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  • Writer's pictureRobert Baharian

The Bond Market Disagrees With You

If you think this inflation thing isn't happening in the land down under? Well, let me assure you it is. Forget monetary inflation, we have time inflation. Everything is just taking so much longer. I waited in line for over 30 minutes at Mad Mex at Chadstone on Sunday afternoon just to place my order. Who would wait over 30 minutes in line for a burrito? Generally I wouldn't either, believe me, but I had 2 whinging kids hanging off me, we just spent 3 hours at Lego Land, and man I was hangry. Forget waiting 30 minutes for a burrito, you want a new Tesla? Forget about it. You're waiting 12 months.

Chadstone shopping centre was insanely packed. The food court was like a night club with people literally rubbing shoulders trying to get from sushi train to KFC. What COVID? What social distancing? I'm quietly optimistic about this post pandemic boom. I think we're going to see a surge in spending, travel, business, and so on.

Imagine a busy nightclub. Everyone in the one building. The fire alarms goes off. There is only one exit. What do you think is going to happen? This is precisely what is happening right now. Everyone is heading for the same exit. And we now have a huge bottleneck. This is why you're seeing these big inflation numbers. What do you think happens when the nightclub opens another door? And one quarter of the guests have already left the nightclub? The bottle necks is not so narrow anymore now is it?

You know who else agrees with my nightclub analogy? The entire bond market. In today's chart we look what the bond market is pricing in for interest rates in 10 years' time. And guess what? It completely disagrees with you as it continues to hover around 1.6%.

You've probably heard that inflation is bad for stocks? Yeah, maybe it should be. But history isn't as convinced. I've covered this in depth here and here. Essentially as input costs rise, companies should be able to pass these costs on to the consumer. As Warren Buffett has said before in one way or another, betting against corporate America is a dangerous game to play. Anecdotal granted, but here is McDonald's CFO when they raised menu prices by an average of 6%.

“We haven't seen, I’ll say, any more resistance to our price increases than we've seen historically,...The 6% has been pretty well received by customers."

If Chadstone shopping centre's queues were anything to go by, I'd say Australia too, is willing and able to pay. The bond market agrees with me. Or maybe I agree with the bond market. Whichever way you look at it, the headlines and narratives are just that.

Let's take a look at some fact. Over the last 90 years or so, we have seen 17 calendar years with inflation ranging from 5% to 15% (US data), with corresponding stock market returns from -26% to +37% with the average return being 9.4%. Eight out of the 17 years were double digit returns, and almost one third of the time, the stock market return was more than 20% when inflation was at it's highest. In my humble opinion, I think these numbers stack up pretty well.

Just because inflation is rising right now, 1) it doesn't mean it's permanent, 2) although interest rates are likely to rise, I don't think they're going to 5%, and 3) it's not a guaranteed death sentence for the stock market.


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