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Summary of My Post-CPI Tweets (January 2021)

January 13, 2021 1 comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments!

  • Welcome to #CPI Day 2021! We get the last of 2020’s CPI figures today.
  • There’s always volatility in year-end figures, and this one is no exception. Last month, in fact, was pretty weird. In the Nov CPI we had soft housing, very strong Apparel. Broad softness sprinkled with some large moves in small categories. My write-up: Summary of My Post-CPI Tweets (December 2020)
  • As a result, while core CPI was higher-than-expected, Median inflation (which is a steadier measure) was soft. However, skewness on the upside is DIFFERENT from the way we’ve seen it for a while and I’ll be interested to see if that remains.
  • Economists’ consensus is that Core is gonna soften – the m/m core CPI consensus is around 0.12%. I think that’s mostly a call on rents, which have been softening.
  • But here’s the thing – rents haven’t really been softening much outside of big cities. What has been changing is that landlords have been expecting less rent due to financially-stressed tenants. This shows up in CPI as softening average rent growth.
  • And that could change, although probably not until next month. Payments looked soft in December. But rent tracker indices have payments a bit better this month, and they should be: there was just another Federal money drop.
  • Next month or two, we should see a rebound in rents. And in the long run, we definitely will because home prices are jumping and these two can’t diverge forever.
  • Away from Shelter, dislocations in the supply chain remain and part of the trick over the next 6 months is going to be teasing out the COVID effects from the long-term effects. Freight costs have risen steeply and there are goods shortages in places b/c of container shortages!
  • Another category I’m watching that has been weak for a while: Medicinal Drugs. Interestingly, this month (again, probably starts to hit Jan CPI when it is released next month) some major pharma manufacturers announced price increases.
  • Not a huge surprise: pharma prices had been suppressed when President Trump was threatening to introduce Most Favored Nation rules (saying companies can’t charge Americans more than other countries). Pharma played nice. CPI-Medicinal Drugs is negative y/y!
  • I wrote about that here: Drug Prices and Most-Favored-Nation Clauses: Considerations back in August. But the Biden Administration won’t be doing that. Ergo, it’s safe to raise prices again. And they have. We’ll see how much – starting next month.
  • That’s all for the walk-up. Expect volatility! I will probably focus on the ex-shelter number. BTW, be aware that monthly comps get super easy after this month, for a few months. Core CPI will be over 2.5% y/y, probably, by April & push 3% in May. Then the comps get much harder.
  • Do remember, as I constantly remind: the #Fed doesn’t care one bit about inflation. But if YOU do, and have interests in how to hedge/invest in the inflationary period approaching, visit https://enduringinvestments.com
  • And one more note: I will be on Bloomberg TV with @adsteel and @GuyJohnsonTV at 10:10ET this morning. And my interview with @MetreSteven on @RealVision just dropped this morning. A lot happening in inflation today!! Good luck…
  • Core CPI was +0.09%, a touch softer than expected. Y/Y at 1.62%.

  • Seems like Dec is always weak…even accounting for the seasonals! Let’s see. Primary rents rose 0.10%, y/y declined further to 2.28% from 2.45%. As I said, that will start changing soon. OER was +0.14%, y/y down to 2.17% from 2.28%.
  • Apparel took another big jump, +1.36% m/m. That’s part of the general strength in core goods. Core goods at 1.7% y/y, up from 1% just three months ago!
  • Check THIS out. Core goods inflation above core services inflation for the first time in years. Since the GFC, actually. A lot of that is supply chain folks. But a lot of it is people buying products with government money drops.

  • That rise in core goods happened even with CPI-Used Cars and Trucks -1.15% on the month, second weak month in a row. Looks like the used car prices in the CPI aren’t going to catch up with the private surveys on the upside, as they didn’t on the downside.

  • Airfares slipped -2.29% after +3.49% last month. Lodging Away from Home flat vs +3.93% last month. Motor Vehicle Insurance though continued to rebound, +1.42% after +1.23% last month. Those are my main “covid categories.”
  • In Medical Care, which was down for the second month in a row: Medicinal Drugs -0.24% (y/y down to -2.13%!), Doctors’ Services -0.02% (y/y to 1.74%), Hospital Services +0.30% (y/y 2.99%).
  • I’ve said it before and I’ll say it again. It’s hard to measure medical care, but these are just silly numbers. I doubt doctors are charging less when their costs have gone up enormously. But perhaps they’re charging CONSUMERS less, and we’re measuring consumer prices? Hmm.
  • CPI for Medicinal Drugs, y/y. Come on, man.

  • Core inflation ex-shelter was roughly unchanged this month, +1.45% y/y. Was +1.46% last month. It hasn’t been much higher than 1.7% since 2012.
  • So only two categories had large negative changes: Car and Truck Rental, -49.9% annualized, and Used Cars and Trucks, -12.96%. The latter coming down from a high level. But long list of >10% gainers again:
  • >10% annualized: Jewelry and Watches (39.5%), Men’s/Boys Apparel (+31.8%), Women’s/Girls Apparel (+18.3%), Car Insurance (+17.9%), Misc Personal Goods (+15.5%), Personal Care Goods (+12.9%), Tobacco/smoking (+12.9%), Misc Personal Svcs (+10.8%).
  • Those are just non-food and energy. Also >10% annualized increases in Dairy, Nonalcoholic Beverages, Fuel Oil, and Motor Fuel. But we know those are volatile. I include them in case anyone says “the government ignores milk.”
  • Anyway, Median should be soft again but not as soft as core this month. Median category will be a housing regional so it’s just a guess but I’m saying +0.13% m/m, 2.23% y/y. Core will actually pass over Median in a few months, I think, due to base effects.
  • College Tuition and Fees: +0.74% y/y vs +0.58%. I’ve talked elsewhere about how there’s a quality change here that the BLS knows about but is ignoring for now b/c should reverse: online college ain’t same as in-person college.
  • University costs themselves are up a lot. Talked at length to a university CFO consultant yesterday and they believe many of these costs will remain BUT there are some really interesting applications of virtual education that I can’t fit in here. 🙂
  • Circling back, just want to put the Apparel jump into context. Here is the Apparel price level index. So acceleration in 2011 (after years of nothing), slow deflation, crash into COVID, and just recovering some pricing power. Will be interesting to see how far it extends.

  • Update to our OER model. And honestly, everyone’s model looks something like this – lagged effect of home price rises is a big contributor, as are incomes, to where rents should go. But we’re looking at measured rents ADJUSTED for non-collection. That’s the key.

  • Here’s a fun one. 10-year inflation swaps are about to cross above current median inflation. That hasn’t happened in a long time. You would think the forward should be above, at least because tails tend to be to the upside, but they almost never are. At least, recently.

  • Distribution of y/y price changes by bottom-level category. Big spike is OER of course. But a really wide dispersion otherwise. Chaos.

  • Four-Pieces charts and then I’ll wrap up. Piece 1: Food & Energy.

  • Piece 2: Core Goods. Wheee! Honestly this overshoots our models so I think at least some of it are dislocations. But some of it is real, too much money pushing too few goods. And some is the recently-weak USD, so if you get a much stronger dollar (@MetreSteven) it could change.

  • Piece 3: Core Services less Rent of Shelter. This is the conundrum. I can’t imagine doctors services and hospital services stay depressed in this world. Other services may (office cleaning if there are no offices), but that’s also a consumption basket change. Stay tuned here.

  • Piece 4, Rent of Shelter. I think this will start to reverse as early as next month when the next gov’t checks go out. And the Biden Administration promises more. So delinquencies should decline, raising measured rents.

  • And that’s all for today. I’ll post a summary of these tweets in a bit. Remember to look up my interview on @RealVision, tune in to @BloombergTV at 10:10 to see me there, and visit http://EnduringInvestments.com if you need an inflation nerd!

Recent inflation prints have been held down by soft rents, and that continued this month. A lot of this is artificial: when landlords expect to collect less rent…which is not unreasonable during a recession…then this shows up as a decline in collected rents. But when/if those renters get more current, it shows up as a reacceleration in rents. That’s what I expect will happen, and it could happen soon since more Federal largesse is on its way. It’s an upside risk for the next few months. Although, in another sense, it isn’t really a risk: it’s what we should be expecting to see, given what is happening in home prices.

Rents are the main part of core services inflation. Because of the softness in rents and the softness in medical care services – which is a real head-scratcher – core services inflation fell below core goods inflation this month for the first time in a very long time. Now, normally you don’t see goods inflation in the middle of a recession, but then again normally Washington DC isn’t throwing thousands of dollars into the account of every family. Too much money: check. And supply chains are stressed. Too few goods: check. No surprise we’re seeing goods inflation.

So really, the wiggles in inflation we have seen over the last year are not particularly surprising in themselves, and it’s easy to explain them by falling back on the excuse du jour: “COVID.” Certainly, a lot of the chaotic pricing environment is due to Covid and the related disruption in our economic system. But the question is, what will happen on the other side? We have had massive money growth, with declining velocity until last quarter. Will velocity continue to decline? I am skeptical of that. Precautionary cash balances are higher than they ought to be, given where rates are, because people are nervous and when you are nervous you keep more in reserve. But this won’t be true forever. And we know that, behaviorally, the velocity of “found money”/windfalls is higher than the velocity of earned money, and moreover people are less price-sensitive when they spend a windfall. So I expect that as things go back to normal, inflation will rise – and probably a lot.

