Archive for the ‘Economy’ Category

Summary of My Post-CPI Tweets (Feb 2018)

February 14, 2018 1 comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guyPV and get this in real time, by going to PremoSocial. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments or Enduring Intellectual Properties. Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • Link to my appearance on TD Ameritrade Network [on Monday]:
  • It looks like I will be able to do most of my CPI tweet storm after all. I will be on Bloomberg live at 8:30ET with @adsteel and @DavidWestin, but I will be on the phone and will post my tweets immediately thereafter.
  • Going in, we’re facing roughly a 0.21-0.22% consensus on core CPI. I think to get an adverse reaction from equities you need to keep y/y from declining to 1.7%, which means you need core CPI to be near the year-ago comp, which means something that rounds to 0.3%.
  • Anything that rounds DOWN to 0.3% will be ugly. Again I’m talking core here.
  • It’s important to remember that this is the hardest remaining comp we have in CPI for a long time. In fact, Jan 2017 m/m was higher than any other core print of 2017. The next 6 months are only 1.1% annualized.
  • This is why we can talk about the ‘bad optics’. Core CPI will appear to be rapidly accelerating over the next half-year unless we get some weird one-offs like we did last year.
  • This month I will be especially focused on Used Cars and Trucks, which is subject to a change in BLS procedure this month. Big difference of opinion out there about whether it’s an add or subtract.
  • I believe it will be an add, because the price level is what BLS surveys and this has been very far below what private surveys have shown. Catching up to do unless the BLS just ignores that prices are higher than they thought.

  • But a tremendous amount of noise around any element of the data so it could be anywhere of course!
  • Have to go now and prep for Bloomberg call. Will be back several minutes after CPI for recap. Thanks for subscribing, everyone.
  • oh my…0.349% on core…1.846% y/y…and this was supposed to be the hard comp.
  • Supposedly the seasonals were going to dampen this figure. Whoops.
  • Remember this is a January number but…it’s hard to ignore. Accelerating major categories: Food/Bev, Apparel, Medical Care, Other.
  • Housing decelerated but that was mostly Lodging Away from Home, -2% for the month. AirBnB making a comeback?!? Primary Rents accelerated to 3.73% from 3.68% y/y and OER to 3.20 from 3.17%. This is on our model.
  • Here’s last 12 m/m core CPIs. Notice a trend?

  • CPI-used cars and trucks…was 0.32% m/m. Sorry, people who thought that it would be down. y/y though it’s still a drag at -0.61%. But last month that was -0.99%.
  • In Medical Care, Pharma decelerated to 2.39% vs 2.77%. But Doctor’s Services -1.51% vs -1.77% y/y last; Hospital Services 6.04% vs 5.09%.
  • That matters more than you think, because more care is being funneled through hospitals every day.
  • CPI for medical care…bottoming?

  • CPI pharma

  • Now, whilst Used cars and trucks accelerated, New Vehicles decelerated to -1.24% vs -0.53% y/y last month. And New Vehicles have almost twice the weight of used vehicles. So cars, actually, were a net drag. Just not the place that pointy-head economists said it would be.
  • I wouldn’t get too overenthused about apparel. Yes, it had a big jump. And with a weaker dollar and some protectionism I’d expect to see this going up. Just…lot of wood to chop.

  • Sorry I am jumping around a bit. Back to hospital services. Near longer-term high pace, but really need to see it break higher. This is an important part of core services.

  • Here’s CPI-Used Cars vs the Manheim survey. Rate-of-change. Looks like it’s catching up. But…

  • Here (again) is the index level (normalized) of CPI vs Manheim. This month’s move doesn’t do much. EVEN IF THE HARVEY JUMP IN MANHEIM GOES AWAY, BLS is still way below where it should be. This is a source of positive variance going forward.

  • Here is the distribution of price changes. As expected the weight in the left tail is starting to decline, which will cause core to converge with median eventually (or anyway, get close).

  • OER accelerated slightly, but as I mentioned this is what our model expects. Not to anthropomorphize a model. The real question is which of our submodels – which agree at this level but diverge – ends up being ‘correct’.

  • So here’s the ‘four pieces’ look. What it shows, frighteningly, is that nothing unusual is happening. As a reminder to people seeing this 1st time…this breakdown of CPI has four roughly-equal pieces.

