Wednesday Briefs – 19 May 2021

THIS WEEK: Inflation Scare; Tax Day Philosophies; Israel – Gaza; Musk Soft Landing.

INFLATION SCARE

“It was mainly because of used cars and trucks” was one explanation for the unexpected jump in CPI in April. That number came at 4.2% year on year vs. 3.6% expected. Matthew Boesler of Bloomberg News produced a helpful chart showing that inflation remains tame if we exclude used cars and trucks.

The fear however is that inflation is a rolling phenomenon. Last month, it was used cars and trucks. This month, it could be another sector. And next month, still another. There are for example reports of some businesses deferring investments due to the high costs of such raw materials as lumber and copper.

The underlying constant is the consumer’s ability to pay up. The pandemic has helped households reduce their debts and repair their balance sheets. After a confined existence for the past fourteen months, they are now ready and willing to spend as the economy reopens. The huge energy dammed in the past year by millions of trips not taken and millions of events not attended is breaking loose. Coupled with the wish to once again live in full, it may quickly turn from a growing spending stream into an uncontrolled gusher.

Wharton’s Professor Jeremy Siegel voiced his concern that the Fed is taking too much risk by staying put. In this CNBC interview, Siegel deemed Jerome Powell “the most dovish Fed Chairman that I have ever seen, not acting against what is very obviously inflation, and we are going to have a lot more”.

The consequences of the Fed falling behind the curve are not known to be benign. The 10-year yield stands at 1.6% today. With annual inflation of say 4% (Siegel thinks 20% is possible over three years, or 6.3% per year), the yield would jump significantly even if we assume a real rate of minus 1% or of zero. This would be negative for financial assets (stocks, bonds) relative to real assets (real estate, gold, commodities) for a year or two. (Note: this is not Siegel’s view. He remains positive on stocks on a relative basis).

TAX DAY PHILOSOPHIES

Tax Day was upon us this week in the United States after a one month reprieve granted due to the pandemic and its effects. This is the usual time of the year when the philosophy of taxation gets an airing from various sides: taxes are too low, taxes are too high, taxation is fair redistribution, taxation is theft, etc.

On the “taxation is theft” extreme are libertarian commentators who visualize a world of unbridled freedom. By this, they mean not only the freedom to set one’s own course but also the freedom to ignore the public good or to invest in it only on a voluntary basis. This theory holds some appeal especially among high earners who believe that their wealth is first and foremost the result of their own meritocratic effort.

At the other extreme are the “billionaires should not exist” advocates, no less misguided about the nature and origin of wealth in society. Whereas the libertarian is prone to overemphasizing the role of personal merit in one’s financial standing, the all-equalizing militant downplays that role to almost nothing. In his view, a person gets wealthy as a result of birth privilege, connections and/or luck, with merit playing a small supporting role.

As most reasonable people acknowledge, these are academic debates. The key question is not whether to have taxes but what level of taxes. Too little means a decrepit infrastructure and faltering social capital (possibly leading to unrest). Too much means an inefficient state that is trying to do too much and that is crowding out the private wealth-creating sector.

ISRAEL – GAZA

Unfortunately, there is some cold logic to the lack of a ceasefire. According to analyst Tim Marshall in this SkyNews clip, once the shooting began, each side resolved to pursue specific objectives: for Israel to degrade Hamas’s capability and to crimp its ability to stage large operations for the next several years; for Hamas to test with new missiles its ability to penetrate Israel’s Iron Dome defense shield.

The Iron Dome seems to have functioned well based on reports that it stopped 90% of the missiles launched from Gaza. But 10% is seen by Israel as an unacceptable number of hits on its urban centers. This map from the New York Times shows that some Hamas missiles struck deeper than in previous episodes of this conflict. As technology improves, the Dome will be made cheaper and more effective. Meanwhile if history is a guide, Hamas will also draw whatever lessons it can and will review its efforts to penetrate the shield through other means.

This calculus is costly in lives and property. But until diplomacy and governance see a better day, it is the tragic reality on this war front.

MUSK SOFT LANDING

Elon Musk once told an interviewer that he saw a cautionary tale in the life story of Howard Hughes, a visionary entrepreneur to whom he is sometimes compared. After a banner 2020, Musk seems to be heeding that tale by adjusting his message on a number of fronts.

His appearance on Saturday Night Live was a win for Musk because it made him more likable and human. Similarly, his retreat on cryptocurrencies restores some grounding to his social media persona.

We speculated last March 3rd that we had seen Peak Elon in early 2021. Tesla stock is down 35% since its January 25th peak and is now near its 200-day average, an important technical level. If it continues to fall, the next technical level is in the low 400s. The latest version of Elon will be more effective in this downdraft. The former more mercurial Elon will undoubtedly return soon enough, with many more exciting projects.

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