This is the test! Modern Monetary Theory holds you can print all you want, with no consequences, subject to certain not-really-binding constraints. The last person who offered me free wealth with no risk was a Nigerian prince, and I didn’t believe him either. I will say though that if MMT works, then we’ve been doing monetary policy wrong for a hundred years (but then, we also leached people to cure them, for hundreds of years) and all of our historical explanations are wrong – and someone will have to explain why in the past, the price level always followed the GDP-adjusted money supply.

Now, over the next four or five months it will be much easier to believe the inflation story. While core inflation was +0.24% last January and +0.22% last February, it was -0.10% in March, -0.45% in April, and -0.06% in May. By mid-year, that is, we will be around 2.8% core CPI y/y (if we just get 0.2% per month) before the comps turn much more difficult. Even though this is fully known, and even though it will therefore be a violation of the Efficient Markets Hypothesis, it will not stop people from becoming alarmed and for the markets to respond accordingly! So buckle in – at the very least, the first half of 2021 will be extraordinarily interesting. 

Summary of My Post-CPI Tweets (December 2020)

December 10, 2020 3 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments!

  • Once again, it is #CPI Day! As the summer shutdown continues to recede (even as a winter shutdown potentially looms), the data is starting to clear up a little.
  • There are still huge dislocations, though, in the global supply chain and we’re seeing anecdotal evidence of that all over the place. Check out the price of polymer grade propylene if you don’t believe me. PGP1 Comdty on Bloomberg.
  • Container shortages are also causing price and quantity ripples in global trade. And of course, huge amounts of money chasing these fewer goods. y/y M2 is +25% in the US. 10% in Europe. 9% in Japan.
  • Often, I go into the CPI report with just a vague sense of looking at the whole number and then breaking it down. This month, I have a little different plan of attack.
  • The word of the day today is “compartmentalize.” There is housing, and then there is ex-housing. Housing is one thing. There seems to be near-term pressure on rents even outside of the big cities, as delinquencies are at last rising (as many have long predicted).
  • Measured rental inflation is lower (even if quoted rents aren’t) to the extent that landlords don’t expect to collect the full rent, so that’s a downward effect.
  • But longer-term, housing is doing just fine – home price changes, in fact, are accelerating – so I am not concerned that rental deflation will stay around very long.
  • For a discussion of housing, see my post from october 23 here: https://mikeashton.wordpress.com/2020/10/23/the-outlook-for-housing-inflation-from-here-oct-2020/
  • So shelter will probably be soft though we’re due for a bounce in Lodging Away from Home. But outside of shelter, the “non-sticky” is what I really want to see. As I mentioned, there are supply chain problems out there and it’s affecting prices because it affects supply.
  • Used Cars might have some more upside, though the early-summer surge looked to be past when that subcomponent declined slightly last month. But the surveys of used car prices are headed back up.
  • Last month, overall core CPI was weak largely because Medical Care tanked. That was the real outlier. I’m keenly interested to see if it rebounds. It’s implausible to think that medical care prices aren’t inflating much.
  • Broadly, consensus this month is for 0.1% on core and just a smidge over 1.5% y/y. No real opinion there – as I said, I’m compartmentalizing. I want to see ex-shelter.
  • Do remember, as I constantly remind: the #Fed doesn’t care one bit about inflation. But if YOU do, and have interests in how to hedge/invest in the inflationary period approaching, visit https://enduringinvestments.com
  • There’s a growing tide of stories about inflation, both anecdotal ones and stories of the “smart people worried” variety. And I’m seeing lots of interest in new product development in inflation space, and working on several with customers. 2021 will be busy.
  • OK, let’s see what the BLS has in store for us this month. Good luck. And in case I forget to say it later, Happy Holidays. Now let’s light this candle!!
  • Core CPI +0.22%, higher than expected. y/y at 1.647%…rounded to 1.6%, but almost ticked up to 1.7%. But remember: let’s compartmentalize. See the breakdown.
  • Just a quick glance tells me this will be interesting. Used Cars, a usual suspect when we’re above consensus, wasn’t it. -1.28% m/m, which means next month probably it adds. And rents were soft.
  • Owners’ Equivalent Rent was +0.03% m/m, dropping the y/y to 2.28% from 2.50%! That’s a huge drop. Primary Rents +0.04%, y/y foes to 2.45% from 2.67%. Also huge. All of that temporary though.
  • Lodging Away from Home did rebound as expected: +3.93% on the month. So total housing was 0.27% m/m, even though the big pieces belly-flopped.
  • And Medical Care was down again, -0.13% m/m. So what was UP??
  • Well, airfares were +3.5% m/m. Motor Vehicle Insurance rebounded 1.2% m/m after falling last month.
  • Core Goods inflation rose to 1.4% y/y. Core services was flat at 1.7%. You’re looking at supply chain and classic too-much-money-chasing-too-few-goods.
  • Core ex-shelter rose to 1.47%, reversing the deceleration from last month. Still not terribly high, but heading the wrong way.
  • Shelter, and core ex-shelter. Outside of shelter, there’s no sign that covid is causing anything that looks like deflation or even disinflation.
  • Apparel was +0.92% on the month, which is a whopper and a part of the ‘how is this happening’ story, even though it’s only 2.8% of the CPI.
  • Biggest declines on the month were jewelry and watches (-14.5% annualized) and used cars and trucks (-14.4% annualized). But there’s a long list of categories annualizing over 10%:
  • Motor Vehicle Insurance (13.8%), Footwear (17.6%), Men’s/Boys Apparel (28.5%), Misc Personal Goods (+31.9%), Public Transportation (+34.4%), Infants’/Toddlers’ Apparel (+51.3%), Lodging AFH (+58.9%), Car/Truck Rental (+66.8%).
  • So here’s the thing. Because there were small categories with BIG rises and big categories with small declines, the “average” CPI is exaggerated. Median CPI in fact should be very soft, maybe even +0.04% this month. And Median y/y should fall, pretty sharply even.
  • To be sure, if the skewness goes from being on the downside where it’s been for years, to being on the upside – that’s partly what inflation looks like. More on this later when I show distribution stuff.
  • Appliances inflation, part of that core goods component, continues to accelerate. CPI for Major Appliances is now +17.2% y/y, which you probably know if you’ve been remodeling.
  • The overall Housing subcomponent inflation rose to 2.00% y/y from 1.95%. But that’s despite big drops in primary and owners’ equivalent rent. BECAUSE of things like appliances, tools, housekeeping supplies, furniture…all up.
  • As noted, a big part of the “small categories, big changes” came from apparel subcategories. But here’s the overall apparel category. Not exactly terrifying (this is price level, not inflation). The price of clothing is back to roughly what it was in the late 1980s.
  • Totally have skipped over medical care so far. At least we saw increases in some categories although it remains…improbably soft. Medicinal Drugs -0.19% m/m. Doctors’ Services +0.13% m/m. Hospital Services +0.33% m/m. I still don’t buy it.
  • Skipping back to rents – the decline is getting to the implausible level. Again, this isn’t really quoted rents – this is being caused by rent delinquencies.
  • It’s really, really important to remember that home prices don’t follow rents, rents follow home prices (usually). With home prices shooting higher, rents will not keep decelerating. These are substitutes. Over time they move together.
  • So, this distribution is starting to look different. Tails are starting to extend to the high side while the big middle is temporarily moving left b/c of rents.
  • But having the long tail on the upside, which will cause median CPI to eventually be BELOW core instead of above it as it has been for years, is part of what inflation looks like. Kernels popping.
  • I’m going to do the four-pieces charts, then the perceived inflation index, then wrap up.
  • I see we have a number of new joiners this month so to set up the “four pieces” charts: this is just one way of slicing the data into reasonable categories so that each piece is around one quarter of CPI. Food & Energy, Core Goods, Core Services ex-Shelter, and Shelter.
  • Piece 1: Food & Energy. About 20% of CPI.
  • Piece 2, core goods, also about 20%. Talked about this earlier. This is supply chain disruption, and money chasing goods. Appliances. Furniture. But not medicines, weirdly.
  • Core services less Rent of Shelter – weak, as Medical Care Services is weirdly soft. I really don’t understand this. Some of it is auto insurance, which is soft because people aren’t driving as much, but this just seems odd.
  • Rent of Shelter, 1/3 of CPI and a plurality of core CPI. This is where you’ll see really strident arguments on both sides over the next month. But remember, it’s largely about delinquencies. If there’s another stimulus and folks get current on rent, this will reverse.
  • Perceived inflation still running about 1.1% above core inflation.
  • So to wrap up: Core surprised to the upside, because of large changes in small categories like apparel, furniture, and appliances. This means median CPI, which we pay more attention to, will be softer this month.
  • Compartmentalizing: rents continue to be soft, but I don’t think they’ll stay that way. Core goods are clearly pushing higher in a way they haven’t for years, and everyone sees this especially during the shopping season. People don’t shop for services for Christmas.
  • Core services, even ex-shelter, remain curiously weak. Softness in medical care remains a conundrum to me.
  • Bottom line is that this upside surprise isn’t as alarming as it could be, in the same way last month’s downside surprise wasn’t really helpful to deflationistas. But the kernels popping to the high side is an interesting phenomenon that is becoming more common.
  • That might be related to the COVID economy, or it might be a shift to an inflationary price dynamic from the disinflationary price dynamic we’ve seen for decades, where the middle is steady but we get occasional downside tails from price-cutting.
  • Time will tell. However, there is nothing here to make Fed governors wake up early to catch the next CPI. They don’t care about inflation, and it will be a while before it gets on their radar screens. By the end of 2021, maybe.
  • Thanks for tuning in. I will post a summary of this string of tweets at https://mikeashton.wordpress.com in a half hour or so. Please stop by and peruse the blog, or better yet come by https://enduringinvestments.com and drop me a note so we can talk about how to work together. Happy holidays!

