October 15, 2021
By Steve Blumenthal
“Inflation is when you pay fifteen dollars for the ten-dollar
hair-cut you used to get for five dollars when you had hair.”
― Sam Ewing,
Former Baseball Player, Chicago White Sox, Toronto Blue Jays
Inflation is important to businesses and governments, which base many of their labor cost decisions on the consumer price index, or CPI. For we investors, monitoring inflation can be critical, since turning points in inflation often determine turning points in the stock and bond markets. For example, this week, the government announced that it is raising Social Security payments by 5.9%. That is a big bump.
Once each month, I review Ned Davis Research’s Inflation Timing Model (pictured below). The model consists of 22 individual indicators that measure the rate of change in commodity prices, the CPI, producer prices, and industrial production. Its objective is to signal the cyclical swings in the rate of inflation. Here’s how it works:
- The model totals all the indicator readings and provides a score ranging from +22 (strong inflationary pressures) to -22 (strong disinflationary pressures).
- High inflationary pressures are signaled when the model rises to +6 or above.
- Low inflationary pressures are indicated when the model falls to zero or less.
The model is an excellent tool for evaluating the stock market since stocks are sensitive to inflation rates and tend to perform especially well when inflationary pressures are low. When inflationary pressures are high, stocks tend to perform poorly. Rising input costs and higher wages have an impact on corporate earnings.
My highest-conviction view is that stagflation (a cycle of rising inflation with little economic growth) is the most probable outcome: a GDP slowdown into mid-2022 and potential recession. Of course, I could be wrong. We’ll take a look at select recession-watch charts in coming OMR posts. For now, recession is nowhere on the radar screen.
For investors, inflation isn’t necessarily bad news. It’s a question of positioning. Some industry groups and sectors do better or worse, depending on where we sit in the inflation cycle. For example, precious metals, industrial materials, commodities, and energy sectors perform best when inflationary pressures are high. Popular stock and bond market indices in general and the utility and financial sectors in particular do well when inflationary pressures are low.
It is for this reason, I find NDR’s Inflation Timing Model to be a valuable tool for both risk management timing and sector weightings. Focus in on the light blue line in bottom section of following chart. Simply note the “high” and “low” zones.
Here’s the bottom line: If you look at prior periods of “high inflationary pressures,” such as the 1970s, the late 1990s, and 2007, you’ll see that the subsequent year or two proved difficult for the stock market (S&P 500 Index year by year returns—captured in the next chart).
Further, high inflationary pressures in 2014 and 2017 created challenges for the market in 2015 and 2018. We crossed into the high inflationary zone in 2021. The simple message is that inflation matters!
Source: Macrotrends. If you click on this link, you can find the chart and scroll over each year for greater detail.
The balance of this week’s post is short. You’ll find more on inflation in the Trade Signals section (next) and a fun quote and short note in the personal section. Appreciate the time you spend with me each week! Thank you.
Trade Signals – Stagflation/Inflation: Not So Transitory?
October 13, 2021
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Market Commentary
Notable this week:
The Fed minutes were released Wednesday afternoon with officials largely agreeing that stimulus easing (a/k/a “tapering”) should begin next month or in December. Inflation fears are rising. The FOMC discussed reducing monthly purchases of Treasuries by $10B and mortgage-backed securities by $5B. The current pace of monthly purchases is $80B in Treasuries and $40B in mortgage-backed securities.
Stagflation – Inflation: Not So Transitory?
Inflation has proved stickier than expected, brought on by supply-chain disruptions, labor shortages and surging energy prices. Meanwhile, the pace of the post-pandemic recovery has slowed. Over the weekend, Goldman Sachs lowered its projections for U.S. growth in the fourth quarter of 2021 and next year, citing factors such as the impact of COVID-19 on consumer spending and a looming drop-off in government support for the economy. (Source: WSJ, October 12, 2021)
Social Security checks will increase by 5.9% next year. Inflation pressures are real. Transitory? Sticky? 5.9% looks pretty sticky.
Energy Inflation
The energy crisis around the world is hitting households and manufacturers that were already struggling to recover from the global pandemic. This is a perfect storm of crises. It features supply shortages, especially from China; inflation; slowing growth; labor shortages; Russia’s continued geopolitical muscle-flexing; and, of course, the fear that the world will burn to a crisp.
