Weighing the Week Ahead: Should Investors Start Worrying About Inflation?
The economic calendar is about normal, with market participants back from holiday vacations (but perhaps fighting the snow). The key reports are the PPI and CPI. Inflation is the key 2018 worry for many, so these reports will get more attention. Especially if the numbers are a little hot, I expect the punditry to be asking:
How worried should we be about inflation?
Last Week Recap
In the last edition of WTWA I foresaw (despite significant fresh data) another week of punditry. It was time for everyone to lay out what to worry about. This allows them to claim victory at the end of the year. This was the dominant theme, if you ignored White House gossip and nuclear war with North Korea. The stories have little beyond what I reported last week, including plenty of help from readers.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. I especially like the Doug Short design with Jill Mislinski updates and commentary. You can see many important features in a single look. She notes the new records along with other indicators. The entire post is well worth reading for the collection of charts and analytical observations.
The trading range for the week was the highest in recent weeks, almost 2.6%. This increased actual volatility, but not the VIX. Our indicator snapshot tracks this important comparison.
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
The economic news was mixed, especially on the employment front. Before the employment numbers I published a guide to assist interpretation. Many seemed to find it useful, and one of my plans for the new year is to more analysis of economic indicators.
- ISM Index registered 59.7, beating an expected 58.0 and the prior month at 58.2 Bespoke shows the significance with one of their typical great charts.
Labor force participation, as explained by the BLS, is also improving as demonstrated with this helpful explanatory table.
Persons who are neither employed nor unemployed are not in the labor force. This category includes retired persons, students, those taking care of children or other family members, and others who are neither working nor seeking work. Information is collected on their desire for and availability for work, job search activity in the prior year, and reasons for not currently searching.
- ISM Services of 55.9 missed expectations and the prior month reading by about 1.5 points.
- Initial jobless claims edged higher to 250K rather than moving back toward recent levels, as most expected. Bespoke’s chart:
- Investor sentiment has become more bullish, a contrarian indicator. (David Templeton, HORAN).
- Headline payroll employment net increase of 148K was a disappointment compared to expectations. Some were also concerned about the changes by industry (WSJ).
The retail decline looks bad, fueling the many worries about the Amazon effect. Economist Michael Mandel is a leading expert on changes in the labor market structure. He frequently discovers important data and draws sound conclusions that you just don’t see anywhere else. For retail jobs, which have varying and sometimes short hours, he uses FTE instead of the simple job numbers. The increase in hours (and thus FTEs) has been dramatic since the peak of brick and mortar.
So let’s look at the two years since brick-and-mortar FTE peaked. Over those two years, brick-and-mortar retail FTE jobs fell by 123,000. That’s a decline of about 1%. The increase in FTE ecommerce jobs was 178,000 over the same stretch. That’s based on hours worked in the electronic shopping and mail-order industry, and the warehousing industry, where many fulfillment centers are reported. FTE jobs at couriers and messengers, including express delivery companies, rose by 58,000. All told, the gains in ecommerce and delivery services was almost twice the size of the losses in brick=and-mortar retail.
Change in FTE jobs, 3Q15-3Q17 (thousands)
Brick-and-mortar retail -123
Express delivery and couriers +58
Data: BLS, PPI.
The data are from October, but on Twitter he cited the continuing improvement.
The lie that won’t die — continuing misrepresentation of the employment situation. How can anyone possibly believe that the US, with a population of 323 million, has 95 million able-bodied people unemployed and looking for work. Check out this video to see two frequent CNBC commentators calling this the most important job statistic. When (via Twitter) I pointed out the error to Mr. Bianco, showing him the BLS chart above showing that the group includes retirees, students, and stay-at-home parents he replied that the chart showed that 90 million people were looking for work. Apparently unfamiliar with this regular employment chart, he missed the word “not.” When I pointed that out, he called me an “angry troll.” He is half right! Investors are harmed by huge distortions in economic data. Instead of gracefully acknowledging his blunder, he switched to a different metric.
I rarely point out errors, preferring to cite excellent work. I sometimes award the Silver Bullet to recognize those who take up the unpopular task of explaining popular but erroneous claims. It is nearly impossible to provide effective refutation, especially when the message is repeated so often. [I have been called many things, but this is a first for “troll”!!]
Maria Bartiromo’s success at Fox. She is now #4 among digital influencers and the top person in finance. She is also beating CNBC in her time slot. A favorite of mine for interview style, she delivers news, but has a touch more opinion than when at CNBC.
The Week Ahead
We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
The new year starts with a normal calendar, featuring the inflation numbers. JOLTs should be considered in this context, since it is more important for interpreting labor market structure than job growth. This has direct bearing on inflation. Retail sales will also be important, but less so than the upcoming earnings. Fed speakers are back on the road, and Congress will be back on the job!
Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.
