The US Bureau of Labor Statistics released its monthly data, stating that the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.3 % in November on a seasonally adjusted basis, after rising 0.4% in October.
Despite historically low unemployment coupled with tariffs on Chinese imports, this signals that inflation remains in check.
American households paid more for energy, food, rent, and healthcare in November.
Source: US Department of Labor
The Energy Index
The price of gasoline increased by 1.1%, and the other major energy component indexes also increased 0.8% in November. Other major energy categories also saw an increase, with electricity edging up 0.3% and natural gas increasing 1.1%.
Over the past 12 months, the energy index has decreased 0.6%. Gasoline prices declined 1.2% over the past year, and the fuel oil index fell 6.7% over the past 12 months. Conversely, the natural gas index rose 1.1% and the electricity index increased 0.5% over the year.
The Food Index
Food prices edged up 0.1%, rising for a third straight month, with the categories for both food at home and food away from home both increasing over November.
Food at home increased 0.1%, after seeing a 0.3% increase in October. Likewise, the food away from home index increased 0.2%.
Over the last 12 months, the food at home index increased 1.0%. The food away from home category also increased 3.2% over the past 12 months.
Source: US Department of Labor
All Items Less Food And Energy
The shelter index rose 0.3% in November. The index for rent also rose 0.3%, while the index for owners’ equivalent rent increased 0.2% over the month. Over the past 12 months, the index for shelter has increased 3.3%. The medical care index increased 0.3 percent. Over the past year, the index for medical care rose 4.2%.
Overall, the index for all items less food and energy rose 2.3% over the past 12 months.
Inflation is a general increase in the price of goods and services, and decrease in the purchasing value of a currency – essentially, it is measuring the temperature of the economy of a country. In addition to the broader implications of inflation on the economy of a country, it also affects one’s personal finances. Inflation is measured by the consumer price index (CPI). The CPI reflects the value changes in a basket of consumer goods and services, which are often adjusted to factor consumption patterns of the average consumer. Yet many people don’t consider the impact of inflation on future financial planning, seeing as the average American doesn’t keep up with inflation. It is something that should always be taken into account, especially when it comes to investments that will provide retirement income. Here are the 4 effects of inflation on your personal finances.
(Source: The Bureau of Labor Statistics)
The Effects Of Inflation On Your Savings
Inflation affects specific aspects of one’s personal finances differently. One area that is perhaps most susceptible to inflation are cash investments like a savings account. Because money is readily accessible, some people prefer to keep it in a savings account rather than invest it. Yet, as time passes, the value of money kept in a savings account can lose its value, considering that prices generally increase in the future. What you could purchase with $20,000 25 years ago, isn’t the same as the value of $20,000 today in 2019. In essence, the purchasing power of money may decrease while it sits in a savings account at a bank.
For instance, if a savings account contains $1,000 with an interest rate of 1%, by year’s end the account will have $1,010. If the rate of inflation is running at 2%, then there must be $1,020 in the account to have the same purchasing power that was started with. It’s important to remember, that interest gained in a savings account never keeps pace with the rate of inflation.
In essence, inflation will eat away at one’s purchasing power, because not only will the money lose value, it won’t gain anything either. This can be a cause for concern during retirement when you have less earning power. To protect the purchasing power of your savings from the rate of inflation, it would have to grow at or beyond the inflation rate. An effectual way to beat the effects of inflation on your savings is to invest some of those savings in the stock market.
The Impact Of Inflation On Stocks
Investing money in the stock market inevitably comes with a higher level of risk than simply keeping money in a savings account. Yet, as time passes, the stock market is expected to be able to handle or exceed the rate of inflation. Because of this fact, some investors prefer to invest their money in potentially higher growth investments like stocks. For those who prefer to avoid the volatility of individual stocks, another option is mutual funds, which usually provide good returns and are professionally managed. Furthermore, index funds might be an even better alternative for some, as they aren’t reliant on a fund manager, and follow their benchmark financial market index.
However, apropos of stocks, inflation still affects the value of the investment. The value of a stock is dependent on the performance of a company. When the economy is strong, inflation is usually high. During these periods, a company may have increased revenue and earnings, which would help their share price. However, as inflation rises, the company would have a larger expenditure for things like wages or raw materials – thus, affecting the company’s value. Additionally, akin to any other return, the stock’s return value will decrease as purchasing power decreases over time.