This was a really different CPI in a number of ways. For one thing, Apparel actually contributed to the upside. The number of core goods categories – small ones – showing large price increases is really unusual, and fascinating. Some of this is clearly temporary: the global supply of shipping containers is all in the wrong places, and there aren’t enough of them anyway, and this is causing sharp increases in shipping costs, delays in shipping, and therefore shortage in end product markets. This would ordinarily be merely inconvenient, but pressing against that shortage of many sorts of consumer goods is a large increase in the amount of money. When helicopters drop a few thousand dollars in everyone’s pocket and many of them run out to spend it, but the shelves are sparse – you get price increases. I am not sure this is as temporary as we want to think. In the initial helicopter drop, a lot of that money was saved at least temporarily, and money velocity fell. But that was partly because we were all shut-ins; we’re also finding out it was partly because there weren’t enough products to buy. I think we’re going to continue to see that money come gradually out of savings and into spending, and I am not sure the global supply chain can keep up yet.

We aren’t yet seeing the broad inflationary pressures. Obviously, rents are soggy but core services in general are weak. I don’t think that will persist; I wonder how much is due to the hangover from the lockdowns. But the lengthening of the upside tails is one characteristic of an inflationary process. I wrote about this recently in “Are the Inflation Kernels Starting to Pop?” and that’s worth a quick read. It has been a long time since we have seen a true inflationary process even when we’ve seen occasional accelerations in inflation itself, so we tend to forget. When inflation is rising at 4%, it doesn’t mean the price of everything we buy is going up at a uniform 4% per year. What actually happens is that prices are sticky, then they jump. This happens for a number of reasons, such a “menu costs” (the cost of reprinting menus, back when that was a thing), and the fact that you have to explain to customers why prices are changing so you do it as infrequently as possible. So what happens is that the price of a particular item goes up 0%, then 0%, then 12%. When that happens, median inflation is below core inflation, because the long upside tails pull up the average. When instead we are in a disinflationary environment, prices go up 2%, then 2%, then get a price cut of 6%. In that case, median inflation will be above core inflation, because the long downside tails pull down the average.

So even though core CPI has been below median for a generation, that isn’t guaranteed. In fact, it’s a possible indicator. Look at the following chart. For years, median CPI had been below core, during an inflationary period. In 1994-5, the positions reversed and they’ve been that way basically ever since.

Obviously, core CPI is still below median CPI. But when the Cleveland Fed reports it today, Median CPI is going to decelerate quite a bit. I don’t think Median is going to keep going down – I think it, and core, are going to go up from here and probably for quite a long time. My point though is that these long tails to the upside are interesting, and worth noting. And if Core CPI crosses above Median over the next few months and quarters, then look out.

Are the Inflation Kernels Starting to Pop?

October 27, 2020 2 comments

On Friday, I wrote about the outlook for housing inflation, which is a big part of the overall (and especially core) CPI. If you missed that piece, you can find it here. As a quick update: today, the FHFA House Price Index was reported +1.5% for August, versus expectations for +0.7%, and the S&P CoreLogic neé Case-Shiller 20-City Home Price Index was reported at +5.18% y/y versus expectations for +4.20%. So, as I noted in that piece – the signs for home prices remain very supportive, and that suggests that rents are unlikely to continue to decelerate for very long.

I focused first on housing because that is the largest and most-ponderous category of the Consumer Price Index. Today I want to turn more broadly and look at everything else, collectively. Because I think there are some reasons to think that not just housing, but the inflation process itself, is starting to look more buoyant.

Although we are somewhat conditioned to think of inflation as a smooth process, with all prices sort of rising/accelerating as one, that’s not how inflation happens. Thinking about the process this way – as a rising tide that gradually increases the price of everything – means that we have a predisposition to look at each individual price change and see if we can identify the “reason” for the price change; if we can find one, then that must not be inflation but rather a one-off event. Used cars CPI is a great case study: over the last few months, the CPI for Used Cars and Trucks has spiked and is now rising at about 10% y/y (see chart, source BLS).

Is that inflation? Well, to some observers it is just a one-off effect. For example, an argument by Twitter user @thestalwart in response to this spike in prices was:

Now, this ‘assumes a can opener’ because there hasn’t yet been a sudden and widespread move to the suburbs; moreover, to the extent that commuting is way down shouldn’t that mean a bigger supply of used autos? What about the car rental fleet shrinkage with business and leisure travel way down? Rental is a large source of used cars. Nonetheless, it is surely true that in each market where inflation (or disinflation) happens, you can point to movements of supply and demand in nominal space…that’s just Econ 101. In other words, there is always an explanation to be had beyond “everyone just raised prices because there’s inflation.” And inflation doesn’t happen in a uniform way. I like to say that it is like microwave popcorn: not all kernels pop at the same time, but eventually the bag is full. For each kernel, you can look at local conditions that determined exactly when that kernel will pop (“this one was moister than others, so that’s why it popped”). But the overall cause is “heat.”

So waiting until that time when you have prices rising for no apparent reason is just waiting for Godot. There’s always an excuse.

Recently, there has been evidence that the “heat” is rising. Anecdotally, the Wall Street Journal had a story a few days ago entitled “Why You Might Have Trouble Getting the Refrigerator, Can of Paint or Car You Want,” with the subtitle “Factories rush to keep up as Americans spend on their houses and vehicles.” Again, the story is that there are various bottlenecks on the supply side but the simple explanation is that there’s a lot of people trying to buy and not enough goods to sell. That’s actually the classic definition of inflation: “too much money chasing too few goods.”

Anecdotes are fun, but let’s try to look at this a little more analytically. Enduring Investments has developed an inflation diffusion index, derived from BLS data, which gives a different look at the breadth of inflation. It doesn’t take a weighted average, like Core CPI, and it doesn’t take the midpoint of the consumption basket like Median CPI. Instead, it looks at the number of categories that are seeing prices increasing faster or slower than 2%, weighted equally in their category and with each of the eight major categories getting 1/8th of the overall weight. As a price index, this is absurd – why would you weight Owner’s Equivalent Rent only slightly more than Full Service Meals and Snacks when consumers spend vastly more on shelter? But as an indicator of breadth, it makes some sense: there are, after all, a lot more different sorts of goods that fall under the category “Full Service Meals and Snacks,” and we make purchase decisions in that category more frequently than we make decisions on rents as well. So, in terms of the proportion of decisions made that are seeing higher price acceleration, arguably the index for meals and snacks should be higher. (There is nothing magic here, just an attempt to get a better view of inflation breadth. There are other ways to look at the same thing).

Over time, as the chart shows, the Enduring Investments Inflation Diffusion Index tends to move with median inflation. But interestingly, in the post-Global Financial Crisis period these two have diverged, with the diffusion index in negative territory more normally associated historically with crisis or recession periods. This helps explain why there has been little investor interest in buying inflation protection even though the Median CPI has been rising fairly steadily for seven years! But that may be changing: the EIIDI has been in the single digits negative for three of the past four months, and the 12-month average is the highest it has been since the end of 2013.

For a while, the story of inflation in the US has been that shelter inflation was strong, some other services were seeing some inflation, but the vast majority of goods were seeing stable to declining prices. This is changing. Shelter has been softening – although as I noted last week I don’t think that will continue – but we are seeing pressures percolate more widely. The corns are starting to pop more frequently. Keep an eye on that bag!

Categories: Uncategorized

Summary of My Post-CPI Tweets (October 2020)

October 13, 2020 Leave a comment

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments!

