Outlook, Trends, Allocations

What comes next?

The problem with what is commonly thought of as inflation is that consumer prices move up and down for many different reasons and, at any one time, there will be prices rising somewhere and falling elsewhere.

So, what prices should be checked by the compilers of the statistics?

The answer, inevitably, contains much subjectivity because the prices of every good and service in an economy cannot be monitored all the time.

This begs the question of what use measurements of consumer price movements are in the first place.

Mark Mobius, the emerging markets investment pioneer, has recently published a book titled “The Inflation Myth and the Wonderful World of Deflation.”

In it, he argues that consumer price inflation measurements are severely flawed, a central reason being that no account is taken of changes to the quality of the good or service, or innovation generally.

In the past – nominal prices might have stabilized for personal computers and TVs, for example, but the product has been so much better year-after-year.

Despite these inherent flaws, consumer price inflation is arguably the most important economic statistic on the planet because it directly influences the level of central bank interest rates which, conventional thinking would have us believe, affects the overall economy.

However the broad economic path is driven by trends in mood. Mood can influence consumer prices, but it mainly drives asset prices and debt.

Yet the money and debt-inflation of the past decade is far more important than consumer price measurements.

Today we see monetary policy causing market participants to bid up asset prices such as debt, equity, and real estate.

What comes after this artificial asset price inflation?

Yes. Asset price deflation.

Powell and inflation

Powell’s approach to inflation has been described as “fuzzy” compared to his predecessors. Maybe it’s because of his background in law.

Asked at the FOMC press conference what the Fed means by “moderate,” Powell said, with perhaps a hint of frustration, “It means not large. It means not very high above 2%. It means moderate. I think that’s a fairly well-understood word.” He then added, “You know, we’re resisting the urge to try to create some sort of a rule or a formula here.”

The approach policymakers settled on involves more discretion than the Fed has exercised since the Greenspan era. Powell and others have refused to say how long or how much they will allow inflation to overshoot 2%. Consider this: Inflation would have to average 3% from now until April 2026 for the price level to reach where it would have been if inflation had been 2% since 2012. It’s unlikely the Fed would let that happen because it doesn’t want shoppers to start thinking of 3% inflation as the new normal. On the other hand, just a month or two of, say, 2.1% inflation wouldn’t be much of a makeup.

Market participants may have to read between the lines until the end of Powell’s testimony tomorrow.

It’s times like these

The following reminders could not be more important in times like these with respect to the stock market.

The outstanding characteristics of financial markets are shortness of memory and ignorance of history.

– John Kenneth Galbraith

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

– Mark Twain

If you’re not confused you don’t understand what’s going on.

– Walter Cronkite

– On prudence

The less prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own affairs.

– Warren Buffett

Earnings are not immune to declines

The reality is that the business cycle is different than the economic cycle.

GDP growth is much more consistent than EPS growth. EPS declines can occur during periods of economic growth.

Across the 68 years since 1950, earnings declined during 23 of them despite positive economic growth in all of those years…34%!

Real GDP growth (excluding inflation) has lagged the historical 3% average thus far in the 2000s and ’10s.

But even if the economy looks positive for the next few years, history highlights that EPS is not immune to decline—especially from such a currently high level of profit margins.