The Baerlocher Bearing

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The Baerlocher Bearing
Stocks slide after Fed's preferred inflation print comes in hot

Stocks slide after Fed's preferred inflation print comes in hot

and a look at RIG's earnings report

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Alan Baerlocher
Feb 25, 2023
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The Baerlocher Bearing
Stocks slide after Fed's preferred inflation print comes in hot
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This morning saw the release of the Fed’s preferred inflation index, the PCE Price Index. It came in at 5.4% which beat the prior print of 5.3% (which was revised up from 5%) and forecasts of 4.8%.

When the FOMC last met, I was disappointed that they did not raise by 50bps. When I later reflected on what had taken place, I commented that Powell had given the market what it wanted which was not necessarily what it needed. The latest two inflation reports (CPI and now PCE) have shown that the inflation genie has not been put back into the bottle. Short-term interest rates have higher to go before this is all over. Luongo believes that 7% could be in the cards and at this point, I wouldn’t doubt it.

Today’s Personal Income and Outlays release also showed an increase in the Personal Savings Rate (4.5 to 4.7) which is up from the bottom seen in June ‘22 of 2.7%. We also got a strong increase in Disposable Personal Income.

Both of these factors show that consumers aren’t tapped out. Gear up for a second wave of inflation because it is rapidly approaching. The market is not ready for what is going to happen next. It is seriously mispricing the Fed’s comments about rates being held higher for longer. Karl Denninger had an article yesterday that got to the heart of the matter, the time value of money.

“There's a serious problem: The cash furnace firms are still running cash furnaces; they have to, since that's all they got.  But the monetary games that allowed this to be done and show "decent operating results" are over -- and there's no reason to believe they will come back.

Ever.

Simply put as I've pointed out since I started writing this column time has value.

Positive real rates -- that is, it must always have a cost in real terms to borrow money, and the more time you wish to borrow for the more it must cost are a necessity for an ordered, stable economy.  A person who borrows to build or run a business must have a reasonable expectation that it is to their advantage to do so now and pay it back later, which in turn must mean they expect they can make more than the cost over that period of time.

If rates are negative in real terms then it becomes "economic" to borrow to do things that are economically stupid -- that is, guaranteed to lose money in real terms.  Why?  Because I can now borrow the funds, do the stupid thing, lose money doing it but the amount I have to pay back is less than what I borrowed in real terms.  This in turn incentivizes me to do an unlimited amount of that stupid thing because the more of it I do in a given unit of time the more I can grift off!

This is where the unprofitable publicly traded companies come into play. These companies have been running a “grift” on publicly traded markets. They are the “cash furnaces” that Karl eludes to. We are approaching a period of time where real rates will turn positive once more. This means that interest rates will be higher than the inflation rate. At that point, the game for the companies that do not possess a path towards profitability will be up. They will have extreme difficultly finding someone to lend them money. I believe that many lenders are already preparing for this scenario however these companies are still catching a bid because traders haven’t realized what is coming. We’ve been in a 40 year bond bull market. The vast majority of market participants have never seen a true bond bear market. Things could get turbulent.

And then I said We're about to experience some mild turbulence ...

Now getting to Transocean’s earnings report…

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