Inflation Monitor Summary - Composite Ranking
The Inflation Monitor is a monthly report that tracks inflation trends. We do this by monitoring various economic indicators, asset prices, and goods and services. The purpose of the Inflation Monitor is to provide more clarity to the CPI number for the average investor.
We summarize the Inflation Monitor statistical data into the Inflation Monitor Equilibrium. This equilibrium summary was devised to help investors understand the impact of economic statistics and what areas of the economy are providing inflationary pressures and which are providing deflationary pressures.
The numbers on this summary are a rating score of the amount of inflation or deflation that exists in a segment of the economy. 10 is the highest score possible to indication high inflation. 1 is the lowest score indicating high amounts of deflation. The brown line indicates the average number of all 9 components of the economy.
Inflation Monitor - March 2017 - Introduction
We have had a crazy winter here in the northeast. Some days it's hot some days it is bitter cold. I cannot remember a February where we had more than 10 days of 65-degree weather. It was nice while it lasted. Now we are back to a more normal 19-degree temperature. I guess it is only fitting that the weather is as volatile as our politics and economic outlook.
I won't delve into politics here since I'm sure everyone has had enough of it on Facebook, TV, and Twitter. However, there are some things that need to be discussed. and are interesting to me.
First, We have officially come out our the earnings growth recession we have been in. We had 5 quarters in a row of negative earnings growth year-over-year. I would call this a recession. Apparently, the NBER and the markets disagree. There is one absolute in the markets, price is always right.
Now, we have had 2 quarters in a row of year-over-year positive earnings growth. It looks like things are picking up economically. Earnings are growing at a 4.6% rate, the highest in 3 years. This is a positive sign economically for the stock market, but not the whole stock market. Certain areas are not doing as well as others.
President Trump has made some grandiose campaign promises. Initially, I wanted to hold off to see if they were just campaign promises that he would not fulfill (like most other presidents), or if he would actually do what he said. I think it is clear he intends to do what he said he would do. Whether he can get it through congress is another story. Let's just say I'm cautiously optimistic.
Whether you like trump or not, I think this is the first time I have seen plans in place to boost the economy in a positive way and at the same time fix some of the nation's ills. The ills I'm talking about are the US infrastructure. President Obama had a chance to fix our nation's infrastructure in his presidency when he tripled the US debt outstanding, but if you look at our nation's infrastructure problems, you will see that he failed at this great opportunity.
Our national debt has increased exponentially in the past 8 years, yet in 2013, the American Society of Civil Engineers gave our nation's infrastructure a D+. They issue a report card every 4 years so we should expect to receive the next one this year. Here is the report card if you are interested. Our national debt has increased exponentially in the past 8 years, yet in 2013, the American Society of Civil Engineers gave our nation's infrastructure a D+. They issue a report card every 4 years so we should expect to receive the next one this year
It is too early to tell if Trump will be able to make the changes needed to this neglected areas of our nation's infrastructure, or if he will. Maybe all the money will be spent on the "wall". However, he has a great opportunity to upgrade our nation's infrastructure and create a lot of middle-class jobs. I'm still a skeptic, but the opportunity is there.
Second, I find it extremely interesting that inflation has picked up right after the US election concluded. Why you ask? It is a good question that I still cannot find the answer to. Apparently, the inflation fairy appeared out of nowhere once the elections results were announced. Am I the only one to think this sudden change is odd?
Stock markets move in expectation of future events, but inflation does not. Inflation works on a positive feedback loop that happens over months or years. If you think there will be inflation, this in effect causes inflation. Deflation works in the same way. This is why the Federal Reserve fears deflation so much. I will show you in the charts below how odd it is that inflation picks up when Trump is elected. I don't know if this is because half the nation is spending money because they are happy or something else, but when I see the same effects happening in other countries, it makes me wonder. All I can say is that if you don't trust the inflation figures, this gives should give you a bit of a chuckle.
