Latest Inflation Numbers and Discussion

[Happyras]

As an occasional follower of Lyn Alden, here is her latest newsletter February 2023 Newsletter: Fixing Inflation
https://www.lynalden.com/february-2023-newsletter/
The past few years she has been pretty good at calling what is going down, and why....I would like to hear any comments from the forum on her views.

 

[pb4uski]

Well it never was. Earnings matter, sure. Cash flow even better. But interest rates *price* those future cash flows by discounting them to the present value. The value of a stock is the discounted value of expected future cash flows.
...

I think that used to be true, and it is true in theory, but not so much in reality today. Think of the meme stocks like GameStop, certainly not anything close to discounted expected cash flows there. The dot com stocks were another notable exception. Casino might not be right but at these multiples it smells like a casino.

The historical average return of domestic equities is about 10%. Let's say that the average earnings growth rate is 4%. That would suggest a P/E of 16 which is about the historical average. The P/E ratio of the S&P 500 today is 22 suggesting that stocks are significantly overvalued.

 

[milford]

As an occasional follower of Lyn Alden, here is her latest newsletter February 2023 Newsletter: Fixing Inflation
https://www.lynalden.com/february-2023-newsletter/
The past few years she has been pretty good at calling what is going down, and why....I would like to hear any comments from the forum on her views.

She does very good analysis, however she seems to be a perma bull on energy and gold. One thing she doesn't address which is odd is the imminent recession. If it is a severe recession I don't see how you can be bullish on energy, which would most likely collapse. Personally, I think without a semi-severe recession, there would be no way to tame inflation at this point.

 

[Montecfo]

I think that used to be true, and it is true in theory, but not so much in reality today. Think of the meme stocks like GameStop, certainly not anything close to discounted expected cash flows there. The dot com stocks were another notable exception. Casino might not be right but at these multiples it smells like a casino.

The historical average return of domestic equities is about 10%. Let's say that the average earnings growth rate is 4%. That would suggest a P/E of 16 which is about the historical average. The P/E ratio of the S&P 500 today is 22 suggesting that stocks are significantly overvalued.

Meme stocks can trade at crazy prices, but that is because of a short squeeze designed to punish hedge funds.

Dotcoms valuation was based on optimism about returns in the future. They got ahead of themselves but that is only clear in retrospect.

Markets are inefficient and trade on sentiment in the short term but fundamentals win out over the long term. The dotcoms crashed.

Equity valuations have to be viewed within the context of interest rates. Earnings rose last year but stocks collapsed. Why? Because interest rates rose sharply, making the future earnings streams less valuable.

And the most speculative stocks declined the most, because their earnings streams were happening far in the future.

I agree with you that stocks appear overvalued now, but you can't look solely at historical averages. You have to look at values in the context of interest rates and rate expectations.

That has not changed.

 

[pb4uski]

I'm not so sure. Back in the days where you had fewer stock investors and most stock investors bought individual stocks vs passive equity investing and stock picking was in vogue I think you have a point. But the world has changed dramatically.

There is a lot of money out there going into stocks just because it needs to. Passive managers end up buying the index with little thought as to whether all the stocks that they are buying are good values so a good portion of demand for stocks has no real consideration of fundamentals. And as a result, P/Es are higher and the market is overvalued compared to fundamentals.

I think we are seeing a paradigm shift where fixed income rates and returns are normalizing away from the very low interest rates of the last 15 years.

CNBC had a 2019 headline that passive management was over 45% of US equity funds so there is a lot of money out there just going through the motion.

I agree that businesses buying businesses and some stock pickers will look to discounted cash flows but a lot of demand for stocks is passive investing and technical analysis that don't really consider discounted cash flows and to the extent that those buyers become a large part of demand then stocks are just like any other commodity and a function more of supply and demand rather than an evaluation of underlying cash flows.

 

[ShokWaveRider]

I saw on the news today that the market maybe anticipating a 50bps hike next month. I think it is all blow, just an excuse to run up the market when we actually get 25bps and then take profits from the gamblers on the following couple of days. But what do I know.

 

[Montecfo]

I'm not so sure. Back in the days where you had fewer stock investors and most stock investors bought individual stocks vs passive equity investing and stock picking was in vogue I think you have a point. But the world has changed dramatically.

There is a lot of money out there going into stocks just because it needs to. Passive managers end up buying the index with little thought as to whether all the stocks that they are buying are good values so a good portion of demand for stocks has no real consideration of fundamentals. And as a result, P/Es are higher and the market is overvalued compared to fundamentals.