Next Week’s Theme
The normal calendar has an emphasis on inflation and, perhaps, the Fed. I expect plenty of speculation about a more aggressive Fed policy, especially if the inflation numbers are a bit “hot.” Many will be asking:
Should we start worrying about inflation?
As usual, here is a typical range of opinion, from bearish to bullish. As a general classification, often confused by those commenting, we have opinions on the rate of inflation, how it is measured, whether the Fed is “behind the curve, and the implications for the yield curve. The links cited provide information about the topic, not necessarily an endorsement of that viewpoint.
- The yield curve will soon invert, leading to a recession.
- Inflation is not well-measured, already out of control in commodity pricing. (Check out the Bonddad chart pack).
- The Fed has waited far too long to raise rates, necessary to prepare for the next recession. (Capital Spectator on the underlying, if not the effect).
- The new Fed will represent a far different viewpoint.
- Higher rates faster, as suggested in the GOP campaign.
- Lower rates longer, as seem to be sought by the President.
- The Fed has been patient, measured, and willing to resist political pressures.
It is a complicated question with many dimensions. I’ll provide my own interpretations in today’s Final Thought.
We follow some regular featured sources and the best other quant news from the week.
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.
The Indicator Snapshot
Recession odds remain low and many economic indicators are improving.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score.
RecessionAlert: Strong quantitative indicators for both economic and market analysis.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession. Here is the unemployment indicator.
Doug Short: Regular updating of an array of indicators. Great charts and analysis.
Brian Gilmartin summarizes expected revenue growth for Q417 (7%) and 2018 (6%). With most preoccupied with earnings, this is valuable information. He also expects upward revenue revisions, something that would be an upside surprise for many. Brian generously shares his data (a great example that others should follow) so you can form your own conclusions if you wish.
GEI republished an excellent discussion of the various measures of financial health. I prefer the St. Louis Financial Stress Index, but readers might wish to know the characteristics of alternatives – construction and correlations.
Insight for Traders
Our discussion of trading ideas has moved to the weekly Stock Exchange post. The coverage is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. This week’s post considers a classic issue for traders, the effect of short-term news. The example is, of course, the tax cut and the conclusions are interesting. Model performance updates are published, and of course, there are updated ratings lists for Felix and Oscar, this week featuring S&P midcap stocks.. Blue Harbinger has taken the lead role on this post, using information both from me and from the models. He is doing a great job, presenting a wealth of new ideas and information each week.
Insight for Investors
Investors should have a long-term horizon. They can often exploit trading volatility!
Best of the Week
If I had to pick a single most important source for investors to read this week it would be this essay: How America Lost Faith in Expertise – And Why That’s a Giant Problem. Author Tom Nichols is a professor at the U.S. Naval War College (and a five-time, undefeated Jeopardy champion). His book, The Death of Expertise: The Campaign Against Established Knowledge and Why It Matters, is an excellent, expanded treatment of the same theme.
This is an important thesis for many reasons, which he lays out quite clearly. It is important to investors because the idea that all opinions are equal has invaded the investment community. Many claim expertise and few know how to distinguish real experts. Investors, like consumers of other services, are at risk from this process.
The larger discussions, from what constitutes a nutritious diet to what actions will best further U.S. interests, require conversations between ordinary citizens and experts. But increasingly, citizens don’t want to have those conversations. Rather, they want to weigh in and have their opinions treated with deep respect and their preferences honored not on the strength of their arguments or on the evidence they present but based on their feelings, emotions, and whatever stray information they may have picked up here or there along the way.
And this …
Experts can be defined loosely as people who have mastered the specialized skills and bodies of knowledge relevant to a particular occupation and who routinely rely on them in their daily work. Put another way, experts are the people who know considerably more about a given subject than the rest of us, and to whom we usually turn for education or advice on that topic. They don’t know everything, and they’re not always right, but they constitute an authoritative minority whose views on a topic are more likely to be right than those of the public at large.
Technological optimists will argue that these objections are just so much old-think, a relic of how things used to be done, and unnecessary now because people can tap directly into the so-called wisdom of crowds. It is true that the aggregated judgments of large groups of ordinary people sometimes produce better results than the judgments of any individual, even a specialist. This is because the aggregation process helps wash out a lot of random misperception, confirmation bias, and the like. Yet not everything is amenable to the vote of a crowd. Understanding how a virus is transmitted from one human being to another is not the same thing as guessing the number of jellybeans in a glass jar. And as the comedian John Oliver has pointed out, you don’t need to gather opinions on a fact: “You might as well have a poll asking, ‘Which number is bigger, 15 or 5?’ or ‘Do owls exist?’ or ‘Are there hats?'”
Moreover, the whole point of the wisdom of crowds is that the members of the crowd supposedly bring to bear various independent opinions on any given topic. In fact, however, the Internet tends to generate communities of the like-minded, groups dedicated to confirming their own preexisting beliefs rather than challenging them. And social media only amplifies this echo chamber, miring millions of Americans in their own political and intellectual biases.
