DISINFLATION WITH A HIGHER RISK OF DEFLATION THAN INFLATION
David Rosenberg had some succinct thoughts on the continuing inflation/deflation debate this morning. He cuts right to the heart of the argument noting that, because end demand remains weak, we are still at a higher risk of deflation than inflation:
There is no more significant source of inflation than the U.S. labour market and we found out on Friday that total employment costs slowed to just +0.4% in Q3 and the YoY trend is extremely tame, at +1.9%. Wages came in at +0.3% sequentially and just +1.5% on a YoY basis.
We can understand the temptation to believe in the inflation story because of what the CRB index has been doing, but our advice is to resist that temptation and remember what we were talking about, quite unexpectedly by the way, six months after oil hit $140/bbl back in 2008. Deflation.
In many cases, pricing power is hard to achieve and so the bump in commodity costs serves as a margin squeeze as opposed to a sustained source of final stage inflation. For real-life examples as opposed to the data, what did the NYT have to say about Colgate’s profit results? This — “Colgate’s revenues in the United States, which produces 19% of its sales, grew 2%, while the company sold 3% more products. Price cuts reduced earnings in the United States by 1.5%.”
This is important because a lot of investors prefer to just look at commodities as evidence of impending U.S. inflation. This is partly misguided for several reasons. First of all, there are many variables influencing commodity prices at any given time. Currently, I would attribute the move in commodities to Asian strength (there is very real inflation in much of Asia ex-Japan), fears of U.S. “money printing” and the rise of the commodity investment class. Except for the case of “money printing” (which I believe is largely the result of misunderstanding how our monetary system works) there remains little worry of these variables influencing U.S. consumer inflation. As Mr. Rosenberg highlighted, there is only so much commodity price inflation that a weak U.S. consumer will allow (reference 2008).
The rise of the commodity investment class has largely created a hedging mechanism for investors and this component of the commodity price increase represents a “bet” that inflation is coming. Gold is generally the oft cited “inflation” hedge. But gold prices merely represent a “bet” and not necessarily a reality.
Perhaps the most interesting component in this debate is the margin compression story. Ultimately, because we are in a debt delevering cycle, a labor recovery will precede inflation in the U.S. With rising input costs margins are likely to become compressed. This will actually put downward pressure on inflation as corporations fight to sustain high margins and the labor markets suffer as a direct result. Therefore, I agree with Mr. Rosenberg and still believe we are living in a world of disinflation with a higher risk of deflation than inflation.
Source: Gluskin Sheff
Inflation: China and other emerging markets.
Deflation risk: US, Japan and other developed markets.
Critical point: inflation is too high in China that monetary policy has to be tightened dramatically.
Interesting aricale about Rosenberg;
Rosenberg said ECRI was predicting an 80% CHANCE OF RECESSION, the dreaded “double dip”. Clearly that was wrong. In fact, he is now so desperate that he uses as justification bearish bets some hedge funds have made that paid off. Really? I could have placed large bearish bets on the dollar and won big…..does that mean ECRI is right? Does it? Does it also signal “double dip”? Buying gold could be construed as a bearish bet, does that mean ECRI 80% recession prediction is right?
He also uses Ken Goldstein’s statement, “More than a year after the recession officially ended, the economy is slow and has no forward momentum. The LEI suggests little change in economic conditions through the holidays or the early months of 2011.” OK……”little change” … that means an economy growing (albeit slowly) will still be growing and no “double dip.” That certainly says ECRI’s 80% double dip scenario was wrong….ergo Rosenberg was wrong. He then uses the Fed’s hinted action as proof of his correctness. Here is the flaw in that logic. The Fed will always try to act when they see things slowing, especially in an election year. ANY prediction of recession MUST assume those actions will be taken. Recessions actually happen “in spite of” Fed efforts to stop it. If you are going to claim a recession, you must expect this and you cannot claim victory because it happens. If you actually thought the Fed would do nothing….well…..
So confident was Rosenberg that in August he took it a step further and said “we are in a depression”. This shows a stunning lack of knowledge of what The Depression actually was like…and yes, that was wrong also
He also called for a “negative GDP print in Q4″…… That will be wrong also…
Suffice it to say that there is probably a greater chance that profits go down than meet the consensus estimate, especially considering the deflationary shock out of Europe as well as the tremendous headwind for foreign-derived corporate earnings from the recent surge in the U.S. dollar. So from our lens, slapping on a 12x forward multiple on a range of corporate earnings of $60-75 leaves quite a bit of downside potential in a market that is still priced for too much growth, and 20% overvalued on a Shiller normalized real P/E basis.
So, lets just say it was all wrong? Q2 and Q3 earnings surpassed expectations and S&P earnings will be well ahead of the $60-$75 Rosenberg predicted (should be ~$80 or more). I’m not sure why we have to slap a 12X multiple on the S&P (maybe it just makes his case better??) when it has historically traded well above that.
