLT – how can BK think that inflation is picking up AND that interest rates are going lower?

Answer: A combination of timing and extreme positioning.

BK is not the first to discover that inflation may be the story of 2017 – plenty of pundits and investment bank strategists have opined that Trumponomics combined with rising factory prices in China could lead to rising prices for US consumers. In fact, BK would suggest that much of the “bond market bloodbath” has been investors re-positioning portfolios in preparation of higher interest rates. The evidence of this shift can be seen in the futures market for both Eurodollars (the interest rate kind) and 30 Year US Treasuries.

In the Eurodollar market (short term interest rates) leveraged funds have the largest short position (green line) in the last 10 years.

The short position in 30 year US Treasuries is not as extreme as Eurodollars, but it has been steadily increasing since the US election.

The takeaway from the futures markets is that leveraged funds are all betting on higher rates…so who is left to sell?

On the timing front, the FOMC meeting offers the perfect trigger for bond prices to head higher. Despite BK’s longer term concern over China importing inflation, the economic data released today gives the FED cover to be more dovish at this week’s meeting.

Import prices dropped the most in 9 months, suggesting in the short term inflationary pressures have yet to hit the supply chain. This sets up a situation where funds are positioned for disappointment.

IBKHO the market is mispricing how hawkish the FED will be and herein lies the opportunity. If “everyone” is short and is expecting the FED signal multiple rate hikes next year, then all the FED needs to do is disappoint the market and voila… a short covering rally in TLT.

Interest Rates have Fallen Since the Election

Donald Trump has been credited (???) with causing interest rates to soar. This in turn threatens the expected economic surge from new policies, or so the narrative goes. The narrative is wrong.

A closer look at the data shows that while the rate on government bonds have spiked, the interest rates for the broader economy have fallen. The Chicago FED publishes a National Financial Conditions Index (NFCI) and Adjusted FCI (ANFCI) which tracks 105 measures of financial activity – an index reading below zero indicates loose financial conditions, while a positive reading shows tighter financial conditions.

Since the election the Chicago Fed FCI has fallen below zero.


So what gives? Everywhere BK looks he sees people with their hair on fire screaming about rising rates and how the “Fed already got its rate increase.” The answer can be found in the credit markets aka high yield bonds – the yields these bonds have dropped since the election.

The following chart shows the High Yield Bond ETF (HYG) since the election – higher prices mean lower yields.

After a 2 day sell-off, the high yield market went on a bull run, pushing yields lower. So while the US Government may have to pay a little more to borrow money, those operating in the real economy have actually seen rates drop.

This also means the FED has plenty of room to increase interest rates. As we head toward the Fed meeting, BK is quite sure many pundits will repeat the phrase that the rate increase has already happened… when they say that, just show them the two charts above.