  • Food and Energy

  • Now the core pieces. Core Goods. With dollar weakness this will eventually go mildly positive. But this happens with a lag and hasn’t happened yet. Maybe Apparel is first shot?

  • Core Services less Rent of Shelter. If Medical Care is bottoming, this is an upside risk. I doubt there’s much downside risk at this point.

  • And Rent of Shelter. It’s decelerated, but home prices are still rising and I don’t think this is going to drop out of the sky. Net result: hard to see where disinflation would come from.

  • This is where I usually conclude by forecasting Median CPI. But median category looks like a subcomponent of OER, which the Cleveland Fed separately computes a seasonal adj for. However, looks to me like Median won’t be anywhere close to core. Probably around 0.2%.
  • Looking forward, remember: the EASY core comps are ahead. Feb 2017 was +0.17%, March -0.07, April +0.09%, May +0.08%. June and July 0.14%. Not until Aug do we have another 0.2% comp. This means core CPI is going to be rising from the current 1.85%.
  • …and that in turn is going to scare investors, and the Fed (which usually follows the bond market) might overreact for all their brave talk currently. Today’s data certainly created a WTF moment at Constitution and 20th St. NW
  • That’s a wrap for now people. It was a fun one. Thanks for tuning in! Thanks for signing up!

The big takeaway from this month was that this was supposed to be the difficult comp for year/year CPI. With all of the sturm und drang about inflation over the last couple of weeks, this was set up to be a whipsaw when the January data turned out to show a decline in year/year core CPI. Going into the data, I would have preferred the long side of equities (for a trade) because it seemed like the talk around this CPI was overdone.

But instead we got the highest m/m core CPI in 12 years, and it was very close to printing 0.4% with rounding. That would have been heart-stopping.

The stock market seems at this hour to have fallen in love with the idea that this was all due to “weird jump in Apparel.” But Apparel is only 3% of CPI and 4% or so of Core. So a 1.5% miss in Apparel would only add 0.06% to core CPI. And core CPI missed by more than twice that. Moreover, the jump in Apparel is just reversing some curious recent weakness in the series, so arguably it’s an unwind of a one-off, not a new one-off. Year/year, Apparel is still deflating at -0.62%/year even with this month’s jump. That’s steeper deflation, actually, than the four-year average! With the dollar weakening, I would expect Apparel to be adding, not subtracting, from inflation over the balance of this year. But, with such a small weight…who cares?

I agree that one should not exaggerate the importance of any one month’s data, for any data series (including Average Hourly Earnings, which seems very likely to reverse some next month). But the next six months are going to see core inflation continue to rise, optically. If we get “only” 0.2% prints for each of the next six months, then July core CPI will be around 2.5% y/y. At that point, people will be extrapolating crazy numbers. But for now, we still have all of the ugly optics to look forward to.

This is a bad figure. There are no two ways about it.


Two Important Changes Coming to the CPI

January 30, 2018 2 comments

There are a couple of potentially important changes to the CPI that will take effect in the next few months. It is worth thinking about how these will affect the data.

  1. Sometime in “Spring 2018,” the BLS will reweight the physicians’ services index, which includes consumer out-of-pocket, Medicare Part B, and private insurance reimbursements, to better reflect the current market weights of various payer types.

This matters, because the ACA (nee Obamacare) caused a large shift in where payments were coming from, and one effect of that shift was to obfuscate actual inflation in medical care. Because CPI only includes payments that consumers make, and not the ones that government provides (Medicare Part A, Medicaid), large changes in the coverage population and the significant change in deductibles caused Medical Care inflation to do things that really didn’t make a lot of sense. We know that total spending on health care grew sharply under Obamacare as Medicare, Medicaid, private health insurance, and out-of-pocket spending all rose, but medical care inflation as measured by CPI sharply decelerated over the last 15 months. It isn’t because health care is suddenly more affordable; it’s because large change in the way medical care is paid for was bound to cause large change in the measurement of medical care. It is likely that reweighting this index to current weights will cause better stability in this measure – but at a higher level than the recent 1.7% rate. Since Medical Care is the main thing holding down core PCE, this will likely make the optics worse over the next year (and see what I have already said about the optics).

  1. With January 2018 data, CPI for used cars and trucks will change from a three-month moving average to a single-month price change. The BLS says “This modification will result in an index that reflects price change closer to the reference period.”