One thing is clear as I look at the inflation data, The Fed is behind the curve in fighting inflation. Most of my data shows that inflation is quickly picking up, yet we still have extremely low interest rates. The probability is close to 100% change of the Fed raising interest rates in March, but 0.25% may not be enough. The Fed may have to quickly get interest rates back to more normal rates sooner than later. While, I don't think that we will have runaway inflation, I do think that if they don't curtail inflation, we could see some volatile fluctuations in asset prices.
Third, while Trump has made some bold campaign promises that it looks like he intends to keep, Congress still has to send him the bill. If there is going to be an overhaul of the tax code, there will be winners and losers. You cannot have a revenue neutral change without changing who the winners and losers will be. This will make some people happy and others unhappy, but this has been going on for many years, so I'm sure we are all used to change by now.
US corporate taxes are high. Lowering them would be good for business and profits. However, we live in a world that is a zero sum game. One winner will be a loser somewhere else. If US companies are net winners, then international companies will be net losers. This could start a trade war. Hopefully, it will not. For the past few years, companies have been doing inversions to locate their company internationally in a tax friendly nation to get better tax benefits. This is the nature of what happens when your country's tax structure is less favorable than other countries. If you want to create jobs here in the US, then you need to make it business friendly. One thing is for certain, until we see some meat of what those changes will look like, there isn't much to be said.
Lastly, I think this point needs to be made clear. Too many people are missing it. Globalization is naturally deflationary because it allows us to export inflation to other countries (i.e. China). We have benefited from this globalization trend for decades. Now the trend is starting to stall. Trump's "Build American, Buy American" theme is certainly putting the nail in the coffin of the globalization trend, but it had stalled before he was elected.
If globalization is deflationary, then de-globalization is inflationary. You should expect inflation in the upcoming years. Your goods and services will cost more. If this trend reverses, as I expect it may, then you should pay attention to inflation. If it starts to take off, you should be prepared.
The "Build American, Buy American" is a nice sound bite, but the reality is much more harsh. If businesses start to onshore more jobs are a higher wage, employers will find ways to replace those jobs with robots or AI technologies. This has started to happen in certain industries. Computer algorithms have been said to control over 70% of the US stock markets. Manufacturers and companies like Amazon are using robots to build, manage and ship goods.
The recent rise in the minimum wage laws in many states has caused certain service companies (i.e. McDonalds, Wendy's, Burger King) to consider replacing their "cheap labor" with robots. This is economics 101. companies will inevitably find the cheapest way to produce goods and services. If that means they have to replace an order taker with a computer, they will do it.
This trend has sparked a lot of conversation about a "basic income" for displaced workers. While this sounds nice on paper, this is not how economics works. You cannot give everyone a base income and everyone will be fine. Where will that income come from? The rich? How are they able to support the entire country? The numbers simply don't work for this type of concept.
In reality, what will happen if such a ridiculous idea ever comes to pass, the price of goods and services will rise sharply to accommodate the increase of money in circulation. Then we will see the US Dollar in the history books right next to the German Marks and the Zimbabwe Dollar as examples of why hyper inflation is bad.
That being said, there is a real problem on the horizon with robots and AI eliminating jobs. If you are 55 years old, you are probably fine, but if you are 30 then you might want to pay attention to this trend.
But I digress...
De-globalization is a real concern for economists. They say no one wins a trade war. I would say that economics is a trade war. People want goods as cheaply as they can get them. That is how economics works. Politicians can certainly make it worse, but it is hard to imagine the same outcome in the great depression as we would have now with globalized information.
However, I personally have no say in the outcome, other than trying to best prepare for the inevitable trends that I see. I would suggest that if you continue to see "pro-American" trends, that you prepare for inflation and continue to read the Inflation Monitor for guidance.
I hope you enjoy this month's Inflation Monitor. If you have any questions, please email them here.