When prognosticators begin to alter the definition and metrics for which their “predictions” are too be judged, beware. Rosenberg has gone from 80% chance of double dip to now essentially saying he was right because GDP slowed. That is like a sports predictor predicting “The Jets will win the Super Bowl” and then claiming he was right because “Well, they did not win the Super Bowl per se but they finished over .500.″ What the bears do is hold to these predictions until we eventually do have a recession (note: we ALWAYS will have them, they are part of the business cycle) and then do their victory lap.
If the Jets win the Super Bowl 5 years from now, would we let the sports prognosticator above run around and say he “predicted it.” No, we would skewer him for being wrong before and tell him he predicted nothing. OR, if he predicted the Jets would win it every year we would laugh at him with the old “a broken clock is right twice a day” saying. …..people ought to stop taking what he says as gospel and look at it far more critically.
Read more: http://www.businessinsider.com/rosenburg-wrong-about-double-dip-2010-10#ixzz143Wc6nzP
When Rosenberg mentions Tyler Durden as his reading source, he host every bit of credit worthiness, seriously. Rosenberg officially becomes a joke to me, I used to respect him a lot when he predicted ahead more than everybody that interest rate will be near 0% soon back in 2008(?). Now, he is desperately defending his disasterous market prediction.
“Inflation” and “deflation” are ambiguous terms. “Inflation” means a general nominal price rise relative to the nominal wage, depressing the real wage, and “deflation” means the opposite. But prices don’t rise and fall in unison, nor do wages. Therefore, perceptions are skewed by one’s vantage. Gold is a hedge against both inflation and instability.
Measuring inflation is a fine art, and there is a lot of room for interpretation in shaping the data. Determining net inflation/deflation is hardly straightforward. Moreover, the definition has shifted over the years, to that it is now difficult to see trends without taking the differences into consideration. It’s like the axe that George Washington used to chop down the cherry tree. It’s had seven new handles and three new heads, but it’s the “same” axe.
The term is so ambiguous that some serious people contend that it is possible to have both inflation and deflation at the same time, which is not possible economically. Moreover, there is only asset “appreciation,” never “asset inflation,” because assets are not included in the data and interpretations. Now that commodities are being treated as financial assets, what are we to say?
Inflation/deflation are largely in the eye of the beholder and the beholder is the Fed and the bond market, since they have the best data in the most timely fashion as well as the capacity for data processing and interpretation. The technocrati at the Fed are supposed to be able to divine the interest rate, whereas the bond market sets yields through price discovery in market equilibrium between supply and demand for financial assets of different maturities and risk levels. Clearly, the Fed and the bond markets are not concerned with inflation. Fed policy, prevailing rates and the flat yield curve show that those supposedly in the know are chiefly concerned with disinflation turning into deflation.
Moreover, with unemployment and underemployment stuck as historical highs with no relief in sight, talk of inflation or inflationary expectations is just silly. The Fed as been “printing money” as fast as it can to no avail, much to the consternation of the inflationistas. The US has slow growth and historically low inflation, which could tip over into deflation, especially in the case of a shock.
What is happening is a concerted attempt to depreciate the dollar relative to other currencies in order to improve the US trade position. That has been somewhat successful, and markets have taken this into account, perhaps overly so in light of the realities of global trade and currency.
it is a somewhat dissappointing day around here when you don’t have a comment…….also at mosler’s “the center of the world”
How is a depreciating dollar against other currencies not inflationary?
If we only bought products from the US?
I agree that inflation (prices), are remaining fairly flat at the retail level, at least as far as I can see.
Just wonderin’…
Sometimes Rosenberg is right, sometimes he’s wrong. Unlike the rest of us, I guess.
Kelly,
Hold your horses on selling Rosie’s predictions as being wrong. The only thing that has slowed down his predictions has been the Fed and the government’s willingness to throw away several trillion dollars to postpone the inevitable. Per one of the best bank analysts in America , that would be Chris Whalen, what we postponed will be hitting the gan in the 1st qtr of 2011. That would be several of our major banks going belly up and forcing the government to take them over a la 1980s and restructure them. This will be a major hit to the economy and I don’t think any rational person believes that it would not force a double dip or a new recession. The only part of this economy doing well is the stock market, and that is being done by Fed financing with our money. A total waste of our tax dollars to take care of the elite banks.
Someone should tell UPS there’s no inflation since they just raised prices…. again. Just like the post office did…. again. Less and less people are using the post office, yet they keep raising prices anyway.
It’s very easy to cherry pick lone data points and come to sweeping conclusions. For instance, I could say that house prices are falling again (40% of the average American’s monthly living expenses) and that that alone is deflationary.
Sure, there are inflationary components in this whole equation, but the final output is still pointing to very low levels of inflation….
Don’t housing prices hardly affect living expenses since only a small minority are currently buying houses and everyone underwater’s payments haven’t changed?
PS. My rent was just raised.
just about the only things left in the CPI are electronics and housing.
my house is worth 40% less, and you can buy my 2 yr old LCD TV for 30% less now
neither of these affects me not one bit.
beer, food and electricity are up 10%/yr. roughly…really…..these affect me.
and i’m waiting for the middle east to heat up again and there goes the fuel.