If you read the entire essay, you will see many connections to the current investment world. Anyone who understands these principles will be much better prepared for the market twists and turns we all expect in the next few years.
I suggest investors join me in reading selections from the first-rate Seeking Alpha Positioning for 2018 series. There are many good ideas.
Eddy Elfenbein discusses the changes in his highly-followed annual buy list (along with the expected useful advice on the market).
Peter F. Way uses his unique market-maker analysis to evaluate money center banks. PNC?
Interested in closed-end funds? The Stanford Chemist analyzes and curates information from this space. There are many anomalies and special situations to exploit.
Double-Dividend Stocks highlights a mid-stream LP with good yield and payout coverage.
Colorado Wealth Management highlights Simon Property Group (SPG), “arguably the best mall REIT.”
Todd Sullivan sees higher oil prices and also features “Davidson” with an endorsement of some energy stocks.
Morningstar has 32 undervalued stocks by sector.
Alan Steel takes up a number of investor traps using a clever analogy. Those who have been reading his commentary have been both entertained and enlightened (and improved their investment results). He begins:
It seems to me that there’s a big financial world out there that’s just bursting with assumptions, eh?
You’d think a process essentially governed by maths and how they’re engineered would be less prone to fantastical imaginations, marketing prose and correlations of the strangest (and often stupidest) kinds.
One example: “Did concerns over the Gaza strip really keep Joe investor from going out to dinner and a movie and thereby reduce GDP by 0.3% last quarter?”
Seeking Alpha Senior Editor Gil Weinreich continues his excellent series. It is helpful both for investors and advisors. This week included several great entries, but I must confess. My favorite was his “Are You an Astute Investor?” which included some kind words for me. As usual, Gil grasps and conveys the key points from the work he cites. My lessons for investors from quarterbacks is intended to help people prepare at a time of calm rather than waiting until it is too late. I am delighted that he provided some extra visibility on a topic that, unfortunately, may not be on the agenda of most. The quarterback part may be of greater interest, partly thanks to Mrs. OldProf, a regular viewer of NFL Matchup.
Watch out for
The Bitcoin space. Fool’s gold, says Blue Harbinger who goes on to cite several sound yield plays. The criminal underworld is dropping Bitcoin? A company changes its name to include “blockchain” along iced tea, and the stock soars 300%. But perhaps a “legitimate blockchain play?” Can it be combined with marijuana?
FAANG stocks. Barron’s notes the risk after the recent surge and identifies funds with high concentrations in the highly valued names.
Inflation “assisted” plays. The Fear and Greed Trader advises patience.
A cautionary note. It’s not wise to load up on these inflation-assisted groups now. While we are being told that inflation risks are elevated, that doesn’t mean they have to occur to the extent that suggest being wildly overweight these groups. Proceeding slowly by adding some exposure now to these sectors is wise. Then it will be time to assess and reassess as the situation develops. Same with dumping Technology just because the stocks have had good runs with the belief they could stumble in 2018.
Here are my own conclusions about inflation.
- We will see it eventually, but not quite yet. The key elements are starting to show, but it could easily take another year.
- The Fed response.
- The Fed prefers core readings (less volatile and more reflective of something they can control) and the PCE deflator (less emphasis on housing) to the CPI or PPI. The latter two run “hotter” than the PCE.
- The Fed does not view 2%, by itself, as a terminal point. Various statements have suggested that variation up to 2.5% might be accepted to make sure that the economy was back on track.
- With a new Fed Chair and other new appointments, we do not know if these preferences are still in place.
- If history is a guide, the Fed will be too late to act, move too far, and start another recession.
- The yield curve. The recent interest in yield curve slope as a recession indicator includes many waiting with bated breath – hoping to be among the first to predict a recession.
- For the slope to flatten, we would need to see an increase in short-term rates without a similar increase in the long end of the curve. I expect inflation expectations and stronger economic growth to send long-term rates higher. The same factors will stimulate Fed action centered on the short end.
- The yield curve gives a healthy warning of a recession. One does not need to jump the gun by guessing how the curve will react.
- There are other important components to recession forecasting, as I review every week.
- Inflation is not all bad.
- In the short term, borrowers are helped a bit and lenders are hurt. Savers and retirees get a boost in cash flow.
- Tighter labor markets are a key. If we start to see wage inflation, it is likely to spread. But – it also will strengthen the economy.
The biggest mistakes people make about inflation are assuming it occurs without any accompanying economic changes, expecting this to be the only Fed focus, and using their personal experience to opine about overall levels.
[Do the economic challenges seem complicated and threatening? Need a year-end tune up for your portfolio? This is the time to schedule a free consultation, read my paper on the top investor pitfalls, or both. If you are concerned about major declines, you might be interested in my paper on risk. Just write for our free information on these topics. While they describe what I am doing, the do-it-yourself investor can apply the same principles. Both the concepts on recessions and how we used it to forecast Dow 20K are available for free from main at newarc dot com].