This matters, because as I’ve been pointing out over the last few months the CPI for used vehicles is quite a bit below where private surveys of used car prices suggest it should be. The recent rise in used car prices is happening largely because Hurricane Harvey removed hundreds of thousands of vehicles from the road, but the BLS measure has been lagging behind the private measure of these prices. This is one of those effects that is expected to make the CPI optics worse in 2018, and this change could make it worse, faster. If CPI measures of car inflation merely converge with the blue line below, it’s worth about 0.5% on core inflation. Moving to a 1-month, rather than a 3-month measure will make this more volatile, but also will make it converge more quickly. Indeed, it makes this month’s CPI report even more interesting and creates a chance for a significant surprise higher as soon as this month.

Categories: ACA, CPI, Quick One

Global Inflation: the Worm Finally Turns

January 29, 2018 6 comments

Approximately nine years ago, I founded a company specializing in developing new ways to invest in and hedge against inflation. I originally had two partners; one left after a few months and the other lasted a year before heading back to a Wall Street job. (I think leaving after 3 months of trying a startup was a little sporty, but I don’t begrudge the partner who stuck it out for a full calendar turn and then some.)

The last nine years have been a difficult time to be developing and marketing inflation expertise. While we conceived the firm as having strategic positioning on inflation protection – whether inflation is going up or down, inflation risk is always there to be managed…and we are all born inflation-exposed, and remain so unless we do something about it – I confess that I underestimated how hard of a pitch that would be to investors who haven’t seen core inflation above 3% for two decades. Unless you have a certain amount of grey hair, you think 3% is high inflation, but that’s not really high enough to damage most asset markets. So why bother?

But times, they are a changin’ back (as Bob Roberts famously sang). Average core inflation around the world is near the highest levels since the 1990s. The chart below shows the unweighted average of the US, Europe, Japan, the UK, and Chinese core inflation (using median for the US, which is a better measure). While the average of 1.7% or so is nothing to be terrified about, it also should be noted that there is nothing evident on the horizon that would tend to arrest this rising trend.

While money supply growth has been slowing gradually around the world, monetary conditions are not likely to seriously tighten until banks are no longer sitting on a mountain of excess reserves. In the meantime, higher interest rates will tend to cause money velocity to rise because velocity is the inverse of the demand for real cash balances – in English, that means that when interest rates are low, you’re happy to hold cash balances but when interest rates rise, cash becomes a hot potato to be invested, spent, or lent rather than sitting in cash. It is no coincidence that both global money velocity and global interest rates are both at or near all-time lows. However, interest rates seem to be going higher – seemingly nowhere faster than in the US, where the 5y Treasury rate has risen about 80bps in the last five months and is at 8-year highs. In turn, that means money velocity is very likely to rise, and any rise at all makes it harder to have an agreeable mix of growth and inflation.

You can subscribe to my live tweets on the monthly CPI day and see why, but not only is domestic inflation rising but the optics this year are going to be much worse for policymakers and investors focused on core inflation. In 2015-16, core inflation accelerated about ¾% to catch up with median CPI; this year the rise is going to be at least that much just from the effect of cell phones and cars. My point forecast for median CPI in 2018 – I hate point forecasts, but to illustrate that I’m mainly talking about optics in 2018 – is for an 0.25% acceleration in median CPI. But core CPI may rise a full percent because of the transitional pieces that are falling out of the y/y number. And that assumes that protectionist rumblings don’t get any louder than they currently are.

In 2015-16, breakevens actually didn’t respond much because investors didn’t believe in the underlying dynamics. They do today, as global inflation swaps (see chart below) are on the rise everywhere except in the UK, where the post-Brexit spike is fading some. Even in Japan! I don’t know where the flows will take us, but the combination of the general inflation uptrend, the optics, the flows, the fact that TIPS are still about 35bps cheap compared to nominal bonds (although down from about 100bps cheap 18 months ago), and the fact that gasoline prices are probably going to make headline inflation look even worse than core all come together to create the possibility of a pretty unfortunate spike in inflation markets. Unfortunate, that is, for owners of stocks and bonds.

Over the last nine years, I have spent a lot of time watchfully waiting, working on product development (this index launched last year by S&P, representing a tuition tracking strategy that we hope will result in new college tuition hedging products, is going to be one of our biggest successes), nurturing the slow growth of the firm, and positioning Enduring Investments to be relevant when inflation heads higher.[1] As the years have passed, I have written less frequently because there wasn’t much to say.