Kirk Chisholm
Reference Pages:
- US Historical Inflation Rates
- Inflation - The Secret to Building Wealth in Real Estate
- Deflation - How a Mortgage Can Destroy Your Real Estate Wealth
Charts of the Month
Interest Rate Sensitivity
I think this is one of the most important charts you will look at for the foreseeable future. Quite frankly, you should know this chart inside and out if you have any money at all in bonds. I say this because we are at what seems to be the end of a historic bond bull market. If you have bonds in your portfolio, you might want to take a serious look at what you previously thought was conservative.
Leading Indicators
Dr. Copper
Dr. Copper has a strong correlation of predicting an upcoming recession. However with zero percent interest rates, it has been faulty. This is true for many leading indicators.
Financials
Financials can also be a good leading indicator. However, with narrow spreads they have lagged many other industries.
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Consumer Price Index (CPI)
Inflation is caused by excess demand. Historically this is caused by a fully-employed economy which also has a huge government spending program in place (which frequently happens in wars). Inflation is also caused by a positive feedback loop of people thinking there is inflation. Also inflation is caused by de-globalization.
Producer Price Index (PPI)
The Producer Price Index issued by the Bureau of Labor Statistics (BLS). It measures the average change over time in the prices received by domestic producers for their products.
US Velocity of Money M2
This is one statistic that you need to know about. The velocity of money is a measure of how frequently one dollar bill circulates through the economy. It has been declining for about 20 years. This means that people are not spending as freely as before. With the amount of money in circulation, watch out if this picks up.
US Monetary Base
The US Monetary Base is the amount of currency in circulation which has been created by the Fed.
M2 Money Stock
This is the amount of monetary assets in the economy. This includes assets created by the Fed plus money created by the banks and its customers.
US Total Federal Debt Outstanding
This is the amount of US federal debt outstanding. As of now it is almost 20 Trillion... Yes you read that correctly. It is currently $19.883 Trillion in debt outstanding.
Oil Prices
Rystad Energy just released an independent study that shows the US is considered to have more oil reserves than Saudi Arabia or Russia. This is the first time in history where the US has held this title. The study estimates the recoverable oil available in the U.S. at 264 billion barrels. Saudi Arabia has about 212 billion barrels and Russia has about 256 billion barrels.
"We keep thinking that lower energy prices are somehow good for the economy. That can’t be, because energy prices or commodity prices in general don’t drive economic growth. Economic growth drives commodity prices.” - Stephen Schork
US Gas Prices
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Currencies Relative to the Price of Gold
Gold is priced in the currency you use every day. If you live in the European Union, you use Euros, if you live in Japan, you use Yen, and if you live in the US you use US dollars. Each of these currencies is used to buy gold in their respective countries, so we look at gold priced in each country to see how people value it in their own currency. This can tell us a lot about the demand for gold inside and outside the US.
Are gold prices strong or weak?
The best way to look at any commodity, especially gold, is to compare the commodity to multiple currencies. If gold is rising or falling in US Dollars, that means nothing if the other currencies are not showing the same thing. A true bullish trend in gold is when gold is rising in all (or at least most currencies).
Currently Gold is in a Bull trend
Gold Priced in Euros
Gold Priced in Yen
Gold Priced in Australian Dollars
Gold Priced in Canadian Dollars
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Bonds
TED Spread
A surge in the Ted Spread means a lack of trust in financial institutions. Currently, the Ted Spread is on the high side. It is far from the 2008 highs of 4.6, but the upward trend is not a good sign since it is confirming financial institutions are not trusting each other.
10 Year vs 2 Year Treasury Spread
The flattening (or inverting) of the yield curve is not good for banks and also typically shows signs on a recession. It is probably one of the best indicators of a recession we have, yet no one knows the status of whether this indicator still works since interest rates are stuck close to zero. I don;t know what will happen if the US has negative interest rates? What will the curve look like then?
