“Average” Inflation Targeting from Central Banks, Compounds Side Effects

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“Averaging” Inflation Does Not Eliminate The Flaws In The Fed’s Policy Approach; It Compounds Them

Larry McDonald with Joe Carson

Federal Reserve has spent over a year conducting a review of its monetary policy strategy, tools, and communication process. The review was an academic re-assessment of an academic experiment called inflation targeting. The new framework of inflation averaging is an extension of the inflation-targeting regime, with a longer timeline.

This decision on inflation targeting moves monetary policy closer to a rule-based framework. A rule-based framework creates the premise that there are no legitimate objectives besides the item being targeted.

Inflation targeting was never supposed to become a rule-based framework. Proponents of the practice argued it would help increase the “transparency” of conventional monetary policy and emphasize the commitment toward maintaining a low and steady inflation environment.

Inflation targeting has never delivered the macroeconomic results that were promised. That’s because it has no practical foundation, focuses on a narrow set of prices that are not entirely market-determined, and creates an uneven playing field between the economy and finance. Inflation averaging will compound the errors.

First, mandating an inflation rate of 2%has no theoretical justification.

There is no such thing as an “ideal” or steady rate of inflation. Policymakers have never offered any empirical evidence to justify a 2% inflation target because none exists.

Research and actual experiences show that an inflation rate too high or too low for an extended period can create imbalances and bad economic outcomes. But that range is very wide.

In the mid-to-late 1990s, reported core consumer price inflation averaged more than 100 basis points above the inflation rate of the last decade, and the macro performance in terms of growth, job creation, and wage gains was far superior.

Policymakers have the freedom to change their operating framework. But any framework should be grounded with solid research and not made up with “alternative” facts to support its use as a policy tool.  

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Second,inflation targetingfalsely assumes there is absolute perfection in price measurement. 

Subtle changes in the prices and quality of goods and services make price measurement at times a “best guess”. Every year government statisticians face new products, changes in old products, shifts in demand, and company pricing strategies.

One of the most complex issues in price measurement is the pervasiveness of item replacements. Item replacement refers to a process whereby government statisticians must select and price a different product because the one previously included could not be found. Previous studies have found that some items are replaced more than once a year and annual replacement rates could be as high as 30% for products.

But item replacements are uneven year-to-year and therefore so too is the judgment component of reported inflation. As a result, price changes that are down or up a tenth or a quarter of a percent from year to the next should be considered nothing but statistical noise. But a rule-based inflation-targeting framework will compel policymakers to fiddle with the stance of policy to account for the noise in price measurement.

How is it that policymakers nowadays have fallen in the trap of placing so much importance on a single statistic to conduct monetary policy?

Third, the Fed’s inflation-targeting regime mistakes indirect measures of inflation for direct ones.

A critical aspect of the design of price targeting is the selection of the price series. The price series must be timely and a direct measure of inflation.

The consumer price index (CPI) is the only direct measure of consumer prices. But policymakers have opted to use the personal consumption deflator (PCE). The PCE deflator is not a direct measure of prices since 70% of the prices come from the CPI. The other 30% is based on non-market prices.

Four of the past 5 years, the core CPI has exceeded the 2% target. The only year it missed was 2018 when it was 1.8%. That small undershoot from the 2% target is not statistically significant and certainty not large enough to trigger a change in the stance of monetary policy.

Over the same 5-year period, core PCE ran nearly 75 basis points below the core CPI rate. Almost all of that difference can be explained by the “invisible” prices, or prices for items that are in the PCE but not in CPI.

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Does it make sense to base policy decisions on “invisible” prices?  

Fourth,inflation targeting lacks balance in anchoring consumer inflation expectations with investor expectations.

The announcement of an inflation target is intended to reduce uncertainty over the future course of inflation and anchor people’s inflation expectations. It is hard to prove that the formal announcement of inflation targeting has had any impact on people’s inflation expectations.

According to the University of Michigan’s consumer sentiment survey, people’s one-year inflation expectations have fluctuated between 2.5% and 3% for the past 20 years, moving above or below the range during an economic crisis or oil shocks. Perhaps people are unaware of the Fed’s 2% inflation target or that “experienced” inflation runs consistently higher than reported inflation.

But investors are readily aware of the Fed’s inflation target. Every little tweak in the Fed’s policy statement on inflation and its impact on official rates triggers almost an instant reaction on the part of investors.

