Pick Nits and Don't Be Smug
Pick nits and don't be smug... Inflation's falling? Are we sure about that?... The data the Fed is really watching... Why you should WISH our economy was like the 1970s'...
The market is wrong...
Before I tell you what I mean by that, please understand that I know how dumb it sounds.
As if I (Dan Ferris) – one loud-mouthed analyst – could possibly be right and millions of folks researching and investing in the market every day could be wrong.
But I didn't say I'm smarter than the market. Nobody is.
I just said the market is wrong. And I know I'm not the only one who thinks that (though I'll speak only for myself in this Digest).
The market is wrong about inflation.
As my colleague Corey McLaughlin reported on Wednesday, the consumer price index ("CPI") – the most widely watched inflation indicator – rose 4.9% in April.
That's lower than the 5% it rose in March and the tenth straight monthly decline in annualized rate of inflation.
Naturally, the stock market reacted by rising that day. The Nasdaq rose 1% on Wednesday. The S&P 500 Index was up nearly 0.5%.
Anybody who has read Extreme Value, The Ferris Report, my Friday Digests or listens to the Stansberry Investor Hour knows I don't like to waste time with overly precise numbers. We don't usually need to take numbers out to four decimal places...
But that's exactly the sort of nit I'm going to pick right now...
In March, the CPI didn't really rise 5% above March 2022. It rose 4.9850% above it. And April's reading wasn't really 4.9%. It was 4.9303%.
So the difference between those two readings was really 0.0547 percentage points, not 0.1%. By rounding the numbers, as nearly everyone in the press does, the difference has been generally reported as twice as large as what really took place.
So you tell me. Did inflation fall in April compared with March... or was it flat?
You'd be right either way but the press narrative and the market's reaction on Wednesday were decidedly bullish, meaning that the interpretation was that inflation fell in March.
I realize that is one tiny nit, but bear with me. They get bigger as we go…
Now, if you look at the chart of year-over-year ("YOY") changes in the CPI, it's not hard to see why most folks say, "Inflation fell, Dan. And overall, it's just falling. It's just a fact. Face up to it. You're wrong about this one." (The CPI charts in this Digest all begin in 1997, when I started in this business.)
After going sideways for a couple of decades, inflation broke out to 40-year highs last year. Now it's back down because the Fed raised interest rates, or so the story goes. Nobody would blame you for looking at that chart and saying inflation is in a downtrend.
So far, we're only talking about YOY increases to the monthly CPI.
Let's pick another nit and look at month-to-month changes in CPI...
The CPI rose 0.4% in April, compared with its level in March.
I'm a little surprised that nobody is talking about this month-over-month number, which is 0.3 percentage points higher than the 0.1% increase between February and March. I seem to remember hearing more about it when it was 0.1%.
And if you look at the monthly changes for the past six months, would you say inflation has fallen, risen, or stayed about the same?
Looking at that chart, would you conclude that inflation is likely to fall, rise, or stay flat over the next six months?
It looks to me like month-to-month CPI inflation has been fairly steady over the past six months, bouncing between 0.1% and 0.5% per month. But falling? I don't really see it. There’s not trend of falling inflation here. It’s flat.
And here's the same multidecade look at the month-to-month changes that we did for the annualized changes...
The red line is at zero. You can see most of the time, month-to-month changes in CPI have been near or even below that line. Only a handful of times in the past couple of decades has it really plunged in a single month. And it hasn’t dipped below zero since the pandemic crisis in 2020.
Nitpicking aside, I noticed something else about this CPI report...
For one, so-called "core CPI" – which excludes food and energy prices – rose 5.5%. The idea behind this number is that food and energy prices are volatile and might have too much influence on the overall inflation picture. So if you leave them out, you get a more accurate picture of the underlying inflationary trend in the economy. It sounds idiotic to me, but OK.
Anyway, whatever you think of the rationale behind core CPI, it was up 5.5% in April compared with April 2022.
So that's what the CPI numbers are.
Of course, we have a little problem with all this, don't we?
The Federal Reserve doesn't much care about the CPI. Its preferred inflation gauge is the personal consumption expenditures ("PCE") price index.
Never mind why they like it better than CPI. They just do. When they're sitting around talking about inflation as they contemplate their next policy decision, the following PCE data are what they're looking at, NOT the two CPI charts above...
Again, we get sideways action for a couple decades. Then – wham! – it breaks out to a multidecade high. Then it appears to peak and enter a downtrend.
But if you look closer, you'll notice something...
Annualized changes in the PCE peaked at 5.4%. And its last four readings are all roughly around 4.6% to 4.7%. That's a maximum difference of roughly 0.8 percentage points.
You could just round off all the PCE data going back to about November 2021 and say, "It has been around 5%, give or take 0.3 or 0.4 percentage points in either direction, for a year and a half."
If you work for the Fed and have to think about where interest rates ought to be, you might even say something like...
"Inflation has been hovering roughly around 5% for 18 months. And it's still nearly three full percentage points (300 basis points) above our target level of 2%. Further interest-rate hikes are likely to be necessary."
That's right. The Fed is targeting 2%, and everybody knows it. That's 2% PCE, not 2% CPI.