  • Another COVID-era #CPI report coming up this morning. After two big upside surprises versus economic forecasts, the forecasts this month are …lower.
  • Last month, economists were looking for a “strong” 0.2%, something 0.21%-0.24%, and got close to 0.39%. That was a month after the 0.62% print.
  • This month, the forecasts are for 0.2% on core, but a 1.7% y/y. We can look at the year-ago number and figure out that to keep 1.7% from rounding to 1.8%, core can’t be 0.21% or higher. So economists are clearly expecting a “soft” 0.2% on core.
  • …something closer to what was normal before COVID. I’m still not sure we get normal.
  • The “COVID categories” (hotels, airfares, etc) still haven’t fully recovered, and despite the recent bump in used car CPI it’s still well behind private surveys which continue to accelerate. Never know if that will happen THIS month but still looks like some room there.
  • We’re also starting to see reports of pressure in medical care, which so far hasn’t made it into the CPI in a significant way. And the weakness in the dollar since spring will eventually help apparel a little.
  • Now, we still have some near-term downside risk from housing, but more and more any weakness there (and it has been a touch soft, which makes the upside surprises even more surprising) looks transitory.
  • We’ve all seen the reports of plummeting rents. But those are in cities, and it turns out that a lot of renters don’t live in cities. Outside of cities, rents don’t appear to be under pressure.
  • If renters are being more delinquent such that landlords expect to collect less, this would pressure the measurement of rent inflation – but the NMHC tracker says the share paying rent through Oct 6 is the same level as in 2019.  https://nmhc.org/research-insight/nmhc-rent-payment-tracker/
  • Meanwhile, there are signs from the housing market that there is actually upside risk ahead – I really meant to write a column this month on the housing indicators but just didn’t get to it.
  • For example, one important longer-term driver of rents and OER and home prices is incomes, and incomes are very strong right now thanks to federal income replacement. Will they be this strong in 4 months? Probably not, but presently these incomes are driving housing outcomes.
  • All that said, OER and primary rents have been a little weak recently and my gut is bracing for something even softer. But there’s no analysis there, just a concern. Even a little housing softness could produce a ‘soft’ 0.2%.
  • Rents are really the only ‘normal’ thing that can drag this number lower. But this is the COVID era, and nothing is normal, so there can always be weird one-offs, in both directions. With M2 rising at 24% per year, these are more likely to be on the positive side.
  • All of these one-offs on the high side are what inflation looks like, after all. Inflation is like microwave popcorn. The kernels go off one at a time, and each has a micro “explanation.” But eventually the bag is full, and the MACRO explanation was “heat.”
  • Outside of rents, inflation is broadening, quickening, and deepening. It surprises me that it has happened so early…I thought it would take until 2021…but if we get a third surprise today then we’ll have to start thinking it’s here already.
  • Do remember of course that the #Fed doesn’t care one bit about inflation. But if you do, and have interests in how to hedge/invest in the inflationary period approaching, visit https://enduringinvestments.com and drop me a line. Good luck today.
  • Well, soft 0.2% it is. +0.19% on core CPI.
  • y/y on core at 1.73%, so basically unchanged from last month.
  • OK, so used cars was +6.7% m/m, even more than last month’s jump. Core goods, partly as a result, went from 0.4% y/y to 1.0% y/y. But core services plunged from 2.2% to 1.9%. And where?
  • Yep, OER was only +0.06% m/m, which pushed the y/y down to 2.49% from 2.69%. Primary rents +0.12% m/m, so y/y fell to 2.72% from 2.95%. My gut was right – there was (near-term) downward pressure there.
  • Lodging away from home, which had been recovering, slipped back some last month -0.38% m/m. I guess the end of the summer vacation season means it’s all business travelers, and not many of those.
  • Apparel fell, -0.45% m/m, despite weaker dollar. But the real surprise might be medical care, which FELL despite lots of evidence that prices are increasing. Need some charts here.
  • Physicians’ services -0.29% m/m. Really? Talk to any doctors who are doing price cuts recently?
  • Amazing that we were able to get an 0.2% even with housing so soft (and again, the bigger indicators on housing are pointing higher). Core inflation ex-housing rose to 1.50% y/y. Disinflationary pulse from COVID basically over already.
  • College tuition and fees fell to 0.71% y/y from 1.31%. This is clearly a quality effect that isn’t being captured by a quality adjustment, and the BLS knows it but can’t figure an easy fix for what is a 1-year problem. Remote-learning isn’t worth the same as in-person.
  • Tuition had been under pressure anyway because endowment returns had been fantastic for a while, but this dip is because colleges can’t charge the same for e-college.
  • Motor vehicle insurance continues to be a drag on services inflation. People are just not driving as much, and insurance companies are rebating premiums. Biggest 1m declines this month were Infants/Toddlers Apparel (-36% annualized) and Motor Vehicle Insurance (-35%).
  • The surprising part of that might be the fact that Motor Vehicle Insurance has a 1.7% weight in the CPI. That seems like a lot, but we only notice it once a year when we get the renewal.
  • Biggest core gainers this month were Motor Vehicle Fees (+10% annualized 1m change) – governments gotta make it somewhere! – Public transportation, jewelry, car & truck rental, used cars, leased cars, miscellaneous personal goods.
  • Health insurance is also finally coming off the boil.
  • m/m decline in health insurance (NSA) is largest in a long long time.
  • …I guess that decline in health insurance is because people aren’t going to the doctor for minor maladies as much? But of course remember health insurance in the CPI is a residual, not a direct measurement of premiums.
  • So here is OER versus our ensemble model. This month I REALLY have to do a column on housing, because the right side of this graph has been revising HIGHER while the spot numbers have been surprising lower. There are big reasons to think rents are NOT about to decline hard.
  • Forgot to mention one of the covid categories: airfares were -2.0% m/m after +1.2% last month.
  • The jump in used car CPI was, as I noted up top, not really surprising. But it looks like we’ve squeezed most of that lemon (no car pun intended) unless the private surveys keep accelerating.
  • So, despite an as-expected number, bond breakevens have plunged 3.5bps since the print. Investors are conditioned to not ever take inflation breakevens much above 2% or swaps above 2.5%, no matter the outlook. That’s a gonna hurt.
  • Sorry for the break – calculations. Here’s a fun one. It’s our measure of perceived inflation minus core inflation (consider it “inflation angst”), versus the subsequent return to gold.
  • Four pieces: Food & Energy, trendless.
  • Core goods, impressive. Although a lot of that is used cars. Pharmaceuticals pretty soft, import prices not worrisome yet. Apparel soft. So this might be best we can expect from this piece, about 20% of the CPI.
  • Core services less rent of shelter. Settled back a bit, although as noted I’m skeptical that medical care costs are about to go into retreat…
  • And finally, rent of shelter. A lot of this deceleration is hotels, but as noted earlier rents are definitely soft and that’s the big story this month.
  • So, to sum up: housing inflation looks soft, but forward-looking indicators there are pretty solid as long as incomes don’t collapse again (they’ll decelerate and maybe even decline, just need them to not collapse). Outside of housing, there’s broadening of price pressures.
  • Yes, core goods exaggerates where those pressures are at the moment, but they are definitely there. And with money supply rolling 24% y/y, it’s going to persist. The question for Keynesians is: where is the deflation, man? We never even got close!
  • Thanks for tuning in. Have a great day.

Later this month, I definitely need to talk more about housing. Since housing is always the biggest and slowest piece of consumption, any argument about meaningful disinflation or inflation must include a discussion about housing. Right now, when there isn’t an overall inflationary or disinflationary trend, the slow waves in rents are really the main driver of core, and everything else is noise around that trend. When we get into a more-extended inflationary or disinflationary trend, then housing will likely follow the overall underlying trend. This hasn’t happened, though, in decades – which is why most models of rental inflation now tend to be built on a nominal frame rather than in real terms. But I digress.

Most of the main rebound of the “Covid” categories seems to be over. While those categories – apparel, airfares, lodging away from home, food away from home – still sport prices below their pre-Covid levels, it may be that they just don’t come all the way back any time soon. Ergo, the potential for upside surprises from those categories, going forward, is lessened. Similarly, I’m not sure we have a lot more upside to used car prices, as CPI has mostly caught up to the private surveys (of course, used car prices might still go higher, but at least the CPI has caught up to what we already knew). So, again, we come back to rents. Will rents continue to decelerate? The headlines suggest an implosion of the rental property market. But in the meantime, the median price of existing home sales was recently reported as +11.4% y/y, the biggest jump since 2013 (and back then, we were still rebounding from the financial crisis). Home prices and rents cannot diverge for long; they are substitutes.

And with the money supply spiraling higher at an all-time record pace, it is hard to imagine that hard assets like homes will see prices decline, or even level off. Think about it this way: if you have an exchange rate between apples and bananas, say 1:1, and suddenly there is a bumper crop of bananas, then you’d expect the price of bananas fall relative to apples. Right now there is a bumper crop of money, and so it’s reasonable to expect the price of money to fall relative to the price of real assets like houses (each dollar buys fewer houses). Of course, what that means is that the price of houses, in dollar terms, ought to keep rising.

If that happens, then the recent softening of rents is likely to be temporary. That’s the next phase of the inflation puzzle – looking for the rebound in rents.

Summary of My Post-CPI Tweets (June 2020)

June 10, 2020 8 comments

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments!