There is, now, starting to be more to say. Inflation is headed higher at least for now, and I am seeing more inquiry from investors curious about how to play it. You can expect to hear more from me, because what I am saying is more urgent than it was. And I’d like to hear from you, too…especially if we can help.

[1] And I should note that we are offering small interests in the firm itself to accredited investors, in a so-called 506(c) offering that is ongoing. Contact me if you are an accredited investor who wants to know more.

Categories: CPI

Summary of My Post-CPI Tweets (Jan 2018 – Dec figure)

January 12, 2018 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guyPV and get this in real time, by going to PremoSocial. Or, sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments or Enduring Intellectual Properties. Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here.

  • 22 minutes until CPI. Not sure I am looking forward to this one. The little birds are all whispering that this is supposed to be high, and that concerns me.
  • Not the economists: consensus forecast is for a reasonably high 0.24% on m/m core. But we drop off 0.22% from last December so the y/y won’t move much from 1.7% if that’s the print we get.
  • Yes – there are lots of reasons this COULD be higher. Chief among them is the divergence between surveys of used car prices and the BLS cars index. Cars are 6.4% of CPI, so it matters. But PPI showed weakness in vehicles for another month. (I usually ignore PPI, though).
  •’s December, which means it’s crazy-seasonal-adjustment month. December is the only month of the year where you can confidently reject the hypothesis that there’s no seasonal (on headline CPI), as prices tend to fall. But there’s also a lot of volatility.
  • Rents have come back to model, and home prices continue to rise, so decent chance that housing starts to contribute again here soon.
  • What I fear is that some of the forecasts for a “surprise” higher are coming from the fact that the inflation markets have been rallying, so people are afraid “someone knows something.” Economists don’t ignore markets. But in this case I think it’s just year-end reassessment.
  • …let’s face it, inflation bonds are cheap. About 50bps cheap at the 10-year point by my model. Commodities are cheap. And everything else is expensive. I don’t have to believe inflation is coming to swap out of stocks into commodities.
  • Of note – inflation swaps have been rising in every major market recently. So there definitely is an undercurrent of inflation concern.
  • Don’t fade the whispers! +0.3% on core. Actually 0.277%. But enough to put y/y up to 1.77%, rolling it to 1.8% rounded.
  • Wow, 2 yr Tsy above 2% for the first time since September 2008!
  • Last 12 CPIs. Try hard not to see an uptrend here. It’s an illusion caused by the low mid-year figures. But that said, this is highest in a while.

  • Let’s see…Housing up slightly, Transportation up, no change in medical care (talking major subgroups here)…will be interesting to see where the wiggle is.
  • Core services 2.6% vs 2.5% and core goods -0.7% vs -0.9% y/y. That’s the least goods deflation since last July. But it’s still deflation.
  • Pulling in the micro data now. The BLS series is so rich. But while the sheet is calculating this is a good time to remind everyone that these figures are for DECEMBER so try hard not to get too excited. The breakdown will be more important to tell us if this is ‘real.’
  • If you haven’t read Ben Inker’s piece in the latest GMO quarterly, arguing why inflation is a bigger risk for portfolios right now than recession, do so. Very good piece. “What happened to inflation? And What happens if it comes back?”
  • One more item of context before we dive deeper: Median CPI is at 2.3%. So we should be expecting something right around 0.2% per month if there’s no trend. The uptick from 1.7% to 1.8% is just catching up, mostly.
  • OK on the breakdown. New and Used cars, 8% of core CPI, rose to -0.33% from -1.05%. As expected, and that’s a big part of the surprise.
  • I say “surprise,” but it really oughtn’t be a surprise. Remember that Hurricane Harvey had a similar effect to Cash for Clunkers in terms of the number of cars removed from the road. The private car prices indices were showing this. BLS has a lot of catching up yet.

