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I feel like there are several misconceptions around inflation.
One: Falling inflation doesn’t mean falling prices. It just means your rent payment went from $1,500 a month to $1,550 instead of going to $1,700.
Two: Lower inflation isn’t any different than higher inflation. Higher or lower make little difference. What makes the real difference is stability. The difference between 2% consistent inflation and 5% consistent inflation is nothing. In a 5% consistent inflation world people would just ask for 5-7% raises instead of 2-4% raises, everyone knows what to expect and then others deliver. We’ve just arrived at a consensus that 2% is good. The bread is the stability of inflation, it’s when inflation goes from 2% to 7% back to 3% then to 8%, you have problems because people and businesses can’t predict and expect the future.
Three: Your personal consumption basket is different than the average and everyone elses. Take a 70 year old man versus a 22 year old woman. The 70 year old man may not be quite as sensitive to college tuition, Starbucks lattes, and housing costs. And vice versa, the 22 year old woman may not be traveling as much as the 70 year old retiree, so he will have a higher weighting to gas, hotels, and plane fights. He may have higher food away from home expenses. Your consumption basket is different than the CPI, most likely.
Four: Inflation affect assets in a unique way. Yes sometimes margins get compressed in businesses and that hurts, but never underestimate corporate America’s ability to pass on costs and sustain their margins and profits. The real way inflation affects assets is in buyer psychology (which sometimes makes consumer spending harder to predict, and thus the company's earnings are harder to forecast and therefor discounted) and in interest rates. An interest rate is the base rate plus inflation plus a credit premium. When those are higher there will be price declines in bonds and stocks because the future cash flow predictions have to be discounted more because there are new higher earning alternatives.
Now let’s talk about the print released on Wednesday.
Here’s how it’s gone down year to date.
Two things, inflation is coming down and the markets love it.
For the first time in a long time there is such a thing as real interest rates. The 6 month treasury is currently riding above the 4.93% CPI rate at 5.105%.
What does that mean. There is likely a floor on revaluation on stocks and bonds. When real rates enter the picture, especially when inflation is falling, future cash flows need not to be discounted more.
It doesn’t mean assets will rise either. What I do know is there can be coupons and dividends into the end of the year, even if the values don’t move.
The hard part is the Nasdaq 100 is up over 22% this year and the S&P 500 is up over 7%, bonds themselves are up over 5%. From a calendar year perspective this is above average, yet when you look at the stats bad years are typically followed by worse years or exceptionally better years.
The outlook seems to be positive yet we have several roadblocks. Government default, worsening recession, banking failures, credit crunches, inflation, and more all pose threats to the wonderful year we have had so far.
Anyways here’s everything I read, wrote and spoke this week.
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