  • It’s #CPI day again! These days it seems we live a year in every month, and from a data perspective that’s kinda true. There used to be months when there were no truly surprising data points. Here is my walk-up.
  • Before I do, let me invite folks to take a look at our newly renovated website at https://enduringinvestments.com. It’s like we finally made it into 2018!
  • Anyway, nowadays those data points that used to be surprising every few months come about once every ten minutes or so. Will CPI be one of them? It’s certainly been an…interesting…number over the past few months.
  • The BLS has had to wrestle with collection issues, such as the fact that in the teeth of the crisis they didn’t want to be placing a burden on medical care professionals to respond to a survey. So measuring prices was difficult.
  • And of course the BLS also recently had the issue with coding Unemployment, because we’ve never had a situation like this and so the book doesn’t explain what to do! CPI has some of those too.
  • There was also a much greater dispersion than usual in prices collected, because of wildly different circumstances at each outlet. Lots and lots of craziness. But the net was that we were -0.10% on core in March, -0.45% in April.
  • Here is one example, from this month, that will be important in Used Cars. The Mannheim index had a massive jump, while the Black Book index slipped slightly further. So how do you forecast CPI for Used Cars??

  • It appears that while used car prices rebounded at the wholesale market, they didn’t at the retail level. I think that, and all of the rebound stories, are “yet.” But who knows what that means for this month.
  • I think we ought to get a healthy rebound in Lodging Away from home, which has fallen 14% or so over the last couple of months. And Airfares. But maybe not until next month.
  • Here’s the thing. From the top down and bottom up, it looks very likely that prices will be accelerating going forward. Clearly, everything is getting more labor-intensive and we’re re-onshoring cheap overseas production in some cases. And here’s the top-down case, which is M2.

  • The rise in M2 is unprecedented, and while a near-term precautionary demand for money will depress velocity, the Fed is in a real corner when velocity rebounds, and it will.
  • But that’s not today. Today the consensus forecast is for flat m/m figures on both core and headline. Food will be a big positive contributor, energy a negative contributor (probably) for another month. Net result: wild guesses.
  • To me, it feels like we’re due for an upside surprise. I would guess Medical Care is due for something funky. But I don’t make forecasts in normal times; sure as heck am not going to do it NOW. Good luck folks.
  • It’s almost creepy. Core CPI was very close to flat, at -0.06% m/m and 1.24% y/y. That’s ridiculously close to forecasts given all of the difficulties.
  • I forgot to mention too that the range in forecasts was not all that wide either…there wasn’t anyone with a -0.3% or +0.3% forecast on core. Which is wild!
  • Last 12 core CPIs:

  • Food and Beverages was (only) +0.72% m/m, raising the y/y to 3.88% from 3.39%. I don’t normally focus on non-core items but this is one where we’ve seen massive moves. So I was surprised we didn’t see more.
  • Here is the y/y change in food & beverages. Not at all bad yet. Food at home is +4.8% y/y, but still not as high as those prior peaks. More coming I am afraid.

  • On to more interesting items. Used Cars and Trucks were -0.39% m/m, which weirdly raises the y/y figure to -0.37% from -0.75% last month. But that’s part of the weakness in m/m core. Black Book was closer, as it has been.
  • But used car prices will come back, so get your deals while you can. Wholesale prices have largely rebounded to the pre-covid levels. Retail will get there, once people are shopping.
  • Overall, core goods fell to -1% y/y from -0.9%, and core services to 2.0% from 2.2%.
  • BTW used cars correction: -0.35% this month, not -0.39%, on the m/m. My error.
  • On rents, Primary Rents were unchanged y/y at 3.49%. Owners’ Equivalent was approximately unch at 3.06% vs 3.07%.
  • BUT Lodging Away from Home fell further. -1.53% m/m, bringing y/y to -15.06% from -13.91%. That’s a bit at odds with what I’ve seen personally, but a big reason for the weakness in core.
  • Also airfares was -4.9% m/m, clearly at odds with what is actually happening to city-pairs prices. This must have something to do with when they collected the data, or perhaps there are fewer first class seats and that’s affecting the avg.
  • Y/y the BLS says -29% fall in airfares, which itself doesn’t seem too crazy, so maybe this month is some kind of catch-up. But again, airfares are certainly going to rise – unless we simply forget about social distancing and start running full planes again.
  • So on core, it seems the usual suspects again this month. Rents fine, airfares and used cars and lodging away from home big losses.
  • How about Medical Care? m/m +0.49%, to 4.90% y/y from 4.81% y/y. Pharma flat, but y/y up to 0.93% from 0.78%.
  • Doctor’s Services finally showed some life as doctors’ offices reopen (another place we’re going to see increases if they can take fewer patients, but maybe it’s not nice to do it right away). +0.65% m/m, to 1.80% y/y from 1.23%.
  • But Hospital Services only +0.11% m/m, and the y/y declined to 4.86% from 5.21%. Again, that’s weird in a time of Covid. I think while the last couple of CPI reports were pretty clean, we’re starting to see some stale prices affect the numbers.
  • I’m not saying that because of the overall result…flat core cpi m/m was about right. But it’s WHERE we are seeing some of these things that’s weird.
  • Now, I totally buy Apparel at -2.29% m/m, -7.90% y/y. That makes total sense to me and less clear that turns into a positive number. We’re not going to start making apparel again in the US. I think we’ll get back to flat prices eventually.
  • OK this is interesting. Alcoholic beverages is 1% of the CPI, but this is Alcoholic Beverages at Home since the other part doesn’t make sense. Note that last two peaks were around big recessions? Expect more upside here! Surprised it isn’t already higher.

  • Biggest core declines on the month (annualized monthly change): Car Insurance -67%, Public Transportation -37%, Car/Truck Rental -34%, Women’s Apparel -30%, Men’s Apparel -29%, Lodging AFH -16.8%, Footwear -16%.
  • Biggest gainers, other than Meat, Poultry, Fish, and Eggs (+55% annualized) and Dairy (+12.6%): Recreation (+11.1%) and Motor Vehicle Parts/Equipment (+10.6%) Guess if you’re not buying new cars, you’re fixing the old one.
  • FWIW, Median is going to be very interesting this month. It’s probably going to be around +0.27% ish. Likely to be the highest since January. That’s yet another reminder this inflation ‘slowdown’ is ALL IN THE LEFT TAIL. Big drops in just a few categories.
  • However, one of those left-tail items is not shelter. So, core ex-shelter is now the lowest since well before the GFC. We are nearing non-shelter deflation. Get ready for the agitated headlines.

  • Again, worth remembering is that that dramatic picture is ALL IN THE LEFT TAIL.
  • Hey, let’s talk about the Fed for a second and then I want to turn to Recreation. This number will not change – and actually, no number would – the Fed’s trajectory. They’re going to stay easy, easy, easy. Even when inflation signs emerge.
  • IN FACT, this dip in prices will help the Fed ignore the acceleration, because they’ll say it’s just a rebound. But the key will be that the acceleration will NOT just be in the tail, bouncing back, but the middle of the distribution.
  • So, the Recreation category (5.8% of CPI) rose 0.88% m/m, pushing y/y to 2.11% vs 0.94% previous. Larger jump than Food & Beverages.
  • In the subcategories of Recreation, the biggest jump by far was in Other recreation services, which was +4.99% y/y versus +1.61% last month. Why?
  • In the sub-sub-categories below Other recreation services, we have Admissions rising 3.63% vs 1.23%. But the BIG increase was “club memberships for shopping clubs, fraternal or other organizations, or participant sports fees”. +7.34% y/y vs +2.55%. Discuss.
  • OK 4 pieces of CPI. Actually 5 today. First Food & Energy. Thanks to Food, not as bad by now as I’d thought we’d have been.

  • Piece 2 is core goods. Apparel, e.g.. Not surprising we’re down here, although Pharma (only +0.9% y/y) continues to surprise me. Pharma will rise once we start onshoring APIs. In the meantime, core goods is weak, but not sure it gets much weaker.

  • Core services. Again, polluted by lodging away from home and airfares. This will snap back over the next few months, because I don’t think Medical Care is about to plunge and it’s steadier than Lodging AFH and Airfares.

  • Piece 4, which COULD be alarming: rent of shelter. But, of course, this is all Lodging AFH (I mistakenly put this in core services less ROS in my prior tweet!). So let’s look at piece 4a, that breaks out the stable part of rents.

  • There is nothing surprising here happening to OER. And in fact, home prices seem to be holding up just fine and foot traffic has been increasing. In uncertain times, what’s better than your own home? If you expect deflation, you better find it here. And you won’t.

  • 10y Breakevens today +3.5bps. That’s interesting, and it suggests people are looking past the current figures. But 10y Breaks are still at 1.28%, with implied core inflation well below 2% for a decade.
  • But it’s still a really big bet that deflationary forces will win. And that seems increasingly unlikely.
  • Breakevens are not as big a bet at 1.28% as they were at 0.94% when I wrote this: https://mikeashton.wordpress.com/2020/03/11/the-big-bet-of-10-year-breakevens-at-0-94/
  • OK, that’s it for now. I look forward to the days when all of the one-offs are done. One last comment: if median CPI is in fact +0.27%, then y/y Median would rise. In fact, anything above 0.21% m/m would mean y/y increases from its current 2.70%…
  • I will publish a summary of all these tweets later. Thanks for tuning in. Be sure to visit the website at https://enduringinvestments.com and tell me what you think about the new look.
  • Oh, one more fun chart. Here is the Apparel series. Clothing prices in the US are now down to levels we haven’t seen since 1988. I can finally break out that old tie. Oh wait, it’s price not fashion.