Treasury vs Corporate Bond Spread
The spread between 30-year treasuries and corporate bonds climbs in times of market distress. It will be interesting to see how this plays out as the great bond bull market reverses and interest rates start to rise.
High Yield Bonds (Junk Bonds)
High-yield bonds are a warning sign for the equity markets. They tend to track the equity markets well, but they can also be a warning sign for the bond market.
Bond Yield Spread
This chart shows the differences in yields for bonds of different ratings.
High Yield Bond Spread
Low high yield bond spreads are a sign of a complacent market.
Asset Class Forecast
GMO puts out a periodic 7 year asset class forecast of real returns. This is their prediction of what they think the different assets will perform over a 7 year cycle. They have a decent track record and worth looking at.
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The Inflation Monitor includes inflation data for the US in a simple summary format. Learn more about US Inflation.
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Inflation Dashboard
The Federal Reserve presents this inflation dashboard periodically. It gives you a more visual perspective of their perspective of the data.
Corporate Debt as a Percentage of Equity
Anything below 40 is when it is dangerous to own stocks.
Baltic Dry Index
The importance of this index is to show the health of global trade and international shipping.
Charts I found interesting...
There is a high probability that the Fed raises interest rates in March.
Corporations Paying No Tax
Corporate Effective Tax Rate
Best States in The United States
Every state has a title at being the best at something. Check out what your state excels at.
Highly Paid Jobs
Who holds US federal Debt?
Historical Ownership of US Federal Debt
Last 100 Years Relative Size of Global Equity Markets
Industries Who Will be Affected by Changes in Immigration Policies
Origins of Immigrants in the US
Undocumented Labor Map
Global Opinion of Their Country's Direction
White House Has a Busy Year Planned for Congress
Sign up for your Free Subscription to the Inflation Monitor, a better way to assess how inflation impacts the US economy.
The Inflation Monitor includes inflation data for the US in a simple summary format. Learn more about US Inflation.
Sign up for the Inflation Monitor right now and get 12 months for free. It will be automatically delivered to your inbox each month.
China consumption compared to the US
European Country Bias
European Producer Price Index
Euro Zone Inflation
Fake News
Correlations and Volatility
Diversification
High Yield bonds
Global Opportunities by region
Consumer Finance
Employment by Education
Japan
Municipal Bonds
US GDP
Inflation and Rates
US Residential Real Estate
US Federal Budget
Wages and Unemployment
Global Yields
Returns of Large Cap Stocks Over 200 Years
That's it for now. I hope you enjoyed this month's Inflation Monitor - March 2017. See you next month.
Cheers,
Kirk Chisholm
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Reference Sources:
- Federal Reserve - St. Louis
- StockCharts
- GasBuddy
- JP Morgan Asset Management
About Innovative Advisory Group: Innovative Advisory Group, LLC (IAG), an independent Registered Investment Advisory Firm, is bringing innovation to the wealth management industry by combining both traditional and alternative investments. IAG is unique in that they have an extensive understanding of the regulatory and financial considerations involved with alternative investments held in self directed IRAs and other retirement accounts. IAG advises clients on traditional investments, such as stocks, bonds, and mutual funds, as well as advising clients on alternative investments. IAG has a value-oriented approach to investing, which integrates specialized investment experience with extensive resources.
For more information you can visit: Innovative Advisory Group
About the author: Kirk Chisholm is a Wealth Manager and Principal at Innovative Advisory Group. His roles at IAG are co-chair of the Investment Committee and Head of the Traditional Investment Risk Management Group. His background and areas of focus are portfolio management and investment analysis in both the traditional and alternative investment markets. He received a BA degree in Economics from Trinity College in Hartford, CT.
Disclaimer: This article is intended solely for informational purposes only, and in no manner intended to solicit any product or service. The opinions in this article are exculsively of the author(s) and may or may not reflect all those who are employed, either directly or indirectly or affiliated with Innovative Advisory Group, LLC.