- Around the world, the demand for coal is far outstripping supply. The price of coal on the Nymex exchange in New York reached $274 per tonne on Oct. 5. A year ago, it was $57.
- European natural gas prices rose by roughly 500% between early May and early October before easing slightly.
- The global energy transition to renewables is well underway but hasn’t come quickly enough.
- “Pressures on the energy system are not going to relent in the coming decades,” writes the International Energy Agency in its latest World Energy Outlook, released on Wednesday.
- Inflation is bad, but energy-price inflation is terrible. It hurts the poorest the most and scares up memories of 1970s-style stagflation, where rising prices are combined with anemic growth.
The bottom line: The world is still reliant on fossil fuels for much-needed growth. The problems with that aren’t just intergenerational. They’re right here, right now. (Source: Axios’ Felix Salmon and Andrew Freedman October 13, 2021)
Businesses will increase prices on the goods they sell to offset their rising input costs or they will eat the costs reducing their profits. The cost of labor is also on the rise. Not so transitory it appears!
And this:
Stagflation is the likely outcome. A tricky time for investors with the US cap-weighted indices sitting near all-time record highs.
Click HERE to read to the balance of Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Personal Note – Oktoberfest
“In the beginning the Universe was created.
This has made a lot of people very angry and been widely regarded as a bad move.”
– Douglas Adams, “The Hitch-Hiker’s Guide to the Galaxy” (published on this day in 1978)
Oktoberfest, Munich, Bavaria, Germany
Hat tip to Sherifa Issifu at S&P Dow Jones Indices for the above quote. Sherifa sends his “Daily Dashboard” email to advisors, and often includes a bit of his witty, lighthearted humor. Here’s how he began his October 12, 2021, email—something beer fans everywhere can appreciate:
211 years ago today, the townsfolk of Munich began a five-day celebration of the marriage of Ludwig, crown prince of Bavaria, to Princess Therese of Saxe-Hildburghausen. The festivities were a great success, kicking off an annual tradition that continued down the centuries to become a fortnight-long party of beer, music, dancing, and, folk activities that is now the largest “volksfest” in the world. Oktoberfest is unfortunately officially canceled this year, so raise your jug in a toast to the hopes for 2022. Here is your daily dashboard.
If you click on the daily dashboard link above, you’ll find a scorecard of sorts reflecting one day, month-to-date, year-to-date, and the last 12 months of performance of the various S&P Dow Jones Indices. If you’re curious as to which sectors are doing best this month, here’s the data through October 14:
Switching gears, my Penn State Nittany Lions were hit hard last week, losing by three points to the Iowa Hawkeyes. Son Matthew and I sat on the edge of our seats, emotions going from high, to low, to very low at the end of the game. Leading 17-3 with six minutes to go in the second quarter, the Lions starting quarterback Sean Clifford took a hard hit and returned from the locker room with shoulder pads and helmet off.
The game changed instantly. Backup quarterback Ta’Quan Roberson stepped into the game to take his first career college football snap—a tall task. It was first and 10 on his own two-yard line. With his back on the goal line, 70,000 appropriately rabid fans cheered as loud as they could. They not only affected the young backup quarterback, the noise level forced numerous false starts as Roberson’s claps for the snap went unheard by his linemen. Five of Roberson’s series started inside the Penn State 10, and a sixth began at the 11-yard line. The 12th man is what makes college football so great. And the pre-game tailgates… And the post-game celebrations. Congrats to my Iowa Hawkeye friends. A great win. It was an exciting game to watch.
This weekend, the forecast is cloudy in the mid 60s with a chance of rain Saturday afternoon. But it’s sunny and in the 70s today, the leaves are changing color and it is absolutely beautiful here in the Northeast. Susan’s high school soccer team plays tomorrow. It’s homecoming for the Malvern Friars and hopefully the rain holds off. I’ll be in the stands. In years past, I’d watch my children play with a special eye on them of course. Now I feel somewhat of a connection with all of Sue’s boys. Fun to watch them get better and better.
Some golf with Matt is on the docket for Sunday. He could use a few bucks. Dad’s an easy target, but I’m not digging into my pocket without a fight. Hope this note finds you doing something you love to do.
Huddle up with some friends, grab a beer, hold it high, and celebrate. Wishing you a fun week!
All the best,
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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