| To get John Authers' newsletter delivered directly to your inbox, sign up here. Scrambled PerceptionsMy colleague Barry Ritholtz has a popular Bloomberg Opinion piece, in which he warns that the current bull market is being misconceived. I'm not sure I agree with all of it, but it does make an essential point. That is that the bull market started in 2009 as we hit rock bottom after the global financial crisis, not last year following the pandemic shock. I think it is wise to look at it this way, even though the dive that stocks took last spring amply qualifies for standard definitions of a "bear market." This is a chart of the S&P 500, on a log scale, starting 12 years ago. I've marked in the trend lines that join the peaks and troughs, but arguably that isn't necessary. The upward trend is very clear. A year ago, in response to an exogenous and scary risk, the market dived below the lower trend line for a matter of a days. Since then, the rally has been remarkable; but perhaps it makes more sense to regard this as a recovery from the shock, followed by a climb from the bottom to the top of the market's upward trend. You could call this a long bull market, followed by the briefest bear market on record, followed by the beginning of another bull market. It makes more sense to call it a briefly interrupted bull market.  Before anyone says I am being Pollyanna-ish, bear in mind that this is, if anything, a bearish point. I've received plenty of excited sell-side research in the last few months explaining how it is reasonable to expect much more growth now that a secular uptrend has started. But we aren't in the early stages of a bull market, we're in the very late stages. That has altogether less pleasant implications. There are many other examples where the extreme shock of last spring, and the remarkable measures that followed it, have messed up the normal cyclical rhythms of markets and the economy, and could wreak havoc with our perceptions. That could be particularly true in the next few months, when year-on-year comparisons will show a sharp rise in inflation, which may prove transitory. What we have seen in the last 12 months or so is a historically anomalous spasm that is still working its way through the economy. That spasm may yet cause some huge changes, which I will discuss lower down. But it would be unwise to regard what happened last spring as the end of one cycle (in markets or the economy) and the beginning of another. The Inflation DebateArguably, no issue matters more than whether inflation is really getting started, and the likely increase over the next few months will only intensify the debate. There is plenty of disagreement. Here are some important points on both sides: It's About Antitrust Lack of U.S. antitrust enforcement in recent decades is well documented. It is widely blamed for loss of economic dynamism, higher unemployment and higher inequality. This is the tale, as charted by Vincent Deluard of StoneX Group Inc.:  Even though large anti-competitive firms have more pricing power, Deluard suggests that monopolistic companies have become a deflationary force. He points to a little discussed 1979 Supreme Court decision: I would single out the Supreme Court's 1979 Reiter v. Sonotone Corp, which set the Consumer Welfare Standard as the litmus test for in antitrust enforcement. Rather than establishing that a company had monopoly power, antitrust regulators now had to prove that monopolies raised prices for consumers. Big tech companies, whose products are "free" (or rather, which found other ways to monetize their customers' data and attention) rushed through this loophole. "Consumer-friendly" monopolies (if it sounds like an oxymoron, it is because it is one) mushroomed as antitrust enforcement collapsed after the 1980s.
This approach to antitrust made it easy for tech companies to evade enforcement. The economics of the tech industry, with capital available for companies to build up an impregnable position over many years without ever turning a profit, have added to this. The questions now are whether antitrust enforcement will stay so muted (there is good political reason to believe that it won't), and whether companies will continue to refrain from using their pricing power. If wages and other costs start to go up, it is easy to see how tech monopolies could decide to start extracting more from customers. Deluard suggests that if Netflix Inc. doubled its price, "no one under the age of 40 would return to old TV" (probably true, though they might move to a rival streaming service). If Google started charging for Google Maps or email, nobody would revert to paper maps or postage stamps, he argues. In short, the quirks of antitrust enforcement have allowed anti-competitive markets to build up without creating inflation. There is reason to believe this will change. It's ESG's Fault Will the new emphasis on ESG investing lead to secular inflation? I've seen two arguments to this effect, although one holds that it will result in stagflation, and the other that it could produce a virtuous boom. Arguing for stagflation is Deluard of StoneX once more. The nub of his argument is as follows: ESG's raison d'̻tre is that the free market, when it is driven only by the profit motive, will create costs for other stakeholders Рsociety, workers, and the environment. ESG investors' efforts to internalize these external costs may be morally just and socially optimal, but they are a cost which did not show up in the consumer prices. By definition, the rise of green standards and the demand for more responsible goods and services from governments, investors, and consumers will raise prices.