I think we are seeing a paradigm shift where fixed income rates and returns are normalizing away from the very low interest rates of the last 15 years.

CNBC had a 2019 headline that passive management was over 45% of US equity funds so there is a lot of money out there just going through the motion.

I agree that businesses buying businesses and some stock pickers will look to discounted cash flows but a lot of demand for stocks is passive investing and technical analysis that don't really consider discounted cash flows and to the extent that those buyers become a large part of demand then stocks are just like any other commodity and a function more of supply and demand rather than an evaluation of underlying cash flows.

I think there is still a sufficient part of the market that is not index that you still have what they refer to as "price discovery".

But I agree that indexing can distort the market if it is dominated by investors who ignore values. and I agree that many do. But that distortion also occurs on the way down also where everything is getting sold at the same time-good with the bad. When that happens stock pickers and hedge funds jump in to grab bargains.

I am not sure what the threshold is for market failure but it will be difficult for indexing to grow as it has. And at some point people realize the distortion and abandon that practice, or regulation limits it.

But despite indexing we still saw stocks fall sharply last year as they should have. Indexers sold too.

And FWIW I have harvested quite a lot of gains in this rally since Oct. Will redeploy into bonds possibly. But I expect a strong selloff in equities, especially if we have a hard recession. That will present a nice opportunity for tactical rebalance.

 

[Montecfo]

I saw on the news today that the market maybe anticipating a 50bps hike next month. I think it is all blow, just an excuse to run up the market when we actually get 25bps and then take profits from the gamblers on the following couple of days. But what do I know.

My guess is they stick to the game plan as stated. They need to give these raises a chance to get into the economy. And there are plenty of signs economic stress.

But if they do a 0.50% with more hawkish jawboning you are going to see some disruption in equities.

 

[copyright1997reloaded]

My guess is they stick to the game plan as stated. They need to give these raises a chance to get into the economy. And there are plenty of signs economic stress.

But if they do a 0.50% with more hawkish jawboning you are going to see some disruption in equities.

Agreed. The Fed has gotten themselves into a "25 basis points" corner. Even if the next CPI/PPI readers were even "hotter" a 50 point raise at this point would cause a major market pullback. So, the best they can do (in terms of rates) is to go 25 and perhaps jawbone about more.

OTOH they (the Fed) could up their selling of assets, thus affecting prices w/o jumping to a 50 point hike. I don't know what their book looks like, but selling more of the long end of the book might help to undo some of the massive yield curve inversion (which even with higher rates Mr. Market might like).

 

[pb4uski]

I hope that the Fed focuses on their dual mandate of inflation and employment, does whatever they have to do and totally ignore any potential impact of their actions on the markets... the markets shouldn't matter... at all.

 

[milford]

Agreed. The Fed has gotten themselves into a "25 basis points" corner. Even if the next CPI/PPI readers were even "hotter" a 50 point raise at this point would cause a major market pullback. So, the best they can do (in terms of rates) is to go 25 and perhaps jawbone about more.

OTOH they (the Fed) could up their selling of assets, thus affecting prices w/o jumping to a 50 point hike. I don't know what their book looks like, but selling more of the long end of the book might help to undo some of the massive yield curve inversion (which even with higher rates Mr. Market might like).

It is wishful thinking for inflation to subside without having a major market pull back, because strong markets creates wealth and increased consumer confidence which feeds into inflation.

What Powell should have done on the last FOMC meeting was come out very hawkish instead he was a bit dovish, which gave confidence to the market and now with the latest CPI reading still hot along with a strong unemployment report it would be interesting to see how serious he is about taming inflation.

 

[Montecfo]

Agreed. The Fed has gotten themselves into a "25 basis points" corner. Even if the next CPI/PPI readers were even "hotter" a 50 point raise at this point would cause a major market pullback. So, the best they can do (in terms of rates) is to go 25 and perhaps jawbone about more.



OTOH they (the Fed) could up their selling of assets, thus affecting prices w/o jumping to a 50 point hike. I don't know what their book looks like, but selling more of the long end of the book might help to undo some of the massive yield curve inversion (which even with higher rates Mr. Market might like).

8.4 T as of a couple of weeks ago.

 

[Montecfo]

It is wishful thinking for inflation to subside without having a major market pull back, because strong markets creates wealth and increased consumer confidence which feeds into inflation.



