Peak Inflation?
“Finding investments is easy, waiting is hard, waiting is the hardest part”
-Clay Baker
The Portfolio Performance
The portfolio is up 14.45% YTD
Our benchmark, the S&P 500 is up +23.78% YTD
Peak Inflation
Inflation has been front of brain for most people lately. I think it's mainly because the things we buy most and interact with on a daily basis have seen considerable price increases in a relatively short period of time. At the same time we hear the Federal Reserve telling us that inflation is transitory and in time high prices will go away. The logic is really hard to follow when the reality of higher gas prices, high food costs, higher wages and more keep slapping us in the face. All of that must be inflation, right? Most likely it's not inflation, it's just a few items experiencing short term pressure.
I'm looking at something most people don't think about and the trend tells me it's time...
I'm going to call it, I think we've seen peak inflation. -Clay Baker
There's a tool that many professional investors use to keep an eye on inflation and the potential direction of the markets, it's called the Baltic Dry Index. The Baltic Dry Index is a shipping trade index created by the London Baltic Exchange. The index measures the change in the cost of transporting various cargos by sea. The cargos being measured are those that are critical to making almost everything be consume. The index looks at 23 shipping routes and tracks shipping costs for various vessel sizes.
The index rises as demand rises and prices continue to increase. Likewise the index declines as demand declines and prices decrease. Dry bulk cargoes are divided into two categories: major bulks and minor bulks. Major dry bulk commodities include iron ore, coal, and grain. Minor bulks include steel products, sugars, cement.
The BDI predicted the 2008 recession when prices dropped dramatically. Between September 2019 and January 2020, the Baltic Dry Index (BDI) fell by more than 70%, a strong indication of economic contraction. This decline happened just ahead of the outbreak of the COVID-19 pandemic. As we entered 2021, the BDI rose dramatically as delays in global shipping and other supply chain disruptions caused prices to soar.
The chart below is the BDI from 1985 to present day. The chart shows the dramatic rise in the BDI in 2004-2005, a time when supplies were becoming constrained by demand. Then in 2006-2007 the BDI sky rocketed to an all time peak above 11,000; something was clearly wrong in the economy as the index was showing abnormally high prices and demand. When the financial crisis hit the BDI collapsed.
We can see in the chart that inflation is above the normal range and that the index peaked in early October and has declined about 50% since the first week of October.
This is about as close as any of us will ever get to having a crystal ball with fresh batteries. With the index sitting at 2,861 today, and the future forecast is for 2,838 by the end of the quarter, it's reasonable to assume that the BDI is trending back to its normal range and inflation numbers should decline along with the BDI.
I should note that the BDI is sort of an early warning indicator. The commodities being transported are raw materials that need to find their way to customers and then through manufacturing and distribution. Many manufacturers can project into the future what their input costs will be and adjust prices of their finished good accordingly to be more competitive.
What about oil?
The metrics above are just dry bulk cargos, crude oil and related cargoes fall into an index known as the Baltic Dirty Tanker Index. Those cargoes are separated into very specific types of commodities along all the shipping routes and by tanker size. The main take away for all of us is that the cost of transporting crude oil has been in decline for many years, reflecting the declining global demand for oil. As global investments in alternative energy, development of more efficient vehicles, buildings and homes, and the increasing development of consumer packaging that relies on plant based plastic vs petroleum, we should continue to see demand for oil to decline.
Clearly we have seen periods of rapid demand causing spikes in demander gasoline and oil during periods of strong economic growth, but the long term demand has been decreasing as new technologies that use less crude oil are emerging at a rapid pace. Some economists believe we have already seen peak oil demand.
The chart below shows U.S crude oil demand since 1985. The rapid rise in demand that occurred at the same time we were approaching the financial crisis is easy to see and we should keep in mind that the EV industry and alternative energy was still in its infancy. From 2009 to today we can see some dramatic spikes in oil demand, but the trend is clearly moving in a downward direction. The current spike in energy prices will pass and we'll see gasoline prices and home heating oil moderate. In time there will be an inflection point where the cost to pump and deliver crude oil will simply be too expensive compared to other energy choices.
What Does This Tell Us?
The main take away for me is that as an investor I want to be putting my money to work in companies that are developing the most innovative and disruptive technology. I want to take 5 year perspectives and try to figure out who will be leading. With every major and many minor oil companies shifting from crude oil and natural gas production to wind, solar, hydrogen and battery development, we should all realize that crude oil as an energy source is moving into the rear view mirror of history. We are witnessing a transition that is exactly like the transition that occurred when we moved from whale oil to kerosene in the 1800's.
We are witnessing a transition that is exactly like the transition that occurred when we moved from whale oil to kerosene.
The pandemic pulled forward at least 5 years of technology innovation and adoption. Technology is deflationary, pushing cost down and wages up. Technology is making it possible for us to live wherever we want and still do our jobs; the "work from anywhere" society. Technology is making us more mobile, more productive and creating wealth that was previously unconceivable. We're witnessing companies hiring at levels never before imagined. We're seeing technology open the entire world as a marketplace for small businesses that once were isolated to their local neighborhood.
The market is at an inflection pint and I plan to keep investing into the end of the year and holding the =really great companies for the long term. I don't think I'm going to continue managing this portfolio of annual returns, but rather for longer term growth that can only come from far more innovative companies.
Next year I'm going to get on a motorcycle and take a very long ride. Along the way I'm going to be talking to people, visiting businesses and trying to get some more insight into investment opportunities. Hopefully I can find a way to bring all my readers along for the ride.
"Markets don't go to zero, Portfolio's do.
Buy quality, be patient...and look twice for motorcycles."
- Clay Baker
Stay Invested,
Clay Baker
ENTER YOUR NAME & EMAIL ADDRESS TO SUBSCRIBE
Keep Me Honest 2021
The S&P 500 will achieve year-end earnings of $170-$175 (1-1-2021).
We are likely to have a significant pull-back during the 1st quarter, about 5%-10% (1-1-2021).
Stock picking will outperform algorithmic trading again as it did in 2020 (1-1-2021).
S&P 500 will reach 5,000 by year-end.
Clay's Rules
Rule #1: Don't lose money
Rule #2: See Rule #1
Rule #3: Portfolios go to zero, markets don't, Stay Invested
Rule #4: When good stocks you own drop 10% below your cost basis, add shares
Rule #5: Bull markets aren't sustained without the Transports
Rule #6: When Forward P/E is lower than TTM P/E, expect earnings to increase
Rule #7: When an investment bank sells below book value, buy it
Rule #8: Tips are for waiters. Do your own homework.
Rule #9: Don't sell a stock because you're bored with it. Do your own homework.
RULE #10: Being early and being late is the same as being wrong...move on.
Rule #11: Investing is easy. Waiting is hard, waiting is the hardest part.
Disclosure: I am personally invested long in some or all of these stocks or funds that appear in the Stay Invested portfolio and may purchase or sell shares within the next 72 hours. I am also invested in other stocks and funds that do not appear in the Stay Invested portfolio but may be mentioned or related to this article. It is not my intention to advise or encourage the purchase or sale of any security. I am invested long in these securities mentioned in this post:
AMD, AMRN, AMZN, AAPL, ARKK, ARKG, CNRG, ENPH, FB, GNRC, GBTC, GLD, HRTX, HD, IPOD, MSFT, NVDA, PSTH, TWLO, VBIV
I am invested short in these securities mentioned in this post:
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation f