EDITOR NOTE: Many of us are well-informed in matters economic. Yet most of us are not experts at the level of data crunching. That’s not our job (though monetary matters remain our “problem”). So, often we defer to those who can present us with figures that we hope are legitimate. More often than not, when the numbers seem skewed, we’re incapable of questioning the figures within the same analytic domain in which they were derived or, more cynically, manufactured. That’s how the government transforms a questionable or false claim into a solid fact. Well, what you’re about to read is a real treat. It doesn’t just posit a case, it’s a point/counterpoint refutation of the figures that mainstream economists, politicians, and pundits put forth as their argument that all is going well economically. You’ll hardly find this many refutations in a single article in regards to the future path of inflation. So, read on, and take note.
At a stunning 5%, the May CPI and the PPI - at an equally stunning 6.6% - marked another month of underestimating the cost pressures in the global supply chain by the market, economists, and even politicians. To put this incredible number in a historical context, consider that the last two months were the largest market survey estimation errors (miss) of inflation on record since 1998, when data tracking began. This is also the highest CPI reading since oil and pump prices were at their peak. Nevertheless, the entire US Government yield curve sits below 2.2% out to 30 years, making bond holders realize deeply negative real returns. What about stocks? According to Ned Davis Research, real 1 year- forward earnings yields (the inverse of P/E less inflation) are 0.27% on the S&P 500, the lowest since 1983.
The path of inflation from here is a big deal. Deflationists, economists, and politicians prefer to chalk this high inflation print to a data measurement phenomenon called base effects, a situation in which the absolute level of measurement of inflation from the previous year, impacts the current year-over-year change in inflation. While perhaps this may be the case, data observers like us are not so convinced. Currently, the 3-month annualized rate of change of inflation is 8.3%. This is the first time the 3-month annualized CPI print has been so high since the early 80’s, without the benefit of a hurricane, Gulf War, or oil crisis. But, still, median forecasts by economists show inflation ‘consensus’ at 2.5% for 2022. Consumers surveyed by the University of Michigan are thinking 4.6% is more likely. We are closer to the public on this one.
A point and counterpoint debate lets you experience the real time debate that is the talk of Wall Street:
- Point #1: The bond market is completely a free-market indicator and at 1.4% it is yelling do not worry about inflation.
- Counterpoint: The Fed now owns 1/3 of all outstanding treasuries; the treasury market is now less-free market than ever since WW2.
- Point #2: Labor markets are in equilibrium.
- Counterpoint: We are far from the Fed’s target of another roughly 8M needing to be employed- is that costless?
- Point #3: US Jobs Quits Rate is not at an all-time high.
- Counterpoint: It is, with 3.7 million workers quitting their jobs. Workers quit at this rate only when jobs are plentiful, and wages are greener elsewhere.
- Point #4: Inventories are back to normal and there are no order backlogs.
- Counterpoint: Inventories are still at record lows and a lot of the economy is still in the reopening stage.
- Point #5: The global supply chain infrastructure is modern and efficient, capable of handling rampant demand.
- Counterpoint: At present, the current demand/supply imbalance is driving price increases throughout many segments of the economy. Bulk shipping rates are at the highest levels since the mid 2000’s and it takes at least 2 years to build a new cargo ship.
- Point #6: Housing costs are rising only 2.1% y/y.
- Counterpoint: We believe this government data is not accurate based on all metrics we analyze. We expect that in 3-6 months this measure, the largest component of CPI, may be 3-4X the May reported number.
- Point #7: The cost to buy a new or used car is at peak and will trend downward from here.
- Counterpoint: Used cars are selling at record prices, and you cannot take delivery of a new build until the chip shortage ends which is forecasted for 2022.
- Point #8: Government deficits are yesterday’s news.
- Counterpoint: The CBO has a more sanguine view of massive deficits for years to come.
- Point #9: The Fed is no longer printing money.
- Counterpoint: In fact, the Fed continues to print dollars in the trillions (not billions)
- Point #10: New mining projects are ready to quench spiraling global demand for copper, nickel, and platinum among others.
- Counterpoint: Mining capital expenditures have lagged badly for years, and it takes at least 5 years to rectify this while green demand for metals is just now accelerating.
- Point #11: The US dollar is undervalued and will rise to slow imported inflation.
- Counterpoint: The dollar loses purchasing power parity as our inflation exceeds our trading partners’. This one is headed in the wrong direction along with our trade and budget deficits.
Over the coming summer as more of the country and developed world reopens it is likely that inventories will not have time to rebuild, order backlogs will intensify, and materials costs will continue to bubble up. In fact, we are not seeing any signs of this ending in the leading soft economic data. Per the Institute of Supply Management, in May, ISM Supplier Deliveries surged to 78.8, the highest level since the 70s. ISM New Orders are at 67, the highest levels since the mid-2000’s. At the same time, ISM Manufacturing Employment has fallen to 50.9, just above contraction level of 50, a likely result of federally instituted stay-at-home checks and workers quitting jobs to look for higher pay, which is causing ISM Production to begin to fall to a level of 58.5. This has resulted in ISM backlogs surging to 70.6, the highest on record. All of these factors are compounded by a record number of 32 out of 55 ISM measured commodities in short supply, and 54 out of 55 commodities increasing in price.
We at Proficio never want to fight the Fed. That is why we have not meaningfully reduced our equity exposure and headed for the hills. However, we cannot ignore the leading data which all signal sustained cost pressures that are NOT going to ease because the global supply chain is healing and the Fed says these pressures are transitory. The path of inflation is critical to returns for both stocks and bonds which now have built-in enormous risks if the Fed and consensus are wrong. We continue to advocate holding roughly 40% exposures to hard currency (Gold, silver, platinum, and short US dollar) and uncorrelated assets. Of course, the Fed could have it just right, but we will follow another famous hashtag: #TrustButVerify.
Original post from Forbes