What Powell should have done on the last FOMC meeting was come out very hawkish instead he was a bit dovish, which gave confidence to the market and now with the latest CPI reading still hot along with a strong unemployment report it would be interesting to see how serious he is about taming inflation.

It is intriguing. I agree with you. But people will come out and say the Fed is very hawkish, ignoring his language it seems.

But it seems silly to do 50bp when you did an unprecedented three 75bp raises within the past 8 months. Are you going to wait and see what effect those have or just keep raising willy nilly?

Is this process or just knee jerk?

 

[HawkOwl]

I hope that the Fed focuses on their dual mandate of inflation and employment, does whatever they have to do and totally ignore any potential impact of their actions on the markets... the markets shouldn't matter... at all.

Agree. Their assigned job is that dual mandate. Trying to boost the stock market on the low is yielding to special interests, even if it benefits some of us personally.

 

[JoeWras]

Agreed. The Fed has gotten themselves into a "25 basis points" corner. Even if the next CPI/PPI readers were even "hotter" a 50 point raise at this point would cause a major market pullback. So, the best they can do (in terms of rates) is to go 25 and perhaps jawbone about more.

Flashback to last late spring when they were indicating 50.

When the time came, BAM, 75. Didn't stop them then.

The market is still fine. If anything, it can still use some cooling. I don't think they are worrying about it this time.

It seems like the traders got used to the Fed caring about the market. They are still adjusting to a Fed caring about something else (CPI).

 

[copyright1997reloaded]

It is wishful thinking for inflation to subside without having a major market pull back, because strong markets creates wealth and increased consumer confidence which feeds into inflation.

What Powell should have done on the last FOMC meeting was come out very hawkish instead he was a bit dovish, which gave confidence to the market and now with the latest CPI reading still hot along with a strong unemployment report it would be interesting to see how serious he is about taming inflation.

I'm about 40% equities which is the lowest I've been since...well ever so I am playing the "major market pull back" thesis. Whether that works out (i.e. I property time re-entry) is TBD. The fixed portion (about 55%) is pretty much all short duration (1 year or less) T-Bills/CD's, but I have done a little bit a little longer term (e.g. 10-year TIP, 10 year RBC 5.2%, a few CD's of 2/3/4 years that had "good" rates (4.9%, etc.)

So I don't have "wishful thinking", I think there is quite a bit of pain ahead if inflation is to beat. However, my thesis (which was/perhaps still is looking incorrect) is that the Fed and fiscal policy don't have what it takes to beat it, and that we will fall far short of the 2% goal before they are off to the races (printing money/providing stimulus). But so far that has not happened...then again we haven't gotten to the hard part because thus far there hasn't been a lot of impact on the employment front nor have we had any major surprises in terms of some firm or industry struggling. I thought (when Crypto exchanges started going under) that it might be the financial shock catalyst, but so far that hasn't happened.

 

[Gumby]

I just found the transcript of a recent Ezra Klein podcast in which he interviews economist Paul Krugman at length about inflation and the intricacies of measuring it and controlling it. I found it to be a fascinating discussion. There is also some discussion about the debt ceiling and about industrial policy. I enjoy reading things more than listening to them because it takes less time and I can go back and read it twice if I don't understand, but you could also just look for the podcast if that's how you roll.

https://www.nytimes.com/2023/02/17/podcasts/transcript-ezra-klein-interviews-paul-krugman.html

 

[milford]

It is intriguing. I agree with you. But people will come out and say the Fed is very hawkish, ignoring his language it seems.

But it seems silly to do 50bp when you did an unprecedented three 75bp raises within the past 8 months. Are you going to wait and see what effect those have or just keep raising willy nilly?

Is this process or just knee jerk?

We started with unprecedented conditions as well with zero fed's fund rate and over 5 trillion dollars of stimulus money in a matter of couple years so I think the unprecedented three 75bp raise is not as daunting as it sounds.

The current fed's fund rate (4.75%) is still below the average fed's fund rate over the years which is closer to 6% so if the fed is serious that their #1 priority is to reign in inflation then I think 50bp is the way to go. If not, there is a new term floating around that I saw yesterday called "no landing" meaning the economy hums along raging inflation.

 

[Koolau]

I just found the transcript of a recent Ezra Klein podcast in which he interviews economist Paul Krugman at length about inflation and the intricacies of measuring it and controlling it. I found it to be a fascinating discussion. There is also some discussion about the debt ceiling and about industrial policy. I enjoy reading things more than listening to them because it takes less time and I can go back and read it twice if I don't understand, but you could also just look for the podcast if that's how you roll.

https://www.nytimes.com/2023/02/17/podcasts/transcript-ezra-klein-interviews-paul-krugman.html

I started reading it (thanks for the site) but started getting sleepy (almost time for PM nap). Were there in your opinion any ah-hah take-aways? Anything that would help the average person here (I'm very average) get a sense of the economy and its direction. Thanks.