  • Just lost power. Anyway. Wasn’t just used cars. Used cars went from -2.1% to -0.99% but new went from -1.08% to -0.53%
  • Owners Equivalent Rent went to 3.175% from 3.124%, and primary rents from 3.675% to 3.689%. So housing back on track.
  • Medical Care broadly went to 1.78% from 1.68%. Pharma went 1.87% to 2.37%. Other components pretty stable (in medical). Medicinal drugs (pharma) is about one fifth of medical care subindex.
  • Wireless telephone services again steady. The jump will be fun when the plunge washes out. Right now it’s -10.19% y/y vs -10.24%.
  • Wish I could post my chart of distributions of price changes. Left tail starting to move rightward a bit. Hopefully get power back soon. This is all on backup power to my pc. [Editors’ Note – I added it later, see below]
  • Well, looks like power isn’t coming back on quickly. I will have to come back later with the median CPI estimate etc. Got most of the details out though.
  • Bottom line is that the components we expected to start converging, did. Housing behaved. Medical care behaved. And so we moved towards the real middle of the distribution, around 2.3% or so presently.
  • This shouldn’t be taken as an acceleration in inflation. This is just one (flawed) number converging with the better ones. Core inflation is going to head higher, but this isn’t convincing evidence that it is yet doing so.
  • Having said that, in a couple of months the y/y comps start to get better so the inflation story will have much better OPTICS. And it’s optics these days, more than fundamentals, that drive markets. So don’t jump off the commodities or tips bandwagon. That trend will continue.
  • Power’s back on! Of note is that Median CPI printed at 0.29%, the highest level since July 2008 (sound familiar? That was also true two months ago when it was 0.27%). So y/y up to 2.44% now.
  • Yeah, I know I said don’t think of this was an uptrend. And it’s not; it’s an unwind of one-offs. But still, that’s gotta look scary.

  • Better late than never. Here’s what I meant about the distribution moving right. Those two bars on the left were one bar before today. So you can see those components – largely cars and cell phones – are dragging down core relative to median.

  • The rally in breakevens shouldn’t be terribly surprising – this chart shows it’s just keeping pace (and not even) with the turn back higher in median CPI.

  • The market is NOT AT ALL ahead of itself in this sense.

This was certainly not the easiest time I have had with a CPI report, but that’s mostly because the power grid in this country is as brittle as glass. The story was actually not as much about screwy seasonal as I was concerned about. Actually, it was a fairly humdrum report in many ways, and that’s what is scary if you’re thinking we are in a “lowflation” period. The chart of Median CPI is interesting. Core inflation had risen mostly because car prices are starting to catch up with private measures of car prices – what remains in the gap between the red line and the blue line in the “Manheim” chart would add about 0.5% to core CPI – and housing stopped decelerating. But then Median CPI, which doesn’t care about the New and Used car prices since those are outliers, rose at the highest rate (m/m) in nearly a decade, and the Median-Core spread actually widened slightly this month. That means more core acceleration is ahead.

I mentioned that in a few months the year-ago comparisons will start getting easier. This month, we got 0.28% from core CPI versus 0.22% last year. But in Jan 2017, core CPI was +0.31%. That will be a hard comp to beat. But after that, Feb 2017 was +0.21%, March was -0.12%, April was +0.07%, May was +0.06%, June was +0.12%, and July was +0.11%. At the time, we mused “is the natural run rate for core really 0.5%/annum?” which was what those five months were averaging. That seemed very unlikely. Median CPI told us that wasn’t the case. Now, if core CPI merely averages a monthly 0.17% print from now until July, the y/y figure will be up at 2.20%. And if it’s 0.2% per month, in July we will be sitting at 2.42%.

I don’t think you want to fade those optics, even if you think we’re only going to get 0.15%. Perhaps the next month or two, because of the more-difficult comps, will take some wind out of the sails of the inflation bulls and offer better entry points. But the direction of travel looks fairly clear for the next six months or so. And that also means that the direction of travel for monetary policy is also likely set, to be at least as aggressive as the market is pricing. And, perhaps, the direction of travel for equity prices isn’t quite as clear as it currently seems.

And it bears repeating that this is going to be the case even if inflation is not actually in an uptrend, but just maintaining its current run rate around 0.2% per month (commensurate with median CPI at 2.4%/yr). If inflation is in fact turning higher – and there are some signs of that, though not as widespread as everyone seems to suddenly think – then it could be a lot uglier in 2018. As I said again above: don’t jump off the commodities or TIPS bandwagon yet. But…you might want to trim some of that nominal bond exposure!

Some Abbreviated but Important Thoughts on Housing

November 29, 2017 3 comments

I posted this chart yesterday to my Twitter feed (@inflation_guy, or @inflation_guyPV through PremoSocial for some additional content), but didn’t have time to write very much about it. This is the Shiller 20-City Home Price Index year/year change (Source: Bloomberg).

