Can Deflation Stop the Rally?

Will deflation doom stocks?  If prolonged logic dictates it will.  Lower cost = lower earnings = lower prices AND higher real rates = good alternative to stocks = lower valuations.  This is why looking at the latest CPI numbers it’s at least a tad concerning:

The chart shows disinflation and is getting worse -- see the arrow.  Currently inflation is running a little under 1%; thus, we are currently not in deflation, but disinflation.  An article in FT highlights the concern moving forward:

“’The lesson of the past, [CLSA], is that the three previous times the US rate of inflation dropped below 1 per cent since 1957 — 1998, 2001-02, and 2008-09 — stock market investors suffered significant losses.’ … 

In 2002, during the period when Ben Bernanke made his infamous helicopter money speech, stocks fell by almost a third after US inflation dropped below 1 per cent. 

Also, in 2008, inflation fell through that 1 percent line days before Lehman Brothers filed for bankruptcy.”

I decided to dig a bit deeper and put together my own data table – here.  I was looking for points in time when inflation for all items (there appeared to be little link between inflation ex. food and energy) was lower than both our current level of inflation and subsequent one year returns.  Here is the summary:

To me the data and subsequent analysis shows the following:

• First there is a small sample size, so certainly findings should be taken with a grain of salt.
• Returns are lower and the probability of a negative return over the next 12 months is elevated.
• But the lowest return, while large, still isn’t a bear market and I wouldn’t consider it catastrophic, especially with diversification and risk control.
• And there are still positive returns with some large ones even.
• What’s also interesting is the negative correlation (lower inflation number = higher forward returns), which on the surface seems counter intuitive…
• Until you take into account that as these numbers worsen the Fed will ease more and thus provide a bump to the markets.
• When you look at the 2009 data, this illustrates that.  The big fall in the market coincided with disinflation/deflation; however, once we fell below 1% the 12 month forward returns on the S&P were all positive.
• Thus, my view is even if disinflation persists, based on recent history the Fed will step up and pump up the inflation number, and subsequently the market.  Now if the Fed doesn’t step up or their efforts no longer work, then the risk of negative returns on stocks is elevated.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

The Inflation Concern

I am still not terribly worried about near-term inflation; although, I am paying more attention to the intermediate-term.  Many of the disinflation/deflation prognosticators I read regularly, who have been right, are changing their tune slightly, and this is causing me pause. Eventually we will transition from this disinflationary secular bear/range bound market to an inflationary secular bull. 

However, here is why nothing is imminent: until wages move, we won’t have inflation, and wages have been stagnant:

Second, if inflation does get out of hand an equity allocation should do quite nicely:

The charts indicate basically that inflation doesn’t appear to be a threat now, but if it does become one then stocks should help weather that storm.  One caveat is that inflation is the only thing in my opinion that will cause interest rates to rise (via the Fed), so that could have a near-term negative impact on stocks.

The views and opinions expressed in this blog are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  04/13

Inflation? Not Sold Yet

With gas prices high and food prices rising, many people are feeling the squeeze.  This begs the question: Is inflation a concern?  I say no, not yet at least, and the chart from the St. Louis Fed (via the Pragmatic Capitalist) illustrates why:

As the chart shows, essentially all prices outside gasoline are staying relatively flat.  While there has been a modest uptick as of late, as Paul Krugman points out, inflation is still way below trend. 

That isn’t to say inflation won’t eventually be a problem.  In fact, I have seen charts, given the recent move up, that demonstrate there could be higher inflation in the near future.  Still, given the small uptick in inflation, high unemployment, and lack of credit moving through the system, inflation should be relatively tame and I certainly assuage only a very small probability to hyperinflation.