January 2013 Index

February 21, 2013

Inflationary Expectations: When Inflation Picks Up, What Prices Will You Care About Most?

Inflation in the U.S. remains subdued. Consumer Prices (as measured by the current Bureau of Labor Statistics’ consumer basket), was up only 1.7 percent in 2012. Meanwhile, prices at the wholesale level, often referred to as Producer Prices were up only about 1.4 percent for the year. In short, the government’s measures paint a benign picture on prices. The low inflation data allows the Fed to keep interest rates near zero, and gives the Fed latitude to continue to stimulate the economy through asset purchases. Their current asset purchase programs effectively print 85 billion dollars each month.

This newly-printed money finds its way into the financial system, asset markets, and commodities. Eventually its effects show up in the prices of items that people purchase every day. In calculating consumer prices, the Bureau of Labor Statistics (BLS) classifies consumer expenditures into more than 200 categories. According to the BLS’s website, these categories are arranged into the following eight major groups, and it highlights some of the components as follows:

FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)

HOUSING (rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture)

APPAREL (men’s shirts and sweaters, women’s dresses, jewelry)

TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)

MEDICAL CARE (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)

RECREATION (televisions, toys, pets and pet products, sports equipment, admissions)

EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories)

OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

The BLS also makes periodic changes to what is in the representative basket and what weights are used. As of July 2012, the basket looked like this:

Often People Complain that Prices are Going up Faster than the Government’s Inflation Statistics Suggest

We maintain that the frequent adjusting and seasonal smoothing within the data serves to understate the rising cost of living. Obviously, not all of the components within the consumer basket carry the same degree of importance. In the Guild Basic Needs IndexTM (GBNI), we focus on certain food, clothing, shelter, and energy items that are being consumed by Americans every minute of every day. In our view, basic, essential needs are not subject to preference or fashion. We believe tracking the rising costs of these items is perhaps more important than following the prices of a consumer basket filled with non-essential items, and is adjusted and manipulated frequently.

Plotting the prices of the components within the GBNI may lead to a more volatile chart (see our charts below), however tracking them can help one understanding the fundamental trends that underlie economic decisions made by people every day.

Household Income and the Cost of Living

When income doesn’t keep up with rising prices, the standard of living falls and behaviors change. Investors should pay attention. In our research, the cost of basic needs is rising much faster than incomes. The shrinking difference between the two represents money that is available for households’ discretionary spending, savings, and investment. We also argue that this shrinking pool of savings and investment capital at the household level is one of the reasons the Federal Reserve is inclined to keep printing nearly a trillion dollars per year.

Investors can follow the changes in prices of basic, essential needs in our letters and at www.gbni.info. After all, the cost of living will have an impact on investment and asset markets.

February 7, 2013

Speaking of Understating Inflation…

In our opinion, the inflation rate is understated by the officials in many countries, not just Argentina. In the U.S. inflation as measured by headline CPI is still near historically trough levels. In the 35 years since 1977, the U.S. median 12-month rolling inflation rate in the U.S. has been about 3.3 percent. The monthly data point has spent the vast majority of these past 35 years between 2.3 percent and 4.3 percent. The current official 12-month trailing headline inflation rate is only about 1.7 percent. Most people who buy things in the U.S. will tell you that prices are going up faster than 1.7 percent. Regardless of what the real number is, it is lower than normal.

Investors and Consumers Should Not Get Too Comfortable with the Current Lower-than-Historical Inflation Rates

It is no secret that the Federal Reserve would prefer a higher rate of inflation. Its various QE programs are designed to influence the CPI along with the economy. The Fed’s current program of $85 billion per month of bond and asset purchases will eventually have an effect on prices… asset prices, commodity prices, and other prices. All prices may move higher, but of course they will not move at the same pace. For example, the prices of necessities can be expected to rise faster than that of many discretionary items. We also expect these prices to begin to elevate sooner. The Guild Basic Needs IndexTM (GBNI) tracks the prices of certain food, clothing, shelter, and energy components; therefore we expect it can give our readers an advance warning as to when headline inflation will turn higher. Since 2000, you can see in the charts below that basic essential needs have been more volatile, but have also more than doubled the government’s official inflation rate.

There Are Ways to Protect Yourself from Coming Price Increases

So, assuming you are reading our letters and notice a prolonged upward move in the prices of basic essential needs in the GBNI, what are you to do? First of all recognize that your investment portfolio needs to have assets that can appreciate to protect your purchasing power. If you have not already done so, reduce investors’ cash savings and bond allocations; these will not be able to keep up. In the case of bonds, not only will they not keep up, they will hurt your real net worth. Global stocks, gold, commodities, real estate, and well-managed currencies should be bought and your bond allocations should be reduced.