Another month, another set of crazy figures from Airfares, Lodging Away from Home, Apparel, and Cars. Outside of those, there really haven’t been many big surprises. I guess it’s surprising booze inflation isn’t higher yet. But if we were entering into a deflationary period, we wouldn’t see core decelerating only because of left-tail events, and we wouldn’t see Median CPI accelerating. This really gives every sign of just being a set of one-offs that will pass out of the data before long and be replaced by the true underlying trend. Prior to COVID-19, that trend was a gradual but unmistakable acceleration in inflation, so in my view that’s probably the best outcome you can hope for if you are a bond investor: that we settle back to something like 3% in median inflation and 2.25-2.5% in core inflation. There is as yet no sign of the collapse in housing that we would need to usher in another Depression-like scenario, and for all the errors the Fed made back then the one they have not made this time, indubitably, is the error of failing to add enough liquidity. Indeed, the error they’ve made this time is that they have added far, far too much liquidity and there is no good way to remove it.

That isn’t this month’s story, and it isn’t this quarter’s story. Short-maturity TIPS, not surprisingly, trade at very low implied inflation rates even though energy prices have aggressively rebounded – right now, TIPS carry is awful and if you own a short TIPS bond you’re not looking at next year’s inflation. Beyond the front end of the TIPS curve, though, pricing of inflation-linked bonds relative to nominal bonds is almost comical. Yes, real yields are very low and it’s hard to love TIPS just for TIPS. I don’t understand, though, why TIPS aren’t currently beloved compared to all forms of fixed-rate debt. Some of it is indexed money, but I don’t understand why the indexed money is insisting on smashing into a wall. This will all become obvious eventually, and people will look back, and everyone will remember how they were very bullish on breakevens and can’t believe how everyone else messed up. And everyone will be an inflation expert.

Today’s figure doesn’t mean anything to the Fed, as I said before. Well before this all happened, Chairman Powell had effectively abandoned the inflation mandate. Late last year, he’d declared “So, I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.” And then, on February 11th in front of the House Financial Services Committee Powell, in response to a question from Congressperson Ayanna Pressley (D-MA) about whether the central bank could ensure economic conditions such that “anyone who wants to work and can work will have a job available to them,” Powell responded that the Fed will ‘never’ declare victory on full employment. Not a word about inflation in his response. With Unemployment in the teens right now, I think we can safely say it will be a very long time before the Fed makes inflation its primary worry.

But, I think eventually they will.

Why We Can Be Pretty Sure China is Lying About COVID-19

March 28, 2020 14 comments

This post has nothing to do with inflation (although to the extent that China’s problems are worse-than-advertised, the supply shock could be worse-than-expected and the resulting inflation impulse larger-than-expected). However, as a longtime participant in the financial markets – which, over the last decade or two has increasingly meant an observer of China and Chinese data – I have been absolutely flabbergasted at the evident willingness of press, government officials, and healthcare experts to accept at face value the reports China has released about the development of COVID-19. At worst, some observers will allow that these numbers might not be “verifiable,” but this is generally expressed as sort of a minor issue. Now, I realize that there are potentially partisan reasons to slant interpretations one way or t’other, but I don’t think this is a case of ‘ a little bit of wiggle room’ in the figures.

Just for fun, I decided to take what China has said about its experience with COVID-19 and use what we know about the development of the virus in the US to project what the true cases probably are. Obviously, as with any model, there are wide error bars…but it’s simply implausible that China is experiencing anything like what they claim to be experiencing. Here’s the math of it.

We know from the US and the rest of the world that the virus cases grow around 33% per day until they downshift “at some point.” See for example this outstanding chart from the Financial Times from last week.

That point of shifting is somewhat speculative and probably depends on a lot of things. But for our model we’ll assume that the virus grows in China at 33% per day and downshifts to a 2% growth rate (which is roughly what South Korea’s growth rate in new cases is now, so we are being very generous) at the point China claimed that the growth rate of new cases was starting to decline, roughly around February 11.

We also can infer from US numbers that the death rate is around 5%, with deaths taking about 5 days and recoveries about 17 days. So, we look backwards about 5 days to see the number of open cases, and realize about 5% of those will die. Similarly, we look backwards about 17 days and realize that about 95% of those cases eventually recover (recoveries take longer because they tend to be cases that were caught earlier, plus a ‘recovery’ is not defined until we get two negative tests while a death is pretty clear). There are a number of combinations of period lookbacks/mortality that work, but that’s about the best case. We can’t get a model that is consistent with the number of deaths we have in the US with a longer resolution time unless the fatality rate is much higher; if the fatality rate is lower than 5% it implies that cases resolve even faster than 5 days after detection which seems unlikely. Globally, the ratio of deaths to (deaths + recoveries) is about 16% (see here under “closed cases” for a source of that data), so 5% is quite conservative. Similarly, we can’t have the low number of recoveries we have unless recoveries take a lot longer than deaths to resolve, or the recovery rate is a lot lower (death rate is a lot higher) than 5%.

And that 5% is with the US having some advance warning, and outstanding medicine. I don’t have any reason to believe it would be lower in China. So those are the parameters I’m going to use. 33% growth rate of infections downshifting to 2%, 5% mortality rate, with resolutions happening in 5 days for death and 17 days for recovery.

The first case in China dates from 12/16/19.

Growing at the aforementioned rates, from 1 case on 12/16/19, China ought to have been around 72 cases by end of December. They admitted to 27. Since at low numbers the growth rate has a lot to do with idiosyncratic details of the particular cases, we will re-set to 27 on 12/31, to be generous. But recognize that there is some reason to think China was low by a factor of 2-3, two weeks in.

Growing at the aforementioned rates, China ought to have been around 14,300 by January 22, when they told the WHO they had 547 cases. (From here on, all of the data comes from Bloomberg whose numbers differ slightly, but insignificantly, from the Johns Hopkins data). So they’re off by a factor of about 25 from what we would expect, based on the experienced growth rates of other countries.

Around February 11, China claims to have had 44,653 cases. By our growth rates, it should have been more like 4.3 million. China must have had spectacular medicine! (even if we grow the 547 number from Jan 22, they would have been at 125k by Feb 11). So it looks like by Feb 11 China was already off by a factor of between 3 and 100. The 3 requires us to believe that they were being completely honest on Jan 22 when they said 547.

So let’s assume the new cases downshift on Feb 11 to only 2% growth. Even starting from their 44,653, we would see 109k cases by now (March 27) if growth rates were only 2%. Literally the only way to get to China’s figures is to say that the transmission rate was never very high, despite the widespread travel around the Chinese New Year and the fact that as the origin of the pandemic is it reasonable to conclude that their recognition of the danger of this disease would take a little longer. And if all of those things are true, then the aggressively autocratic crackdown seems really over the top, given the vanishingly-small prevalence of the disease in a country of 1.4 billion people.

Going back to our original trends of 33%, downshifting to 2%, and with the death and recovery rates I am estimating: I think the actual number of cases in China is more like 10 million, with 465k dead and 7 million recovered. Honestly, it’s hard to explain why their traffic and power usage is recovering so slowly if only 0.006% of the country ever contracted the virus and an even tinier fraction died. The economy should have immediately sprung almost fully back when the quarantine was lifted. Most people in China wouldn’t even know anyone who had been infected…only 1 person in 17,000 ever got the disease. The numbers would just be too small to notice.

We don’t just have to believe China is inherently deceitful…we just need to believe that the country doesn’t have miraculous medical powers. And we need to believe in math. There are other reasons why the numbers could be technically accurate, and yet not illuminating. It might be the case that China simply isn’t testing people very aggressively, so that it is the case that only 81,340 people have tested positive, and only 3,292 of those have died. In that case their numbers would be accurate but not necessarily the whole truth since the country would also be having the small issue of seeing a bunch of other bodies piling up for “unknown” reasons. That inconvenient fact would eventually become hard to not notice, which is one reason why it might make sense to expel external journalists…

Categories: Uncategorized

Summary of My Post-CPI Tweets (Dec 2017)

December 13, 2017 1 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.

  • ok, 10 minutes to CPI. 10y Breakevens unch to +0.5bp. They’re at 6 month highs of 1.92%, but amazing they can’t get to 2%.
  • On CPI: Last month there was an upside surprise with a strong 0.2%, making it 2 of the last 3 months with upside surprises.
  • The comparisons to year ago are about to get more difficult though. Today we drop off a 0.18% from last November.
  • We drop off a 0.22%, 0.31%, 0.21% next three months after that.
  • This month we’re again watching New & Used Cars and Trucks, which have not yet shown any response to survey evidence of increases.
  • Also an eye on Primary Rents, which have been declining although the Shiller Home Price Index is reaching new local highs.
  • Last mo, median CPI scored its largest m/m incr since July ’08. So in short – we’re in an inflation upswing; just need to see how much.
  • Consensus for today’s number is 0.2% on core – almost exactly, keeping y/y at 1.8%.
  • Well, core is 0.1%…but waiting for Bloomberg to drop the actual figures. Looks like a big miss, not a little miss.
  • yeah, 0.12%, pushing y/y down to 1.71%. Last 4 months have seen two high misses and two low misses.

