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The Illusion of Low Inflation & the Hidden Alpha in Cryptocurrencies

Traders Magazine Online News, November 29, 2018

Patrick Tan

Inflation has been so low for so long despite rapid economic growth in the developed world that it’s easy to take it for granted. That somehow, “this time is different” and that the masters of the economy have managed to have their cake and eat it, while still maintaining those six-pack abs. But the inflationary genie is not some sort of mythical creature who appears straight out of the lamp, sometimes inflation can be creeping. And there are many portents that this might be one of those occasions.

In the simplest terms, inflation (at least for consumers) means that the buck you used to buy a loaf of bread yesterday can only buy you half a loaf of bread today. The developed world had bouts of rabid inflation, including a period in Germany’s history where German marks were so worthless, people used them as wallpaper and kite-building material.

The current economic cycle of almost zero interest rates and glacial inflation has led to a dangerous confluence of economic factors, distorting the valuation structure of assets across the globe where valuations are now in the realm of fiction, P&L statements be damned!

First, certain regular-paying dividend stocks have emerged as “pseudo-bonds,” where companies which deliver reliable earnings, but are not exactly on high-growth trajectories. In this corner, some of the largest names in the business in utilities, household goods and foods can be found. But to treat a company’s stock as good as a bond, is a bit like granting Walmart sovereignty. Bear in mind, that in a liquidation, bond holders rank as unsecured creditors, well above shareholders who can expect to receive next to nothing in a liquidation. Couple that with the fact that bonds pay out a coupon rate and represent a debt owing from the company to the bond holder, whereas a stock entitles its holder to the somewhat more speculative dividend payouts. That the two have now grown to be regarded as pari passu is testimony to just how distorted low interest rates and low inflation have distorted market behavior.

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