By
The
Inflation Trader
:
While central banks continue to fret about the risks of
disinflation and deflation due to expectations of slower growth,
the numbers continue to suggest those concerns are misplaced. Yes,
I know that inflation is supposed to lag growth, so that this
year's recession is next year's disinflation, and I know that the
S&P/Case-Shiller Home Price Index is also lagged due to its
averaging structure. But the HPI is also exceeding economist
expectations that ought to incorporate these facts. Consensus
expectations were for the index to be flat on a year-on-year basis;
instead, it rose 0.50% (June/June for the S&P/CS Composite-20)
or 1.22% (Q2/Q2 for the broad U.S. HPI) depending on your preferred
flavor.
However, yesterday's news was blunted by the fact that Consumer
Confidence posted its lowest reading of the year, fully 6 points
below expectations at 60.6. The good news is that the subindex
"Jobs Hard to Get," which is usefully correlated with the jobless
rate, was essentially unchanged at 40.7 (see Chart, source
Bloomberg), which is encouraging since the rise to this level
augured the bump higher in the Unemployment Rate a few months
back.
(click to enlarge)
Incidentally, this is a great illustration of the fact that we
are good at internalizing the actual condition of the employment
situation. Respondents tend to say that jobs are getting harder to
get
before
the Unemployment Rate actually rises. This is in sharp
contradistinction to inflation, which we are very poor at
internalizing. Survey responses about inflation tend to
lag
reported inflation, suggesting that respondents anchor on reported
inflation; moreover, survey responses about inflation
expectations
also have an extremely high correlation to trailing inflation -
which also suggests anchoring on the reported number, and by the
way makes it hard to argue that "contained inflation expectations"
might act as a meaningful brake on actual inflation. We just aren't
good at evaluating the true inflation level, and our 'personal
inflation heuristics' tend to be misleading because of cognitive
biases (noticing rising prices more than falling prices, e.g.).
The weak Confidence number helped push bonds higher, but
inflation-linked bonds rallied more than nominals, again. The
10-year inflation swap reached 2.59%Tuesday, up 0.26% in just over
one month. Ten-year expectations are tracking gasoline prices to an
unseemly degree (since 10-year gasoline prices are not moving
nearly as much as spot gasoline prices!); retail unleaded gasoline
is now over $3.75 and near the highest levels ever recorded for
this date. This ought to affect 1-year inflation expectations, and
it has: the 1-year inflation swap has risen 100bps since gasoline
bottomed at the end of June. But the effect on the 10-year point is
surprising, and suggests that investors believe the energy price
rise isn't the usual (mean-reverting) type but driven by different
underlying price dynamics.
Stocks were again near unchanged, and volumes again were punk.
But we're yet another day closer to Jackson Hole, to the next
Employment Report, to the next ECB meeting, and to the next Fed
meeting. Speaking of the ECB, it raised eyebrows when ECB President
Draghi canceled his trip to the Jackson Hole
symposium, citing a 'heavy work load.' Poor, overworked Mario! Some
investors took this to mean that the "heavy work load" involved
imminent ECB actions, but I suspect that too much is being read
into this. More likely, he is simply trying to avoid being lectured
to about his monetary largesse - which has lifted year-on-year
eurozone money growth to a whopping 3.3%, the highest since 2009 -
by policymakers who until recently were sporting M2 growth around
10%.
In talking about money velocity and the multiplier and so on,
I alluded
to an interesting relationship that I stumbled upon with respect to
velocity. I'm not completely sure what to make of it. Here it is
(chart source Bloomberg):
(click to enlarge)
The yellow line above is M2 velocity. The white line is the
S&P 500, divided by 10-year average nonfarm, nonfinancial
corporate profits before tax (from Fed report F.102), which are
easier to find on Bloomberg than S&P earnings. Because the
earnings series covers earnings for a much wider swath of corporate
America than is included in the S&P, this isn't an earnings
multiple
per se
. It can fall because equity prices fall, or because earnings rise,
or because the share of corporate earnings represented by the
S&P declines. (This is the reason that the S&P appears much
cheaper on this measure than if you use 10-year Shiller earnings on
the S&P itself.) However, generally speaking this chart ought
to trace the broad outlines of market valuation.
And this is very interesting. Prior to the first quarter of
1987…really dating right up to when Greenspan took office, plus or
minus a few months… equity valuations varied
inversely
with changes in velocity. After that point, represented
approximately by the vertical line, equity valuations varied
directly
with changes in velocity. In fact, the regime shift is shockingly
abrupt, and shockingly clear. Almost every wiggle on the left of
the chart is mirrored (the correlation of levels is -0.739); almost
every wiggle on the right of the chart is echoed (the correlation
is +0.745).
My friends, that's odd. And I don't really know what to make of
it, at the moment. What happened in 1987 to change this
relationship? Was it one of these things?
- The stock market crashed.
- Alan Greenspan became Fed Chairman.
- The money multiplier peaked. Could the
direction of change
in the money multiplier have anything to do with the interaction
of money velocity and asset prices?
What else? I am not presenting answers today, just more
questions - and I am curious what readers may come up with.
See also
AOL's 100% Run Is Not Going To Stop Here
on seekingalpha.com