One of the inherent weaknesses of inflation targeting is the inability to balance consumer and investor expectations. That is, as policymakers attempt to simultaneously hit an arbitrary price target and anchor inflation expectations they are inadvertently un-anchoring investor expectations as it eliminates the fear of higher interest rates, encouraging extreme speculation and risk-taking in the financial markets.

Why do policymakers only focus on people’s inflation expectations and not people’s/investor’s asset price expectations as well since both have become unstable at times resulting in bad economic outcomes?

Informal and formal price targeting has been in the Fed’s tool kit for the past 25 years or so. The effects on income and portfolio flows are not similar to conventional monetary policy. At the end of 2019, the market value of equities in people’s portfolios’ stood 3X times workers income, up from 1X times in the mid-1990s.

The shift to inflation averaging compounds the unevenness. That’s because inflation averaging will extend the period of low-interest rates, encouraging more speculation and risk, increasing gains in finance over the economy.

A critical review of the pros and con’s inflation targeting will have to wait for the next crisis. It usually takes three crises before policymakers realize something is fundamentally wrong with their framework.

By then there will be several new academic papers that will highlight the flaws of inflation targeting/averaging, expanding on those that are listed in this article while adding others as well.

After over 40 years researching in the field of economics, with experience on the buy and sell-side of Wall Street, government, and private industry and mostly focusing on financial markets and policy analysis, our long-time friend Joe Carson decided to share his research and opinion on The Carson Report. Please feel free to contact Joe if you have any questions or want to discuss any of his research or opinions. 

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Don’t make it a long dance with the Devil

Warning: Do NOT hold the TQQQ Nasdaq ETF for the Long-Term

Let us be clear, we are discussing the largest casino on the planet earth right now. The 3x Levered, ProShares UltraPro QQQ should come with a surgeon general’s public warning. All one has to do is look at the average trading volume – nearly $5.5B a day for this ETF. It makes the Wynn casino empire’s annual revenues of $6.6B look like child’s play.

We are talking about a borderline scam here? It’s a mathematical fact that this beast is NOT long for this world. Sustainability is the question. It’s a high stakes game of musical chairs, DON’T get caught holding the bag.

TQQQ Total Assets

The TQQQ ETF has lost nearly -35% since the Nasdaq’s September 2nd perch, yet the fund’s total assets have only decreased -16.1% in the same period. This difference is because the TQQQ has seen net-inflows throughout the month of September, the idiots have been buying the dips on this slot-machine with BOTH hands.

TQQQ: “ProShares UltraPro QQQ is an exchange-traded fund incorporated in the USA. The Fund seeks investment results which correspond to three times (300%) the daily performance of the NASDAQ-100 Index.

The popular TQQQ ETF is commonly referred to as a 3x levered version of the Nasdaq. Let’s see how this has played out in action…

Returns: QQQ Nasdaq ETF vs. TQQQ UltraPro 3x Nasdaq ETF

% Return Today (9/24)

QQQ: +0.5%
TQQQ: +1.5%

Makes sense…

% Return Past Month

QQQ: -6.4%
TQQQ: -20.5%

Little more than 3x, but close enough…

% Return Since 2010

QQQ: +520.7%
TQQQ: +6,931.6%

Wait… what?

% Return Since the February 2020 Top

QQQ: +11.3%
TQQQ: -5.1%

Wait… what???

“The scary part of TQQQ is a 10-year chart gives off the impression that a long-term investment is safe.”

What’s Going on?

We must think about the math. If an investment starts at $100 and loses -5%, you are at $95. To get back to $100, you need appreciation of +5.26%. However, if that investment is 3x leveraged, you lose -15%, and instead are at $85. To get back to $100 in this scenario, you now need appreciation of +17.6%. Notice that the 17.6% needed is greater than 5.26% x 3.  

Now, let’s take is up a notch…

Scenario A: Stock XYZ is a non-leveraged stock that falls -33%. The stock needs a +49.25% appreciation to get back to even. $100 would have gone to $67 and a after a +49.25% rally, $67 becomes $100 again.

Scenario A (but 3x leveraged): Stock 3XYZ is a 3x levered version of the same stock. When stock XYZ falls -33%, stock 3XYZ falls -99%. This stock needs +9900% appreciation to get back to even! $100 would have gone to $1 and after a +147.75% (3 x  49.25%) rally, $1 becomes just $2.47!

The Nasdaq 100 Index has NOT seen a -33% drawdown since TQQQ was created in 2010. Once it does, TQQQ’s prior high is likely to NEVER be reached again.”