  • Core goods rose to -0.9% y/y from -1.0%, but core services down to 2.5% from 2.7%. SO IT ISN’T THE INTERNET, FOLKS.
  • 10y breaks plunging 4bps since pre-data, on the way to creating another buying opportunity.
  • Only way 1.89% 10y BEI make sense is if inflation is permanently broken. But median CPI is 2.3% y/y. So it’s not broken!
  • (We have TIPS about 53bps cheap at current nominal yields).
  • In major subgroups, Apparel decelerated, Recreation decelerated, Other decelerated. Medical unch. Everything else up. Interesting.
  • In Housing, Primary Rents decelerated slightly again 2.68% from 2.70%, but seem to be converging on our model.
  • OER 3.12% vs 3.20%…there’s your problem…and Lodging Away from Home plunged to 0.60% from 1.36% y/y. But the latter is a small weight.
  • New vehicles -1.08% vs -1.38%; used cars to -2.10% from -2.89%. Not really the bump we are due.

  • In Medical Care: drugs 1.87% vs 0.88%, so that’s a big up. But Prof Services -0.26% vs 0.38% and that’s 2x the weight.
  • Just doesn’t pay to be a doctor any more. Here’s CPI- Prof Services y/y.

  • College Tuition and Fees 2.29% from 2.17%.
  • This is a mysterious number. Haven’t found “the culprit” yet.
  • Core CPI ex-housing 0.65% vs 0.71% y/y.
  • Biggest 1m NSA changes are on apparel, misc personal goods, public transportation, lodging away from home (-15% m/m).
  • Median still looks like it will be 0.22% m/m. Not real surprised it’s outliers. The surprise is that it’s in services.
  • This is even more skewed than usual.

  • But again, most things are inflating.

  • Well let’s look at the four pieces breakdown. Food & Energy:

  • Core goods. Probably starting to head higher. But cars and trucks not helping yet.

  • Core services less rent of shelter. Here’s where Professional (medical) Services lives, and is part of the story on the weak CPI.

  • And Rent of Shelter – not a big deal and not surprising, but part of the softish story too.

  • US #Inflation mkt pricing: 2017 1.9%;2018 2.1%;then 2.1%, 2.1%, 2.2%, 2.2%, 2.2%, 2.2%, 2.3%, 2.4%, & 2027:2.5%. This from CPI swaps.
  • Market is pricing an extraordinary amount of stasis in the global price dynamic.

This was a strange report. The miss was a big miss, but there didn’t seem to be any large culprits. The story seems to be in Professional Services, which deceleration caused a 3bp drag in the y/y, and OER, which was a few bps, and Lodging Away from Home. OER is a little surprising, since the Shiller Home Price Index is rising at the fastest pace in a few years, but that generally only passes through with a lag anyway. Higher wages, combined with higher home prices, means that shelter costs are not likely to be decelerating meaningfully any time soon. But, they recently have decelerated a little bit – we think it’s just coming back to model, however.

The Professional Services deflation is a conundrum I’ve commented on in the past. Part of this is probably compositional since the older/more experienced physicians are retiring rather than deal with the new healthcare regime, but the magnitude is surprising. Some of this might be a drag due to ObamaCare phase-ins and the fact that pretty much everyone now pays out-of-pocket for routine care because of high deductibles. But it strikes me as odd that doctors would respond to a decline in business by dropping prices. There may, though, be some other dynamic that is getting into the data – for example perhaps doctors, sympathetic to their patients’ plight, are dropping prices for out-of-pocket expenditures while hiking them (or upcoding) for insurance claims. In any event, this is passing strange. It seems unlikely that doctors’ prices are going to be declining in the long term, given the aging of the US population. But it’s in the data now, and it’s part of that hefty left tail to the distribution of prices.

But most prices are still rising quickly, and median inflation is right around 2.3% and accelerating. The Fed will tighten today, and likely tighten more in 2018 than the market currently expects unless the market breaks. And that’s really what is being priced: some chance the Fed hikes 4 times, and some chance they stop hiking because the stock market begins to return to something approximating fair value.

(And let’s not fully dismiss that latter point. The equity market is delighted with everything at the moment, but the likely failure of the reconciliation committee to produce a tax bill that both House and Senate can pass, and which can be signed by the President, will be discouraging. Currently the market acts as if this is a rubber-stamp process but remember, both tax bills passed by narrow margins, and have dramatic differences that each house required to get the bare majority. Either some Republicans will be asked to suck it up and vote for a bill with components they refused initially, or the tax bill will fail.)

Categories: Uncategorized

Can’t Blame Trump for Everything

November 15, 2016 Leave a comment

So much has happened since the Presidential election – and almost none of it very obvious.

The plunge in equities on Donald Trump’s victory was foreseeable. The bounce was also foreseeable. The fact that the bounce completely reversed the selloff and took the market to within a whisker of new all-time highs was not, in my mind, an easy prediction. I understand that Mr. Trump intends to lower corporate tax rates (and he should, since it is human beings – owners, customers, and employees – that end up paying those taxes; taxing a company is just a way to hide the fact that more taxes are being layered on those human beings). And I understand that lowering the corporate tax rate, if it happens, is generally positive for corporate entities and the people who own them. I’m even willing to concede that, since Mr. Trump is – no matter what his faults – certainly more capitalism-friendly than his opponent, his election might be generally positive for equity values.

But the problem is that equities are already, to put it generously, “fully valued” for very good outcomes with Shiller multiples that are near the highest ever recorded.

I think that investors tend to misunderstand the role that valuation plays when investing in public equities. Consider what has happened to the economy over the last eight years under President Obama: if you had known in 2008 that growth would be anemic, debt would balloon, government regulation would increase dramatically, taxes would increase, and a new universal medical entitlement would be lashed to the backs of the American taxpayer/consumer/investor, would you have invested heavily in equities? Yet all stocks did was triple. The reason they did so was that they started from fairly low multiples and went to extremely high multiples. This was not unrelated to the fact that the Fed took trillions of dollars of safe securities out of the market, forcing investors (through the “Portfolio Balance Channel”) into risky securities. By analogy, might stocks decline over the next four years even if the business climate is more agreeable? You betcha – and, starting from these levels, that’s not terribly unlikely.

I am less surprised with the selloff in global bond markets, and not really surprised much at all with the rally in inflation breakevens. As I’ve said for a long time, fixed-income is so horribly mispriced that you should only hold bonds if you must hold bonds, and then you should only hold TIPS given how cheap they were. Because of their sharp outperformance, 10-year TIPS are now only about 40-50bps cheap compared to nominal bonds (as opposed to 110 or so earlier this year), and so it’s a much closer call. They are not relatively as cheap as they were, but they are absolutely less expensive as real rates have risen. 10-year real rates at 0.37% aren’t anything to write home about, but that is the highest yield since March.

Some analysis I have seen attributes the large increase in market-based measures of inflation expectations on Mr. Trump’s victory. For example, 10-year breakevens have risen 20bps, from about 1.70% to about 1.90%, since Mr. Trump sealed the win (see chart, source Bloomberg).

usggbe

I think we have to be careful about blaming/crediting Mr. Trump for everything. While breakevens rose in the aftermath of the election, you can see that they were rising steadily before the election as well, when everyone thought Hillary Clinton was a sure thing. Moreover, breakevens didn’t just rise in the US, but globally. That’s a very strange reaction if it is simply due to the victory of one political party in the US over another. It is not unreasonable to think that some rise in global inflation might happen, if Trump is bad for global trade…but that’s a pretty big reach, and something that wouldn’t happen for some time in any event.

In my view, the rise in global inflation markets is easy to explain without resorting to Trump. As the previous chart illustrates, it has been happening for a while already. And it has been happening because global inflation itself is rising (although a lot of that at the moment is optics, since the prior collapse of energy prices is starting to fall out of the year-over-year figures).

The bond market and the inflation market are acting, actually, like the Great Unwind was kicked off by the election of Donald Trump. We all know what the Great Unwind is, right? It’s when the imbalances created and nurtured by global central banks and fiscal authorities over the last couple of decades – but especially in the last eight years – are unwound and conditions return to normal. But if pushing those imbalances had a soothing, narcotic effect on markets, we all suspect that removing them will be the opposite. Higher rates and inflation and more volatility are the obvious outcomes.

Equity investors don’t seem to fear the Great Unwind, even though stock multiples are one of the clearest beneficiaries of government largesse over the last eight years. As mentioned above, I can see the argument for better business conditions, even though margins are still very wide. But I’m skeptical that better business conditions can overcome the headwinds posed by higher rates and inflation. Still, that’s what equity investors are believing at the moment.

*

A couple of administrative announcements about upcoming (free!) webinars:

On Thursday, November 17th (aka CPI Day), I will be doing a live webinar at 9:00ET talking about the CPI report and putting it in context. You can register for that webinar, and the ensuing Q&A session, here. After the presentation, a recording will be available on TalkMarkets.