1979 $10,000 Treasury Bond (Photo: Wikipedia)
The Effects Of Inflation On Bonds And Treasury Bills
Debt securities like bonds and Treasury bills are fixed-income assets that payout the same amount each year. These assets are not as affected by inflation as money in a savings account. However, when the rate of inflation increases faster than the return on debt securities, their value depreciates. Earnings diminish as purchasing power declines with the rate of inflation.
One option, especially for those in their retirement years, is Treasury Inflation-Protected Securities (also referred to as TIPS). These forms of inflation-protected bonds are indexed to inflation, therefore protecting investors from the adverse effects of increased prices.
Property Ownership And Inflation
Property ownership is perhaps the most beneficial during periods of high inflation. As inflation increases, so does the value of the property. If you have a fixed-rate mortgage on a property, then the cost of the monthly mortgage payments will decrease as time passes.
However, because most people purchase properties with mortgages, higher interest rates could dissuade people from increasing their debt-load. Therefore, the demand for property decreases, making it more difficult to resell.
(Photo: REUTERS/Carlo Allegri)
Warren Buffet And The Matter Of Inflation
Preeminent investor Warren Buffet has long been a leading authority on inflation, as he is both focused on and fearful of it. In fact, lest it be forgotten, that prior to the financial crisis of 2008, Buffet, the CEO and chairman of Berkshire Hathaway warned that inflation would cause a collective upset – which it did.
In 2010, after the world was wrestling with the effects of the financial crisis, Buffet wrote a “tongue in cheek” thank you note to the US government.
“We are following policies that unless changed will eventually lead to lots of inflation down the road,” Buffet stated on an op-ed.
In his classic piece for Fortune in 1977, aptly titled How Inflation Swindles the Equity Investor Buffet succinctly outlined his views about the effects of inflation on investors.
“It is no longer a secret that stocks, like bonds, do poorly in an inflationary environment. We have been in such an environment for most of the past decade, and it has indeed been a time of troubles for stocks. But the reasons for the stock market’s problems in this period are still imperfectly understood.
There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner. You hardly need a Ph.D. in economics to figure that one out.
It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might.”
Despite the fact that Buffet wrote this 42 years ago, certainly words of wisdom from an individual who is legendary for his investing prowess and sagacity pertaining to finance.
Planning For Inflation
Inflation is a financial component of life that cannot be avoided. However, there are things that can be done. Keep abreast of monthly inflation rates and CPI, via the Bureau of Labor Statistics release schedule. If inflation goes above the 3% level, it could be an indicator of worse things on the horizon. Factor in inflation when investment planning, especially with regards to fixed-income investments. Lastly, when planning for retirement, expect that the rate of inflation will be exponentially higher in the coming decades, rather than decreasing. Also, keep abreast of the market value of gold with a gold calculator. All are good ways to protect your personal finances from the possibility that the rate of inflation increases.
The Consumer Price Index (CPI) is one of the most oft used techniques for measuring inflation the world over. Specific countries scrutinize different sets of data, but all employ a similar method. In the US, there has been contention surrounding the CPI for many years now. Initially, it was calculated by contrasting a market basket of goods from two periods – effectively operating as a cost of goods index (COGI). Yet, under the auspices of the US Congress, the CPI eventually developed into a cost of living index (COLI). In addition, as time passed methodological changes occurred which often resulted in a lower CPI. In this article, experts weigh in and provide compelling insight into whether the Consumer Price Index is a valid metric for inflation.
A Better Measure Would Be “Chained CPI”
“The Consumer Price Index (CPI) has long served as the foundational inflation measure for economic activity. In fact, it underpins the health of an economy because a stable CPI measure indicates the opportunity for economic prosperity. Absent predictable CPI readings, consumers will not have an accurate signal about price expectations and may change their behavior in detriment to the economy as a whole.
One major limitation to the current CPI measure is its inability to incorporate decisions consumers might actually make when evaluating a fixed basket of goods. For example, when a price increases for one consumer product included in the selection of goods used to measure CPI, many consumers would choose to switch to a substitute. CPI doesn’t account for this reality. Instead, CPI assumes the consumer would simply pay more for the same product. Reality usually shows a different response in the form of choosing a substitute product.
Instead, a better measure which accounts for this substitution effect would be “chained CPI.” This more closely resembles the substitution decisions consumers would make in response to rising prices of certain items as opposed to simply paying more for the same good. This metric will capture the switching dynamic.”