DANGER: TQQQ UltraPro Nasdaq ETF

ANY financial product that is levered 3x is NOT meant to be held for the long-term. The 10,693% rally in the 3x levered TQQQ Nasdaq ETF from 2010 to the recent peak may NEVER be replicated. The largest drawdown the TQQQ 3x Nasdaq ETF has EVER suffered was -73% from February to March 2020. Although, the -73% TQQQ drawdown was painful, a recovery to new highs was attainable. However, if the Nasdaq had fallen just a few more percentage points and the TQQQ drawdown went past -90%, a recovery back to the highs would have been nearly impossible. The Nasdaq 100 Index has NOT seen a -33% drawdown since TQQQ was created in 2010. Once it does, TQQQ’s prior high is likely to NEVER be reached again.

Long-term Safety Façade  

TQQQ looks great on a 10-year chart, but there is no such thing as a free-lunch in finance. TQQQ’s +6,410.9% outperformance over the Nasdaq 100 since the ETF’s inception in 2010 will not be repeated for a very long time, if ever. This was only possible because since the TQQQ ETF was created, the Nasdaq has not seen over a -33% drawdown… yet.

Keep in mind, the Nasdaq fell -76% from the Dot-Com bubble’s peak to trough. If this were to happen today, the TQQQ would be a penny stock and the 8 billion dollars invested in the fund would be looking around, scratching its head, wondering what just happened.

Unfortunately, the probability is high that inexperienced retail investors lose over -90% of their investment in TQQQ and do not realize they may never get back to an even P/L, regardless of what the Nasdaq 100 Index itself does.

Bottom line: PLEASE do NOT hold the TQQQ for the long-term. If we see anything near -35% drawdown in the Nasdaq, new highs in TQQQ are nearly impossible, the math proves all 3x leveraged ETFs must be traded NOT owned. The scary part of TQQQ is a 10-year chart gives off the impression that a long-term investment is safe…



Stupid “Rich” Skew in Apple, Greed Breaks Things

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

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Sept 6: What Just Happened over the last Nasdaq 14 days?

1. A Colossal buyer (SoftBank) distorted the price of upside calls on eight stocks.

2. Quants and Robinhood piled on, further distorting markets.

3. Dealers who have been destroyed in recent years (selling vol) holding a small deck, they had to get long more and more stock to hedge upside market risk.

4. As stocks surged, dealers who sold upside calls – must hedge even more as – out of the money options they sold – pick up more delta. Banks buy more stock. Call-put skew reaches record territory on several big-name tech stocks, meaning the cost differential to buy upside vs. protect the downside, reaches all-time wide levels.

5. Nasdaq is nearly 60% 12 stocks, this “three-card monte” game above has a large impact on passive index funds.

6. The original, colossal upside call buyer exits some of their position.

7. Dealers / banks MUST sell stock in size, take off their hedges, sell Mortimer, SELL.

8. Selling brings out more selling, banks take off more hedges as the options lose delta, MORE selling.

9. The little guy / gal gets left holding the bag.

Alert: High and High Closes September 2, 2020
Wednesday, an All-time highest VIX reading on a day with the S&P 500 touching the highest level ever. Of the top 20 occurrences, there were 17 in the 1999-2000 period, and three over the last 7 days. When option traders receive colossal size orders to buy upside calls they have two choices. a) Have your sales force get on the phone to the largest holders of the stock (say Apple and Buffett) and convince them to sell upside calls. b) If they cannot find enough sellers of upside calls, they must buy stock in size to hedge the calls they are selling to the client.
This is taking the street short gamma – likely the largest way all time. As we learned with Lehman, greed breaks things. It’s “high-noon” – the only character missing is Gary Cooper. We are witnessing a battle of wills, high speculation where colossal call buyers are forcing the street to get long more and more stock to hedge their upside risk. It’s the March capitulation selling in reverse. Just the way the street had to BUY downside protection in late March (because put buyers outnumbered call buyers 10-1). Today, they are being forced to BUY upside protection in SIZE (call buyers outnumbered put buyers 10-1). It’s going to break!

Insanity in Options

This post is Part II of New Vol Regime

“As my first boss told me at Merrill Lynch in 1990, ´In options Larry, they show it to you (lush $$ green premium), and then they take it away.´”


The convexity skew picture on big-name equities like Apple $AAPL has gone parabolically stupid. Let’s keep this simple and draw a conclusion.

“Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Our friends at Citadel calculate, over $1 BILLION of premium spent and upwards of $20B in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years, they noted. We agree someone is playing with House Money, and they’re rolling large.”

