Supply and demand drives inflation, including the supply and demand of money itself. Why did inflation spike in early 2022? Because we had record money supply growth in BOTH 2020 and 2021 combined with a Fed unwilling/late to act with regards to rate hikes. The M2 chart below captures the recent history of money supply growth. The US economy had never experienced back-to-back years of >20% money supply growth (including during extraordinary periods such as WWII). Money supply spikes, inflation spikes.
But just as quickly as money supply growth spiked, it is now collapsing. The excess money supply growth induced by COVID stimulus is plummeting. Core inflation ex shelter costs (the one watched very closely by Fed chair Powell) has started to fall and should continue to fall very, very quickly. This week’s minor market indigestion is the result of higher yields and the fear the Fed will be forced to hike rates further. The problem the Fed has is that inflation data is very backwards looking, and they don’t want to get caught trying to cure a problem (inflation) that has already been solved by higher rates and a complete collapse in the growth of money supply (liquidity). I continue to believe that the Fed has 1, maybe 2, hikes left in them…then they will be done.
Our themes and beliefs remain the same: Growth stocks and tech are allergic to higher rates. Value > growth. And once yields peak out, the USD dollar will follow and fall. That will resume strong performance in non-US equities relative to US equities (and yes, that includes China and EM).
Source: EISI as of February 21, 2023
Richard Barrett
Chief Investment Officer
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