Riley Adams, CPA, Youngandinvested.com
Not An Exact Reflection, But Gives A Good Feel For It
“The CPI isn’t an exact reflection of the inflation rate, but it gives us a good feel for it. For the consumer, it shows them the increase in the price of the most common items that people buy, so if this is what they want to know when it is perfect.
However, for anyone interested in a deeper look at the current inflation rate there are other factors to take into account. For example, the CPI is based on a fixed basket of goods rather than taking into account every single product available. So, it really comes down to the reason for wanting to understand this subject.”
Phillip Konchar, Head Tutor, My Trading Skills
CPI Is Likely The Best Measure
“The CPI is one of a few common economic indicators that attempts to measure the magnitude of price changes (inflation) in the economy. The CPI, as the name indicates focuses on the price changes experienced by consumers. There are better indicators if one is looking at price changes for producers
(Purchaser Price Index – PPI), imports and exports (Import/Export Price Indexes – MXP), or employment costs (Employment Cost Index – ECI).
One drawback of the CPI is the time lag associated with the basket of goods included within the CPI. The basket of goods is determined by surveys the Bureau of Labor Statistics conducts to understand what products consumers are purchasing. There is generally a lag of about three years from the survey to when the basket of goods used in the Index is updated. This can be meaningful as the items consumers are purchasing can change quickly, particularly with rapid change in technology or substituting one good for another.
One other consideration is that the CPI can be volatile as it includes volatile products such as the price of energy (gasoline and natural gas prices can be quite volatile) and food. The Federal Reserve prefers to use a core inflation metric that excludes these volatile goods. The core inflation index the Federal Reserve prefers is the Personal Consumption Expenditures Price Index published by the Bureau of Economic Analysis.
Overall, the CPI is likely the best measure of the change in prices that consumers actually experience within an economy.”
John Linton, Managing Member and Portfolio Manager, Elbert Capital Management
There are both benefits and issues surrounding the use of the CPI as an accurate measure for inflation. For instance, the basket of goods used for the CPI is based upon purchases from a “typical household”, which is not a representative sample of all households. Thus, it is not an exact science, as it were. Likewise, the CPI can overstate inflation if it factors goods and services that consumers are using less of due to price increases. Substitution influences the weighting on the market basket, consequently resulting in a lower CPI. In addition, the basket of goods does not always factor the expenditure of new products that people regularly use. Consumption trends take time to be accounted for.
In essence, we are faced with a decision: accept the official CPI numbers provided by the Bureau of Labor Statistics (BLS), or choose alternate measures of inflation, thereby embracing the argument that official figures are inaccurate. Ultimately, whether or not the Consumer Price Index is a valid metric for inflation remains to be seen.
U.S. consumer prices increased for the fifth consecutive month in June, led higher by a rebounding price of gasoline, although there was nothing in the latest release which should pose any immediate alarm for markets or consumers at large. The latest report from the BLS reported an overall increase in headline inflation of 0.3% month on month – an increase that was inline with nearly all economists polled prior to the announcement. Looking at the headline number on an annualized basis, inflation rose 0.1 percent In the 12 months through June, following an unchanged reading for the month of May.
Gasoline prices rose 3.4% month on month, following a 10.4 percent surge in May. Given the recent volatility in crude oil prices and inventory data in July, there could be scope for the influence of rising gas prices to subside in coming months. Oil is currently trading within the $50-60 / bbl range, well below the levels seen in May and June.
Core CPI, which excludes food and energy related costs, increased 0.2 percent month on month following a rise of 0.1% previously. On an annualized basis, core CPI has now risen 1.8 percent.The June reading continues to highlight just how tame the inflationary environment is within the US economy at present. The strong dollar is helping to keep a lid on inflation by reducing the price of imports and wholesale costs. The strong US dollar has been been spurred partly by a flight to safety due to concerns in Europe and China, and partly by the market’s anticipation of a Fed rate hike later this year. We should expect to start hearing comments regarding the damaging effects of the stronger dollar by Fed officials in the weeks and months ahead should this trend continue.
The food index posts largest increase since September 2014
The price of food increased 0.3% in June, largely to an ongoing shortage in wholesale eggs which has caused a sharp jump in retail egg prices across the nation. Egg prices jumped 18.3% in June, the largest monthly gain since August 1973. Elsewhere, the index for meats, poultry, fish, and eggs rose 1.4 percent in June, with the beef index rising 0.9 percent. Food prices are likely to remain elevated in the coming months as the aftermath of the bird flu epidemic works its way through the supply chain. Wholesale food costs have been consistently increasing in PPI surveys, and these costs are likely to make their way down to the consumer in the weeks and months ahead.