On consecutive Mondays spanning November 28, December 5, and December 12, at 11:00ET, I will be doing a series of one-hour educational seminars on inflation. The first is “How Inflation Works;” the second is “Inflation and Asset Classes;” and the third is “Inflation-aware Investing.” These webinars will also have live Q&A. After each session, a recording will be available on Investing.com.

Each of these webinars is financially sponsored by Enduring Investments.

Looks Like a Hag to Me

November 3, 2015 Leave a comment

Suddenly, things are just swell!

Over the last month, stocks have absolutely blasted off with one of the most powerful moves in years. More precisely, in this century the only months with bigger gains in the S&P than last month’s 8.3% were March 2000, October 2002, March 2009, April 2009, September 2010 and October 2011.

There is no ‘because’ – as far as I can tell, there is little coherent reasoning behind the rally. Economic data has been generally weak; there have been positive signs too but the bad signs have been getting worse faster than economists have been expecting. Nothing is collapsing, but we are talking about a market that is overvalued on most major metrics. “The economy is not collapsing” is not a strong argument for why we’ve added 10% since the beginning of October.

One fascinating argument I have heard advanced concerns the Fed’s recent hawkish rhetoric (for the record, I do not expect this to result in an increase in interest rates in December, but consider it so much wind). Stock market bulls for years have used the liquidity argument for a reason to buy stocks. But now that the Fed is preparing (or trying to make us think it is preparing) to hike rates, I read about how that’s bullish for stocks because it signals a return to normalcy. Really? So by similar reasoning, if the Fed enacted QE4 instead it would be bearish. How convenient that the logic of how liquidity helps stocks got turned around 180 degrees right about the time the Fed has few options before it other than the question of when to turn 180 degrees.

Investing, of course, is famously not about selecting the prettiest girl in the room but about selecting the girl that everyone else thinks is the prettiest. If you can get ahead of the screwy logic correctly, you can do quite well. I am awful at doing this. I simply can’t make myself think in this kind of twisted way, which is why I am a systematic value-tilted investor.

I’ve also, although only over the last week or so, heard Amazon cited as one reason the market is doing well. Specifically, Amazon reported strong Q3 growth and expects a record holiday season. But…Amazon isn’t forecasting a record Christmas for everyone; it continues to add market share in the movement from foot-traffic shopping to online shopping. It would be shocking if it were not a record Christmas season for Amazon, even if the economy contracted! In any event: show me. I suspect Christmas will be better than it has been for a few years, since Unemployment is lower than it has been for a while and gasoline prices are lower which should increase discretionary spending. (It should be noted, though, that economists have been looking for the increase in discretionary spending for a few quarters now and it hasn’t really shown up). But as an excuse for adding a couple trillion dollars in market value? Seems a bit of a stretch.

As usual, the signals are not the same away from the stock market as they are within the stock market. Commodities markets remain very weak, although energy showed some strength today. This isn’t a new divergence, though – since the commodity market diverged from the stock market in late 2011, the Bloomberg Commodity Index is down about 42% while the S&P 500 is up about 89% (see chart, source Bloomberg).

diverg

Looking at that chart, it is fair to point out that the recent dip in stocks is reminiscent of the dip in late 2011, which was also from overvalued conditions (although not nearly so overvalued as now) but which culminated in a blast-off in one of the most continuous rallies without a 10% correction the market had ever seen. It is worth pointing out, of course, that in 2011 the Unemployment Rate was at 9% and coming down, while it is now at 5.1% and likely heading up soon. We also had a further QE to look forward to (in 2013), while that looks unlikely now. And there are other differences that seem to me to carry more weight than a curious symmetry of chart patterns. But, as I said, I am awful at figuring out who everyone else thinks is the prettiest girl today. As for the stock market, it looks like a hag to me.

Categories: Uncategorized

Money, Commodities, Balls, and How Much Deflation is Enough?

January 22, 2015 2 comments

Money: How Much Deflation is Enough?

Once again, we see that the cure for all of the world’s ills is quantitative easing. Since there is apparently no downside to QE, it is a shame that we didn’t figure this out earlier. The S&P could have been at 200,000, rather than just 2,000, if only governments and central banks had figured out a century ago that running large deficits, combined with having a central bank purchase large amounts of that debt in the open market, was the key to rallying assets without limit.

That paragraph is obviously tongue-in-cheek, but on a narrow time-scale it really looks like it is true. The Fed pursued quantitative easing with no yet-obvious downside, and stocks blasted off to heights rarely seen before; the Bank of Japan’s QE has added 94% to the Nikkei in the slightly more than two years since Abe was elected; and today’s announcement by the ECB of a full-scale QE program boosted share values by 1-2% from Europe to the United States.

The ECB’s program, to be sure, was above expectations. Rather than the €50bln per month that had been mooted over the last couple of days with little currency-market reaction, the ECB pledged €60bln. And they promised to continue until September 2016, making the total value of QE around €1.1 trillion. (That’s about $1.3 trillion at today’s exchange rate, but of course if it works then it will be much less than $1.3 trillion at the September 2016 exchange rate). To be sure, a central bank always has the prerogative to change its mind, but on the risks of a sudden change in policy please see “Swiss National Bank”. It really is remarkable that Draghi was able to drag the Bundesbank kicking and screaming into this policy choice, and it is certain to end the threat of primary deflation in Europe just as it did in the U.S. and in Japan. It will likely also have similar effects on growth, which is to say “next to nothing.” But in Europe, deflation risks stemming from slow money growth had been a risk (see chart, source Bloomberg).

EUM2

Interestingly, y/y money growth had already been accelerating as of late last year – the ECB releases M2 with a very long lag – but this puts the dot on the exclamation point. The ECB has said “enough!” There will be no core deflation in Europe.

Commodities: How Much Deflation is Enough?

Last week, in “Commodities Re-Thunk” and “Little Update on Commodities Re-Thunk”, I presented the results of using a generalization of the Erb & Harvey approach to forecast expected long-term real returns for commodities. It occurred to me that, since I have previously played with long-term real equity returns, and we have the real yield on 10-year TIPS as well, that it would be interesting to see if using these figures might produce a useful strategy for switching between assets (which doesn’t change the fact that I am a long-term investor; this is still based on long-term values. We merely want to put our assets in whatever offers the best long term value at the moment so as to maximize our expected long-term return).

The answer is yes. Now, I did a more-elegant version of what I am about to show, but the chart below shows the results of switching 100% of your assets between stocks, commodities, and TIPS based on which asset class had the highest expected real yield at a given month-end. Each line is an asset class, except for the blue line which shows the strategy result.

realswitch

The labels at the top show the asset class that dominated for a long period of time. In 2005 there were a couple of quick crossovers that had little impact, but by and large there were three main periods: from 1999-2005, commodities offered excellent expected real returns; from mid-2005 through early-2008 the strategy would have been primarily in TIPS, and subsequent to that the strategy would have been primarily in equities. Fascinating to me is that the overall strategy does so well even though it would have been invested in equities throughout the crash in 2008. The crash in commodities was worse.

Now what is really interesting is that there is a vertical line at the far right-hand side of the chart. That is because at the end of December, the expected real return to commodities finally exceeded that of equities for the first time in a very long time. For this “selling out” strategy, that means you should be entirely out of stocks and TIPS and entirely in commodities.

As I said, that is the coarse version of this approach. My more-elegant version optimized the portfolio to have a constant expected risk in real terms. It was much less risky as a result (10.5% annualized monthly standard deviation compared to 15.5% for the strategy shown above), had lower turnover, but still sported returns over this period of 9.5% compounded compared to 11.2% for the strategy above. I am not, in other words, suggesting that investors put 100% of their assets in commodities. But this method (along with lots of other signals) is now suggesting that it is time to put more into commodities.

Balls: How Much Deflation is Enough?

Being a football fan, I can’t keep from weighing in on one mystery about deflate-gate (incidentally, why do we need to put ‘gate’ on the end of every scandal? It wasn’t Water-gate, it was the Watergate Hotel that proved Nixon’s undoing. “Gate” is not a modifier). Really, this part isn’t such a mystery but I have seen much commentary on this point: “How did the balls get deflated during the game since they were approved before the game?”

The answer is really simple in the real world: the official picked up one of the balls, said “fine”, and put them back in the bag. He has a million things to do before the championship game and in years of refereeing he has probably never found even one ball out of spec. This sort of error happens everywhere there are low reject rates, and it’s why good quality control is very difficult. (Now, if you fired the ref every time a bad ball got through, you damn betcha those balls would be measured with NASA-like precision – which is perhaps a bad metaphor, since similar issues contributed to the Challenger disaster). The real mystery to me is: if the Patriots truly think they are the better team, why would they cheat, even a little? As with the CHF/EUR cross that we discussed yesterday, the downside is far worse than the gain on the upside.

Or, is it? The NFL will have a chance to establish the cost of recidivism in cheating. Maybe the Patriots were simply betting that the downside “tail” to their risky behavior was fairly short. If the NFL wants to put a stop to nickel-and-dime cheats, it can do that by dropping the hammer here.

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