My observation was that when you take out the housing bubble, it looks more ominous. It’s actually really the bubble and bust, which makes the recent trend look uninteresting. This is what the chart looks like if you go further back like that.

So it actually looks calm and stable, because the axis explodes to -20% to +20%. The volatility of recent years has caused us to forget that for decades before that, the behavior of home prices was actually pretty sedate. Although residential real estate over very long time periods has only a slightly positive real return, adjusted for the maintenance and other required expenditures, that means the ratio of home prices to median income has tended to be fairly stable. We have historically valued homes as a consumption good only, which meant that the home price traded as a multiple of rents or incomes within a pretty narrow range. Here’s a chart of median home prices to median household income going back to the 1970s (Source: Bloomberg, Enduring Intellectual Properties calculations).

This is true even though there have been important tax changes along the way which changed the value of the home as a tax shelter, changes in the structure of the typical family unit, and so on. Despite that, homes were pretty stable investments – really, they were more savings vehicles than investments.

The fact that home prices are now accelerating, and are rising faster than incomes, implies several things. First, as the last chart above shows, the ‘investment value’ of the home is again inflating to levels that, in 2005-2008, proved unsustainable. The bubble in housing isn’t as bad as it was, and not as bad as stocks are now, but the combination of those two bubbles might be worse than they were when they were mostly independent (in 2000 there wasn’t a housing bubble and in 2007 the bubble in stocks wasn’t nearly as bad as in 2000 and now).

The second implication is that as home prices rise, it isn’t just the value of the investment in the home that is rising but also its cost as a consumption item. Because shelter to rent is a substitute for shelter that you own, rising home prices tends to imply that rents also accelerate. Recently, “Owner’s Equivalent Rent” has been decelerating somewhat, although only coming back to our model. But the gradual acceleration in the home price increase implies that shelter inflation is not going to continue to moderate, but rather should continue to put upward pressure on core inflation, of which 42% consists of “Rent of Shelter.”

Higher Wages: Good for You, Not Good for Stocks

November 27, 2017 2 comments

The documentation of the endless march of asset markets higher has become passé; the illustration of the markets’ overvaluation redundant and tiresome. After years in which these same arguments have been made, without any discernable correction, the sober voices of warning have been discredited and discounted. The defenders of higher valuations have grown more numerous, more vocal, and more bulletproof.

I recently commented in a forum on cryptocurrencies…something to the effect that while I see blockchain as being a useful technology – although one which, like all technologies, will be superseded someday – I don’t expect that cryptocurrency in any of its current forms will survive because they don’t offer anything particularly useful compared to traditional money, and moreover have a considerable trust hurdle to overcome due to the numerous errors, scandals, and betrayals that have plagued the industry periodically since MtGox. Whatever you say about ‘traditional’ money, no one worries that it will vanish from your bank account tomorrow due to some accident. I don’t see anything particularly controversial about that statement, although reasonable people can disagree with my conclusion that cryptocurrency will never gain widespread acceptance. However, the reaction was aggressive and unabashed bashing of my right to have an opinion. I hadn’t even uttered an opinion about whether the valuation of bitcoin is a bubble (it obviously is – certainly there’s no sign of the stability you’d want in a currency!), and yet I almost felt the need to run for my life. The bitcoin folks make the gold nuts look like Caine in the TV show “Kung Fu”: the epitome of calm reasonableness.

But, again, chronicling the various instances of bubble-like behavior has also become passé. It will all make sense after it’s over, when the crowd recovers its senses “slowly, and one by one” as Mackay had it about 170 years ago.

Today though I want to address a quantitative error that I hope is hard to argue with. It has become de rigeur throughout this…let’s call it the recent stages of an extended bull market…to list all of the reasons that a continued rally makes sense. I always find this fascinating because such enumeration is almost never conducted with reference to whether these things are already “in the price.” On the weekend money shows I heard several pundits opine that the stock market’s rally was likely to continue because “growth is pretty good, at around 3%; interest rates are relatively low; inflation is relatively low; government has become more business-friendly, and wages seem to be going up again.” As I say, it seems to me that most of this should already be in the market price of most securities, and not a cause for further advance. But one of those items is in fact a bearish item.

