Thread by @FabiusMercurius

📉Why #Inflation Triggers A Sell-Off?📉

Today's news that CPI surged 4.2% sent equities and crypto markets to hell. But WHY??
What are the mechanics of how inflation affects equities, and why is tech falling hardest?

Here's a thread on inflation's 1st & 2nd order effects.
👇

1/ Inflation Lowers the NPV of Money

Say I'll give u $100 in 1yr. How much 💸is that worth today? If every $1 you invest now can earn 3% interest, then it's worth ~$97.
Let's add hypothetical inflation of 2%. Now the real rate is 5%. So your promised $100 is only $95.

What does lower NPV mean for stock valuations?

If you've done DCFs, you know that the equity value of a company is literally the sum of its cashflows projected out to ♾ then discounted back to today.

Inflation -> higher discount rate -> higher denominator -> lower equity value

Why is tech hit hardest?

Compare (a) a warehouse making $50M profits, growing at 4%, vs (b) a data infra unicorn making -$100M loss, growing at 25%. Who's equity value is more concentrated in future value?

Ya, (b). Money in 2Y is divided by (1+3%)^2. Money in 10Y by (1+3%)^10.

Another reason tech's taking the beating

High Beta.
When the party's bumping, tech is the prom king; it will outperform general market indices. On the flip-side, when the cops come a bustin', tech is the night's cannon fodder.

2/ Rising prices -> Rising revenue -> Rising profits?

Revenue =volume x price
A baker who used to sell bread @ $5/loaf now charges $7. Volume may go down a bit, but ppl need to eat.
COGS (raw material cost) may also have increased. But net effect on profits is still usually ➕.

3/ Consumption Slowdown

When times are tough, regular joes wanna hold their hard-earned salaries close to their chests. So they travel less. #Delta is sad. #Marriott is sad. They drink less whiskey. #JackDaniels is sad. Liver is happy! They drink more beer. $BUD is happy!

Consumer discretionary vs Consume Staples

First pic is a snap of today's returns broken out by sector. Second pic is an expanded view of what comprises "staples" (-1.3%) vs "discretionary" (-3.3%).
Bagel man falls into staples. Patagucci & Marriott fall under discretionary.

**Discretionary needs further splitting btw luxury & non-luxury ("upper middle class leisure")

What billionaire will change his/her spending habits b/c of inflation? They don't need to peacock.

Luxury example: investment property in Vietnam
Leisure example: Gucci handbags

4/ Expectations of Fed Hike

We tell kids not to play god. But after 2020 we should be telling them not to play Fed.

CPI hits 4.2 & suddenly everyone thinks Powell will cave. "He'll hike rates! US gonna be Japan 2.0!"

Ok but wait. Why should inflation motivate the Fed to hike?

Fed's job is to keep prices stable

Which prices exactly? That's a rabbit-hole for another day...
For now, let's talk supply & demand.
Demand drop -> price drop. So 1 way to cancel hyperinflation is to force lower aggregate demand -- i.e. by making it harder to borrow $$$.

5/ Hodling Dollars

Instead of thinking this 🍌 is worth 2💸, think this 💸 is worth 1/2 🍌. What if tomorrow 1💸=1/3 🍌? Would you rather hodl 🍌 or 💸?

Now replace 🍌 w/ ¥ or £ or stocks. In isolation, inflation's cheapening of the dollar is a relative richening of stocks.

6/ Increasing Volatility: Why is this both ➕&➖?

➕ for market makers: spreads widen
➖ for investors: we pay those spreads
➕ for gamma: congrats you're long options
➖ for delta: if your gamma comes from calls not puts, too bad you're still net red

7/ What about crypto?

Cross out 2 ➖s & 1 ➕
- Fed hiking still makes it harder to take on 10x leverage regardless whether you're using it to buy $BTC or $TSLA
- Dollar devaluing still triggers appetite for more inflation-hedged assets
- Looks like {4} is beating out {5} for now