A Change in Inflation’s Momentum
By David Reavill
One of the critical skills for any investor, or anyone in finance, is to comprehend momentum. Where the markets are headed, in simplest terms, you don’t want to be bullish stocks are headed down (a bear market). And you don’t want to be short when stocks rise.
Having a feel for the direction and momentum of the markets is a skill developed over many years. The best I saw at this was William J. O’Neil, founder and publisher of Investor’s Business Daily. O’Neil would sometimes take out a full-page ad in his newspaper warning investors that the market looked to be topping, and they should watch out for a bear crash. On the other hand, he sometimes noted that the market was under-priced and likely headed higher—time to take advantage.
We paid attention to these calls because they were usually right on the money. O’Neil’s years of experience and knowing how to evaluate indicators (and the IBD Data was one of the most extensive market records in the country) allowed him to make the right call time after time.
Unfortunately, Mr. O’neil is retired, and I’m afraid we have few like him among the country’s policymakers. By and large, the country has replaced experienced practitioners, like O’Neil, with the academics we see most often from the Federal Reserve, Treasury, and other government agencies.
The financial markets are the most reliable and timely assembly of economic knowledge at any given time. And practitioners like O’Neil put their faith in the markets. Where investors put their capital on the line, making reasoned decisions on their capital allocation.
Academics, on the other hand, rely mainly upon the assembled data of the various agencies in Washington. Data that is always days or weeks behind, measuring what is past, not what is current.
Having academics in control leads to the trap we are in currently. Today, data from August or earlier in the year guides much of our economic decisions. And the economy continues to change rapidly. Our decision-makers, Fed and Treasury, look increasingly in their rear-view mirror.
If I were to ask O’Neil what he thought of Inflation, I’m sure he would say it’s dead, over, not to worry. Incidentally, that’s the same thing Professor Jeremy Seigel of the Wharton School has been saying lately.
Here’s where O’Neil and Seigel are looking. First, housing prices are down dramatically, as are the stock and commodities markets. These declines suggest that we are in a period of significant asset deflation, not Inflation. Overall, interest rate-sensitive assets are falling in price. The Fed’s policy of higher interest rates has already had its effect. Momentum has changed, and we’ve transitioned from a period of rising Inflation to falling Inflation.
The Consumer Price Index (CPI) confirms this decline in the current inflation rate. After peaking in June, the CPI decreased in the latest two reported months. Ditto with the price of gasoline and, to some extent, the cost of groceries.
None of these measures are where we’d like them to be. But it’s the direction we’re looking at, the momentum, and the Inflation Tide is going out.
At 1 pm, we will get the latest report on the Nation’s Money Supply. Money, the fundamental driver of Inflation, has been declining since March. And Professor Seigel thinks we will see another decline today. A lower money supply would make six declining months in a row. Something that hasn’t happened in 80 years in this country. Again another sign that the momentum is squarely running against Inflation.
So, real-time measures of the asset markets, real estate, and commodities are all declining—all indicating asset deflation, not Inflation. Finally, the CPI is falling, as is the money supply. All show lower, not higher, Inflation.
So what’s the harm if the Fed’s policy is too tight for a little too long?
The Federal Reserve’s primary mandate of stable prices requires it to steer a course down the middle. Indeed, we don’t want to veer into hyperinflation. However, we don’t want the Fed to crush the economy with overly restrictive interest rates. Rates that make it impossible for small businesses or individuals to obtain credit.
As we’ve pointed out several times on this podcast, we’ve just gone through an extraordinary financial cycle. Fed and Treasury pumped expanded the money supply at an unheard-of rate. Fortunately, that’s all behind us now. The money printing may have helped us out of the Covid Recession, but it also propelled us into this current Inflation.
Today, we need to ride this current inflation wave. Not to stop dead in our tracks.
Yes, we have Inflation. Yes, we can work our way out. But to do that requires calm guidance and a steady hand. Stay in the middle of monetary policy. Don’t swerve from nearly Zero Interest to the highest rates in the developed world.
In other words, the Fed needs to ease off the brakes before they shut this economy down.