 

[MichaelB]

I started reading it (thanks for the site) but started getting sleepy (almost time for PM nap). Were there in your opinion any ah-hah take-aways? Anything that would help the average person here (I'm very average) get a sense of the economy and its direction. Thanks.

It’s a very wide ranging discussion covering many topics, and doesn’t lend itself to a quick summary.

As for your question, the economy is growing and the direction is up.

 

[Gumby]

As MichaelB mentioned, a summary would be a poor substitute for the real thing. But, basically, inflation is abating, by some measures faster than others. How and why the Fed chooses to use certain measures as a guideline and ignore others is an important issue. Recent changes in the methodology for seasonal adjustments probably has had a distorting affect that makes it difficult to properly discern the trend. Everyone, including the Fed itself, seems to believe that the target inflation should be 2%, but that number was arrived at 25 years ago. Under current circumstances, is that still valid, or should it be 3%. Does the ongoing shift from a goods economy to a service economy change things?

There are many more issues discussed than these, and it is worth an in-depth read. As with many things, even if I don't get the answer, I learn more about the actual question and about the things that may affect an answer. With that knowledge, I can better figure out my answer.

 

[Koolau]

It’s a very wide ranging discussion covering many topics, and doesn’t lend itself to a quick summary.

As for your question, the economy is growing and the direction is up.

As MichaelB mentioned, a summary would be a poor substitute for the real thing. But, basically, inflation is abating, by some measures faster than others. How and why the Fed chooses to use certain measures as a guideline and ignore others is an important issue. Recent changes in the methodology for seasonal adjustments probably has had a distorting affect that makes it difficult to properly discern the trend. Everyone, including the Fed itself, seems to believe that the target inflation should be 2%, but that number was arrived at 25 years ago. Under current circumstances, is that still valid, or should it be 3%. Does the ongoing shift from a goods economy to a service economy change things?

There are many more issues discussed than these, and it is worth an in-depth read. As with many things, even if I don't get the answer, I learn more about the actual question and about the things that may affect an answer. With that knowledge, I can better figure out my answer.

Well, thanks for trying.

I did try to read it, but my back has been acting up. Amazing how a little pain can affect your ability to concentrate. Hoping the PT w*rks, though, so far, seems to make things worse. Returning you now...

 

[JoeWras]

Well, thanks for trying.

I did try to read it, but my back has been acting up. Amazing how a little pain can affect your ability to concentrate. Hoping the PT w*rks, though, so far, seems to make things worse. Returning you now...

Yeah, my back pain acted up when it went off on politics as my muscles tensed (not joking). Thought it was going to be a balanced line or two, but then it kept going, and going, and ... I'm out.

 

[Gumby]

I hope the discussion about the credit limit battle (which is unavoidably political) does not preclude you from mulling over the inflation discussion (which is not at all).

 

[MichaelB]

As MichaelB mentioned, a summary would be a poor substitute for the real thing. But, basically, inflation is abating, by some measures faster than others. How and why the Fed chooses to use certain measures as a guideline and ignore others is an important issue. Recent changes in the methodology for seasonal adjustments probably has had a distorting affect that makes it difficult to properly discern the trend. Everyone, including the Fed itself, seems to believe that the target inflation should be 2%, but that number was arrived at 25 years ago. Under current circumstances, is that still valid, or should it be 3%. Does the ongoing shift from a goods economy to a service economy change things?

There are many more issues discussed than these, and it is worth an in-depth read. As with many things, even if I don't get the answer, I learn more about the actual question and about the things that may affect an answer. With that knowledge, I can better figure out my answer.

That’s a very good summary, thanks.

I would add one thing that wasn’t in the interview but is important to always keep in mind when looking at these monthly data releases. They are not real time indicators and many are constructed with a combination of data and methodology. Rather, they lend themselves to track trends and direction.

One more point also bears repeating. The Fed is deeply concerned with changes in the cost of labor (wage growth), more so than employment growth, because that’s what makes inflation persistent. The economy today presents a real challenge, because there’s both job and wage growth, there has been significant wage growth in the lower income levels, which has lagged for decades, and I think it’s safe to assume they would prefer that to continue if at all possible.