Make no mistake, wages going up is a great thing. And it’s nice to hear that people are finally starting to note that wages are rising (I pointed this out in April of 2016, citing the Atlanta Fed’s macroblog article on the topic, here. But not everyone reads this column, sadly). The chart below shows the Atlanta Fed’s Wage Growth Tracker, against Median CPI.

So wages are going up for continuously-employed persons, and this is good news for workers. But it’s bad news for corporate earnings. Corporate margins have been very high for a very long time (see chart, source Bloomberg), and that’s partly because a large pool of available labor was keeping a lid on wages while weak global demand was helping to hold down commodity input prices.

Higher wages are, in fact, a negative for stocks.

The argument for why higher wages seem like they ought to be a positive for stocks goes through consumption. If workers are earning more money, the thinking goes, then they can buy more stuff from companies. But this obviously doesn’t make a lot of sense – unless the worker is spending more than 100% of his additional wages in consumption (which can happen if a worker changes his/her savings pattern). If a worker earns $10, and spends $9 buying goods, then business revenues rise by less than wage expenditures and business profits fall, all else being equal.

This shows up in the Kalecki profits equation, which says that corporate profits equal Investment minus Household Savings minus Government Savings minus Foreign Savings plus Dividends. (Look up Kalecki Profit Equation on Wikipedia for a further explanation.) Rearranging, Kalecki profits equal Investment, minus Government Savings (that is, surplus…so currently the deficit contributes to profits), minus Foreign Savings, plus (Dividends minus Household Savings). So, if workers save some of their new, higher earnings then corporate profits decline. The chart below shows how the Kalecki decomposition of profits tends to track pretty well with reported business profits (source: Bloomberg).

Now, profit margins have been high over the last year despite the rise in wages (not because of it) because the personal savings rate has been declining (see chart, source Bloomberg).

If wages continue to grow, and workers start to save more of their earnings (paying off credit cards perhaps?), then it means that labor is taking a larger portion of the pie compared to the historically-large portion that has been going to capital. This is good for workers. It is not good for stocks.

Categories: Stock Market, Theory, Wages

Summary of My Post-CPI Tweets (Nov 2017)

November 15, 2017 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guyPV by going to PremoSocial or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments or Enduring Intellectual Properties. Plus…buy my book about money and inflation. The title of the book is What’s Wrong with Money? The Biggest Bubble of All; order from Amazon here or get it a little cheaper on our site here.

  • Consensus is for a soft 0.2% m/m on core CPI, keeping the y/y figure at 1.7%. I think the consensus works out to about 0.16%.
  • We are dropping off, from y/y numbers, last October’s 0.147% print. The last two months we’ve seen are 0.25% in Sept, and 0.13% in Oct.
  • The upshot is that to get the y/y to round up to 1.8%, we need 0.201%
  • We will be paying attention to cars and trucks. Today the Daily Shot caught on to something I pointed out a while ago:

  • That chart is actually out of date; the Mannheim used car index has risen further. Floods lead to car price increases. Only Q is when.
  • I don’t spend a lot of time on headline CPI forecasts – they obv matter more to TIPS holders in the near-term but they’re all gasoline vol.
  • Still, the consensus of 0.1% m/m looks low to me given the rise in gasoline prices. To me, gasoline should be additive this month.
  • Does seem like everyone talking about upside risk, which scares me a bit. Guess we’ll know in 6 minutes.
  • 10y breakevens -1bp on the day. Investors concerned they’re out over their skis at 1.89% breakevens!!
  • 1%/0.2%. But it’s a hefty 0.2%, 0.225% to three decimals.
  • y/y to 1.774%, rounding up to 1.8%.
  • Last 12 months. Is high the aberration or low?