Bear Traps Report, August 24, 2020

Apple $AAPL Stock near $130

Jan $180 Strike Calls costs $4
Jan $80 Strike Puts costs $1

*Both options are $50 out of the money, approx data, BUT it is nearly 3x more expensive to buy upside risk in AAPL equity. Downside protection normally costs more than upside risk participation, NOT today. What does this mean?

“The public is trapped long and institutions are trapped long and the snowball that was pushed very quickly up the hill and got big is now at risk of becoming an avalanche.”

Julian Emanuel, chief equity and derivatives strategist at BTIG, Bloomberg

Nasdaq Whale Makes a Splash

One large buyer has made a colossal splash in the market and the scent of greed has drawn thousands of other market participants into the dangerous game. Several clients in our institutional chat on Bloomberg have cited SoftBank as the original size buyer. We have NO IDEA if this is true, just that highly credible clients have made this reference several times over the last week. It’s a high-stakes game of musical chairs, the ultimate greater fool theory moment. The colossal call buyer has thrown meat in the water and drawn in the sharks, but unfortunately thousands of Robinhood minnows at the same time. When the large players’ exit, the little guy and gal will be left holding the bag.

Apple closed near $130, while the cost of speculative upside calls is weighted heavily against the buyer. Someone must have reached out to Buffett today because he can make a fortune in selling $AAPL upside calls. Let us explain.

Very Expensive Upside
Call it extremely unusual activity. We have a higher stock price in Apple AAPL with a much higher cost of equity upside. Equity vol usually explodes higher in market crashes, NOT bull markets. As you can see above, in normal Apple equity bull markets – see all of 2019 – AAPL implied vol has been CHEAP, NOT RICH (expensive) like today! In March and April, near the market bottom – the price for puts was more than 4x the price for calls, today we have done a 180, extreme fear to extreme greed. 

In our institutional client chat on Bloomberg, a hedge fund put on this trade and we are sharing it with permission. 

With Apple stock near $130, think of the January 2021 expiration. The client bought the $200 call and sold the $250 call, 1 x 4, and got paid $3.50 to put the trade on. What does this mean? See below.

Extreme Premium to Extreme Discount
Apple $AAPL is near $140 pre-market on September 2nd. In July, the Street’s 12-month price target was $85, now $116. In March, the price target commanded an $18 PREMIUM to the Apple stock price, NOW it’s close to a $24 discount. In classic 1990s fashion, the mad mob of Wall St. analysts cannot raise their stock price targets fast enough to keep up with the equity price appreciation. That is from 44 analysts, Bloomberg data.

The Trade

Apple was worth $1.5T at the end of July and today she stands tall at $2.2T. In order for the client to lose money* at January expiration, the stock has to breach $270 ($130-$136 this week), which would put the company’s market capitalization very close to $5T, by January 2021, that is a little over four months away.

*The mark to market in the short run can be extremely painful though – if Apple equity soars another 10-20% (Apple is up 50% since late July), that is indeed the catch. AAPL is trading nearly 65% above its 200-day moving average vs. 42% in February’s great bull run. 

Cost of Upside is Insanely Expensive
There are a handful of quant funds pushing around a few stocks (with high impact on QQQ, NDX, SPY) in the options markets. The dealers are getting very nervous.  Last 15 days – Imaging being a large market maker in Apple and Tesla equity options. You make a market, bid – offer, you get lifted and lifted over and over again by buyers to the point where you have raised the price of calls vs puts to multi-year extremes. How short is the Street gamma? VERY.

The Ultimate Lesson From Stan

“So, I’ll never forget it. January of 2000 I go into Soros’s office and I say I’m selling all the tech stocks, selling everything. This is crazy at 104 times earnings. This is nuts. Just kind of as I explained earlier, we’re going to step aside, wait for the net fat pitch. I didn’t fire the two gunslingers. They didn’t have enough money to really hurt the fund, but they started making 3 percent a day and I’m out. It is driving me nuts. I mean their little account is like up 50 percent on the year. I think Quantum was up seven. It’s just sitting there… So like around March I could feel it coming. I just – I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks. and in six weeks I had left Soros and I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to that. I was just an emotional basket case and couldn’t help myself. So, maybe I learned not to do it again. but I already knew that ”

Stan Druckenmiller

When call vs. put skew gets this extreme it can be a solid leading risk indicator.  Join our live chat here, tatiana@thebeartrapsreport.com.