The annualized change in the CPI peaked last summer at more than 9%. Now it's less than 5%, a drop of roughly four percentage points. That's a big change. Another 0.5 percentage points, and it'll be half its peak value. If you're looking at that, I understand why you think inflation is plummeting.
But I don't see how anybody can afford to be smug and confident that inflation is licked when it's still running nearly three percentage points above the Fed's target more than a year into the steepest tightening cycle since 1980.
This gets us back to where we started, with me telling you the market is wrong about inflation...
For example, one corner of the market says the Fed will leave interest rates unchanged at its next two Federal Open Market Committee ("FOMC") meetings... and will begin cutting rates after that.
As of around 1 p.m. Eastern time today, the Chicago Mercantile Exchange's FedWatch tool says there is an 82% probability that the Fed will leave the federal-funds rate unchanged at its June 13-14 meeting, and there's a 57% of doing the same at the July 25-26 meeting. At that time, it indicated a 47% probability of a 0.25 percentage point cut at the September meeting. (The FOMC takes August off.)
We've mentioned the FedWatch tool before. It turns futures market pricing into probability estimates of how likely it is that the fed-funds rate will be at a certain level by a certain date.
An 82% probability means the market has little doubt that the Fed will leave rates unchanged next month.
Wow. I wish I could be 82% certain of anything besides death and taxes...
I wish I could understand how anyone is certain that the Fed is done hiking rates and will soon begin cutting when its widely discussed preferred inflation barometer has been solidly around 5% for 18 months.
And it's still within roughly 0.4 percentage points of 5% today.
Maybe it'll be a little lower next time it comes out. And maybe that'll mean inflation is really becoming less of a problem every day. Whether you should bet on that is another question entirely.
The bond market doesn't seem so worried about inflation now, either...
Since the regional banking crisis broke out in March, the two-year Treasury note yield has fallen from 5% to less than 4%. The yield on the 10-year bond has dropped from 4% to around 3.4%. The idea is that since the Fed broke the banks by raising rates, it'll have to cut them soon to fix them.
But as Jamie Dimon, Duke of Manhattan, Protector of the Banking Realm, and Defender of the Status Quo, said in a Bloomberg interview yesterday...
"We're at the tail end" of the regional banking crisis, the JPMorgan Chase CEO advised.
I've said I don't think it's over and that more banks will fail, but what if Dimon is right? That would mean the Fed doesn't have to worry about banks anymore. That would mean it doesn't have to worry about hiking rates more if it deems it necessary.
That leads me to my final chart. It's the CPI itself... the actual price index whose changes are so widely reported. I've published it before.
It's just up and to the right. If you look at the charts of changes, inflation seems volatile. But if you look at the actual index, it doesn't look so volatile. It just goes up and up and up... forever...
Inflation is insidious. It's always there. It's never not there. And it's not to be trifled with. Don't get smug about it. Be prepared for more of it.
One last thing...
Comparisons with 1970s inflation era aren't a bad idea. I've made a few of them myself. But this isn't the 1970s. That was a more economically benign environment.
The 1970s started out with the government's budget in a surplus, and when it went into deficit, that deficit never exceeded 4.4% of gross domestic product ("GDP") and averaged 1.7% for the decade, according to data compiled by Bloomberg.
Today the deficit is 5% of GDP.
In the 1970s, the debt-to-GDP ratio never reached 36%. Today, it's 120%.
It's not a coincidence that we have big debts, big deficits, and multidecade-high inflation. That's how it works.
Folks are too myopic.
That has been OK in financial markets for much of my life. But every now and then, the big cycles become important.
They're important today. And while it's possible that we're mostly done with inflation, it's way too early to get smug about it.
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In today's mailbag, more thoughts on investor Stanley Druckenmiller's recent observations about Uncle Sam's debt... and feedback on our announcement of Lance Armstrong as the keynote speaker for the 21st annual Stansberry Conference this October in Las Vegas... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"Druckenmiller is right. I've been saying the biggest problem in the U.S. is the national debt since my days in college in the early '90s. It's only gotten worse (exponentially). We are [screwed]." – Paid-up subscriber Matt C.
"Druckenmiller is an idiot. Do we have a spending issue? Sure – anytime you have politicians involved, you're going to have spending issues. But the real issue this country has is a revenue issue. If the creeps and criminals in D.C. would have the wealthy and the corporations pay their fair share of taxes, like what's left of the middle class does, this country would be giving tax rebates. And please note, there was no D, R, or I in my rant." – Paid-up subscriber Donna H.
"Expounding on yesterday's balanced budget amendment, can these clowns also figure out that lower tax RATES will result in greater tax RECEIPTS? Duh!" – Paid-up subscriber Don R.
"Good choice [with Lance Armstrong]. He certainly has a lot of interesting things to say..." – Paid-up subscriber Fabian H.
"I always wanted to hear why he 'confessed' to Oprah that he had cheated. I always thought the French and Europeans hated and were jealous of Lance because he was an American who was continually beating them in their Tour de France.
"I never believed the accusations of blood doping or performance-enhancing drugs until he admitted them. I wanted to keep believing in Lance." – Paid-up subscriber D.J.
Good investing,
Dan Ferris
Eagle Point, Oregon
May 12, 2023