  • 10y breaks back positive.
  • New and Used cars and trucks are NOT the culprit so we will have to see.
  • Medical Care broad category 1.68% from 1.56%, so the breakdown there will be interesting.
  • Core goods stayed at -1.0%; core services rose to 2.7%. Three months ago core services y/y was 2.4%; a year ago it was 3.2%.
  • y/y core cpi. BUY THE DIP!! Well, something like that. Those dips were one-offs, and those one-offs are fading (I think…calculating now)

  • OK, breakdown…housing was unch at 2.786% y/y. But primary rents dropped again, to 3.695%. OER rose slightly, to 3.196% from 3.182%.
  • Those two effects don’t quite offset, actually a net drag.
  • So new vehicles (3.68% of CPI) was -1.38% vs -1.00%; used cars (1.99% of CPI) was -2.89% vs -3.79%. So used cars contributed a tiny bit.
  • But still….wayyyyy lower than it should be. Unless the Manheim index is just plain wrong, and BLS is right, this is all in future.
  • In Medical Care, always fun: Drugs dropped further to 0.88% from 1.01%. So crazy. But Prof Services, and Hospitals, both rose:
  • Prof services 0.38% vs 0.23%, hospital services 4.54% vs 4.27%. Not big increases, but changing the direction.
  • Health insurance still basically zero: 0.15% vs 0.06% y/y. This should change if my latest renewal is any indication.
  • Professional Services y/y. A bounce, but don’t get too excited!

  • @pearkes: doesn’t CPI HI measure profit margins, not gross premiums?
  • Replying to @pearkes: Well, sort of, tho not exactly. But if all of the pieces of medical care are low, and insurance rises sharply, gotta show up somewhere.

[Editor’s note: I don’t usually put comments and responses in this summary but that was an important question]

  • College tuition & Fees: 2.17% vs 2.08%. Tuition increases have been moderating because endowments are flush thanks to the bull market.
  • Core inflation ex-housing: 0.71% vs 0.58%. The sudden drooping in primary rents is really the main story now.
  • Oddly, CPI for shelter in Houston has decelerated from 2.6% to 1.5% the last two months. That’s at odds with what happened after Ike.
  • But this may be another delayed effect.
  • 10y breakevens spiked 1-2bps on the print, but are fading. Word on Street is “used cars, shelter, airfares…this was all expected.”
  • Apparently not so expected that they could have forecast it. And primary rents were down, not up.
  • and used cars were not up more than the seasonal expectation so the y/y didn’t change. So really, no.
  • Early guess at median is 0.24%-0.26%…median category looks like one of the OER subindices and the BLS doesn’t release the seasonal adj.
  • This is our model for OER. So I think Primary Rents’ decline is the outlier.

  • And here are primary rents.

  • I think the real story here is that medical was not the drag it has been recently. But the one-offs still haven’t really reversed hard yet.

  • Speaking of one-offs…the most famous one is wireless telecom. This will all smooth out over 12 months.

  • OK, inflation in four pieces: First Food & Energy.

  • Next less-volatile piece: Core goods. Deflation here surprisingly persistent, given dollar’s retreat.

  • Core services less rent of shelter bounces for 2nd month in a row. This is where medical care shows up.

  • And rent of shelter we have already discussed. It’s where it should be and probably accelerates marginally from here.

  • Last one: weight of categories above 3% still hanging out just below 50%. Still some very long left tails separating core from median.

  • Thanks for tuning in.
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This data is going to get increasingly important as the one-offs fade and the next upswing in inflation happens. And we don’t need anything really weird to happen in order to get that upswing. The cell phone aberration will gradually exit the data, and make year-on-year comparisons of cell phone service very easy (actually, we might have inflation in cell phone services, simply because after unlimited data it’s hard to have any more big quality improvements!). Autos will eventually respond to the heightened demand post-flood. Medical Care is unlikely to be flat forever, once all of the compositional shifts have happened (and, if Obamacare is gutted, as the Republicans keep trying to do, then the compositional shifts back could make medical care inflation seem illusorily high, just as now it is illusorily low).

The next few months see difficult year-ago comparisons for CPI: 0.18%, 0.22%, 0.31%, 0.21% are the m/m figures for November and December 2016 and January and February 2017. That averages 0.23%, compared to 0.20% for the last three months we have seen. Ergo, rises in the y/y figures will happen slowly if at all, until March’s data in April. March/April/May/June/July averaged 0.05%, so in that time frame the y/y will be rising 0.1%-0.2% every month. And that’s when alarm will set in in the bond market, even though this is totally foreseeable.

Inflation is rising globally. The only place this isn’t really clear is in Europe, where it’s rising but from such a low level that the wiggles change the visceral appearance of the chart every month. This will keep the US central bank tightening, and other central banks will gradually exit QE. This is very bad for asset markets, and as rates rise and money velocity perks back up, the vicious cycle may well be ignited. 2018 is going to be very, very interesting.

Categories: CPI, Tweet Summary
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