There's plenty of research to suggest that ESG investing pays for itself and leads to better returns; though if this were clear, there would be no need for the label because everyone would do it anyway. ESG sets out to change the economy; it's logical to expect that it could also change the dynamics of pricing. Deluard points out that big oil companies are cutting back capital expenditures significantly, a trend that should lead to lower production and supply. All else equal, less supply means more inflation:  Also, the oil industry no longer reacts in the way that might be expected when there is a major change in crude prices. Higher levels should encourage frackers and drillers to open more capacity, while lower prices will force them to shutter facilities. Last year's oil crash had exactly the effect predicted. The subsequent rebound has so far had minimal impact:  From the point of view of an ESG investor, this is a consummation devoutly to be wished. If fossil fuels are more expensive, they will be used more prudently and there will be more incentive to invest in alternatives. High oil prices in the 1970s led to much greater fuel-efficiency. The problem is that the 1970s also saw stagflation, with higher fuel costs helping to make everything more expensive. There is a separate debate to be had over whether this is a price worth paying; the point is that ESG is having a significant effect on behavior, one that appears to be inflationary in the long run. There is also an argument that the ESG movement will spur not only inflation, but growth too. Liberum Capital Ltd. in London points out that new technologies tend to be copper-intensive. Electric vehicles use far more copper than conventional internal combustion engines:  Meanwhile, solar and particularly offshore wind power need far more copper than conventional sources of electricity:  Copper continues to be a vital commodity for conventional manufacturing and construction, so this implies long-term structural pressures on producer price inflation. Liberum's analysts point to a range of CEOs from capital goods companies complaining about rising input prices on earnings calls, and also to clear evidence from ISM surveys that supply shortages and delays are being turned into higher prices:  Even without the big increases in demand which many expect later this year when pandemic restrictions are finally eased, it makes sense to brace for higher inflation:  This argues for a paradigm of secular inflation in the longer run, which might be healthy. Liberum's analysts discuss their case in this podcast. There Are Debt Constraints All of this is very well, but in the real world governments, companies and people are all staggering under an immense weight of debt. This is the ultimate deflationary force. Rui Soares of FAM Frankfurt Asset Management AG asks the following pithy question: We live in highly leveraged, high duration economies (see charts). And highly leveraged financial markets. Why wouldn't small increases in long-term interest rates (1% - 2%) be more than enough to cause a massive economic slowdown and ease any potentially building inflation tensions?
That's a very good question. Here are the latest numbers on debt to GDP for a range of economies:  The argument here is that capital markets will act as a balancing mechanism. We've already seen one frightened selloff, in 2018, at the notion that rates would rise to a level that was still unremarkable by historical standards. Are we in a Catch-22 world, where any confidence that we are at last out of the deflationary trap will merely lead to a market reaction that sends us straight back there? Answers on the back of a postcard please... Demographics Aren't Really Destiny My former colleague Matthew Klein, now of Barron's, wrote this magnum opus on demographics and inflation for the FT Alphaville blog back in 2016. It remains relevant. He was taking aim at the view that an ageing population would lead to great bargaining power for labor, and therefore higher prices and wages. Klein's most important argument, I think, is that there is no clear link between the working-age population and the number of people who are actually employed. Changes in the pattern of work, with people staying active later in life, shifts in female participation, and changes in immigration, have all over time made it impossible to predict the size of the workforce. Book Club: Demographic ReversalThe argument for a secular rise in inflation stemming from demographic change was stated forcefully last year in The Great Demographic Reversal, by Charles Goodhart and Manoj Pradhan, which we subsequently discussed in the Bloomberg book club. The authors continue to defend and develop their views. You can watch this presentation from Tabula Investment Management Ltd. in which Pradhan, one of the co-authors, undergoes an interrogation from the CEO. There is some marketing at the beginning, but the following discussion is excellent. Also, if anyone thinks I am overdoing the degree of disagreement over inflation, take a look at this chart produced by Tabula on forecasts for U.K. inflation:  The data are from the Bank of England; it is very unusual for views to be so widely dispersed, even on the direction of change. On the subject of the book club, we held our latest live blog last week, discussing Reminiscences of a Stock Operator, a classic written almost a century ago. Amazingly, it continues to be relevant, even though market structures and technology could scarcely have changed more. My profound thanks to the discussants; my colleagues Larry Tabb and Kriti Gupta, and O'Shaughnessy Asset Management's Jamie Catherwood, author of the Investor Amnesia blog. It's worth reading the entire transcript, but perhaps the conclusion, put succinctly by Tabb, is "market structures change, but human nature doesn't." Survival TipsHappy Passover everyone. And for the observant Jewish among you, I hope you're enjoying munching your Matzah. Unleavened bread isn't exactly a delicacy, and it isn't very pretty. But one survival mechanism for teenagers of the last year has been to buy and sell some rather imaginative artworks that they've created. So, I offer you some earrings made by my daughter. They're kosher for Passover, and I think they might even be on sale somewhere, $3 a pair (but I'm not going to help her sell them):  Keep having a good Passover or a good Holy Week, everyone. And I also wish a really good week to those who celebrate neither. Like Bloomberg's Points of Return? Subscribe for unlimited access to trusted, data-based journalism in 120 countries around the world and gain expert analysis from exclusive daily newsletters, The Bloomberg Open and The Bloomberg Close. | 
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