Inflation 101: Prep School for Preppers
Mention Preppies and visions of Izods with popped collars and boat shoes may come to mind. The Official Preppy Handbook, published in 1980, regaled readers with the “merits of pink and green,” instructing that, “socks are frequently not worn on sporting occasions or on social occasions for that matter. This provides a year-round beachside look that is so desirable that comfort may be set aside.”
Reference “Preppers,” on the other hand, and fashion goes out the window replaced by sturdy wears and wares. Gucci is supplanted by the “Bug Out Bag (BOB)” and “Get Out of Dodge (GOOD) Kit.” Modern day survivalists have upgraded their essentials to include electric generators, water purifiers, and several years’ worth of provisions. Who’s to blame them? Go big if you can’t go home.
In the blink of an election, the two worlds of Preppy and Prepper have collided. Rather than the possibilities being remote as doomsday scenarios suggest, potential outcomes are conspicuous in their size, abundance and mystery. Hence the logic when yours truly received this warning from a reader logged into a posh investment website in the wake of last week’s upset win for Donald Trump: “Buy brand name defensive ammo for handguns. It will hold its value better than gold. It is an inflation hedge. Buy a box every month. Diversify the calibers.”
Such sophisticated language and tone for a disturbingly dire forecast. And his admonitions came before the tizzy the bond market has thrown in recent days in anticipation of all manner of fiscal stimulus. The question on everyone’s mind is how far does the backup in bond prices in anticipation of inflation have to run?
Theories abound: Is this simply a boomerang reaction to Trump’s more hawkish tone on Fed policy? Will the $500 billion in infrastructure spending arrive as fast as Dr. Copper’s moves suggest? What of all that debt that’s still out there? Haven’t we been lectured by monetary authorities for years that it’s only the cost to service the debt that matters? OK, now what if it’s looking like debt service costs will matter and in a hurry?
Perhaps it would be best to catch our collective breath and take a step back for a moment and assess how underlying inflation has been behaving. In the spirit of keeping things on Planet Earth, let’s look at the consumer price index (CPI). In September (October due out manana), headline CPI rose 0.3 percent over August and 1.5 percent year on year, the quickest pace since October 2014 but tame nevertheless historically speaking. Meanwhile, core CPI, which excludes necessities one and two in life – food and energy – was up 2.2 percent over last year.
If you just said, “Huh?” get in line. Yes, it’s unusual for the core to be rising at a faster pace than headline, and that’s only half the story. The fact is, core has been above two percent for nearly a year making one wonder about Janet Yellen’s initial promise that the upside-down dynamic would be ‘transitory’ in nature. What gives?
It comes down to the services side of the equation, which has been fueled by the Affordable Care Act and rental inflation that’s risen into the stratosphere care of the low interest rates that have encouraged luxury unit construction. To be precise, the CPI tells us rents are up by 3.7 percent in the last year, which is apt to be understated for reasons you need not be bored with, while medical care prices are up by 4.9 percent over 2015. So it’s safe to say services inflation has been driving the train.
The Daily Shot’s Lev Borodovsky is an avid observer of just about every economic and financial market trend out there. From his vista, a switch could be in the process of being flipped.
“We are now seeing price stabilization in the goods sector with a number of indicators such as manufacturing surveys around the world showing rising prices” said Borodovsky. “Perhaps the greatest single indicator is the end of producer price deflation in China, which started about five years ago.”
By the looks of some of the metals charts, ‘end,’ timed conveniently at the end of last year, has segued into ‘frenzy.’ Since mid-December of last year, coal prices have more than doubled; steel prices have increased by 50 percent. A similar story can be told across the entire industrials metals complex, which is best reflected in the Baltic Dry Index (BDI), a broad shipping gauge treated as a proxy for global trade. According to Hellenic Shipping News, after bottoming at a record low on February 11, at 290, the BDI has more than tripled, most recently closing at 1,084.
What does this all mean? Could China truly be in the position to finance a fresh round of infrastructure spending? The answer is, sort of. The government has doubled the funds it funnels into Chinese public-works projects, which naturally drives up demand for primary commodities. At the same time, though, authorities have broadcast their intention to cut supply output from the country’s bloated industrial sector. So boost credit and restrain supply?
This dichotomy was sufficient to bring out the hot money. According to Bloomberg data, trough-to-peak daily turnover in steel spiked by nearly 9,000 percent, a boon for traders and metals and mining firms, a bummer for consumers of said goods.
The bottom line is, before the election, some of the underlying demand that raised the specter of inflation was real, but a good bit of it was fabricated. Looking out to 2019, China’s aggregate demand for base metals is forecast to be about one-fourth of what it was in the five years ended 2015. Of course, China is but one country, albeit a biggie.
Fast forward one week, to a Trumpian reality, and all the world is atwitter pondering the magnitude, the majesty, of potential public works projects in the United States, ones that bring us back in line with first world standards.
Does this new world of possibilities now justify speculative bets on metals hovering at mid-2014 levels, when oil was still at its cycle highs? In his typical dry fashion, Borodovsky asked, “Is the rally overdone?” If so, he answered rhetorically, “the unwind could get ugly.” As if on cue, over the last few trading days, many of the metals have come off their highs, in part because they’d risen too far, too fast. But on a more fundamental level, the U.S. is simply incapable of displacing China in its peak commodities consumption years, regardless of the size of infrastructure spending Trump succeeds in securing.
If you listen to campaign promises, that figure could be in the half a tillion dollars a year vicinity. The economists at Goldman Sachs estimate a much tamer $150 billion a year fiscal boost. Their number crunching equates that figure to a 0.6 percent marginal increase in economic output. The author of the report, Daan Struyven, added that timing must be taken into account: “The late-stage cyclical position of the economy makes the multiplier smaller than it would have been in recession or early recovery, especially if the Fed offsets the fiscal impulse.”
Lest we forget the Fed’s role at this late stage. As things stand, all indicators point to a ‘go’ in December. Wages are increasing at the fastest pace since 2008, inflation expectations looking out five years are upwards of 2.6 percent and most importantly, the market is pricing in a 94 percent probability the Fed will pull the trigger.
As for 2017, ‘gradual’ best characterizes the markets’ hopes for just about everything from the aforementioned inflation to the Fed’s reaction function. Steady as she goes to push the second longest bull market in history to first place.
At the risk of injecting the equivalent of a cold shower into this perfect scenario, what if (about to use a four-letter word, so close eyes if under 18) mean reversion applies to the bond market, and in turn the stock market and commercial real estate? What if, after 35 long years, the inflation genie really has been let out of its bottle?
Well then, you’d best take cover. Which brings us back to those smartly dressed preppies, who will inevitably go all in on gold. After all, as The Official Preppy Handbook reminds us, “In a true democracy everyone can be upper class and live in Connecticut. It’s only fair.” Hmmm.
Do any of you doubt that this traditional hedge proffers adequate protection in a world awash in over $200 trillion in debt? If that’s the case, you might consider sturdier shelter. Yes, we’re talking about taking the prepper path, a.k.a. farmland. The bonus is, unlike some other asset classes, farmland prices have fallen at the fastest pace and for the longest stretch since the 1980s.
So stock up on dehydrated water, canned goods and maybe even that brand name ammo, as the sophisticated reader suggested. While you’re at it, take up hunting and gardening in your free time. In a world full of surprises, it’s better to be prepared than not.
Originally published on Danielle DiMartino Booth’s website.