Medical Price Inflation starting to cool off
Medical related inflation cooled in June which will be a welcome deviation from the overall trend in 2015. The price for Medical Care Services fell -0.2% in June and the prices for Medical Care Commodities remained unchanged month on month. Health care costs have been one of the largest contributors to inflation over the past 12 months, with both indices rising 2.3 percent and 3.3 percent respectively.
Rent Prices continue to Climb Higher
The shelter index climbed 0.3% in June, and 3% on an annualized basis as the supply of housing continues to shrink in key regions. Rent increases are also amongst the largest contributors to overall inflation in the United States within the past 12 months.
Outlook for Rates
This month’s CPI data contains no surprises, and the relatively tame reading in the core number on the back of the strong US dollar will likely stick in the minds of Fed officials in the weeks ahead. Globally, sentiment continues to wane dramatically given the continued turmoil in Greece, and increasingly China. While Greece appears to be on the verge of some sort of political settlement, the headline risk remains. In China’s case, there is a very real danger of investor sentiment turning, which could spell disaster for emerging markets overall. Latin American and South East Asian markets look at particular risk, especially on the currency front. The fate of these regions would be sealed in no uncertain terms should the Fed raise rates, and it is for this reason that it appears increasingly unlikely that the Fed will raise by year end, despite all of their rhetoric and expressed intention to do so.
Deflationary signals are beginning to crop up all over the world and investors need to sit up and take notice of these trends to ensure their portfolios are positioned to effectively deal with the potential onset of such an environment. Deflation is characterized by slumping demand, slower growth, and decreased credit growth which lead to falling prices throughout the economy. There are several investment strategies to help investors during periods of deflationary stress – here are some of the most popular strategies available.
Cash is King
Cash is one of the sure fire investment strategies during the onset of a deflationary cycle. The old cliche “Cash is King” definitely holds its own in these situations. Deflation triggers a mass scramble for cash in anticipation of crashing prices and slumping demand. Its often said that “He who panics first panics best” and this is definitely true in an increasingly overcrowded investment landscape. Having physical cash on hand can be a life saver during extreme periods such as government debt defaults, bank failures and widespread credit market collapse. Having cash can help you remain liquid during tough economic conditions. It means you aren’t overspending on goods that will have lower prices in the future, and you will have capital on hand to buy discounted assets.
There is increasing concern about the value of fiat currencies globally and the unsustainable deficit and debt positions which most countries currently find themselves in. Many investors are turning to gold and precious metals in order to remain hedge against inflation and deflation – precious metals in this instance are acting like a currency and may also be of interest to certain investors.
Control Credit Risk with Municipal Bonds
Muni bonds generally have decent rates of return and are often backed by tax raising powers of the state or county issued – this leads to low default probabilities which is a highly sought after quality during periods of deflationary stress. Longer term bonds in general are a good investment strategy but you need to be careful about the credit ratings of certain companies. Companies which currently enjoy “A” rated debt securities can deteriorate quickly in a slow economy.
Avoid big ticket purchases
Large ticket items, especially if bought on credit like household goods, cars, trailers, and boats are unlikely to be wise purchases during the onset of a deflationary environment. Leverage as a general should be avoided during such periods. The problem with such purchases is that prices are likely to fall during an episode of deflation within the economy. This results in debt repayments on a depreciating asset over a potentially long time horizon. Under such a scenario you are effectively paying back dollars that are worth more than the ones you borrowed.
Paying off your existing debt can be one of the most important forms of investment during a periods of sustained deflation. As prices fall throughout the economy, the purchasing power of money increases which ultimately leads to your debt becoming more expensive. By increasing your debt repayments every month, you are effectively investing for the longer term by decreasing the value of your debt burden.
Invest in companies with large stockpiles of cash
The stock market is generally a place to avoid investing when facing the threat of an oncoming deflationary shock. Some stocks however will provide a level of security. Companies with large cash stockpiles are the most likely to benefit, as they face less pressure to deleverage. In a deflating environment such companies may be able to pick up cheap assets, as their competitors struggle with high debt burdens, solidifying their position within the market.
If history is any judge, stock markets tend to get hammered during the initial phases of a deflationary shock no matter how much cash or liquid assets they have on their books. With current stock market valuations at record highs, it’s unlikely that any stock would hold up to the violent selling pressure that a deflationary shock would create. The value of such stocks tend to come into their own during the second phase of a deflationary environment when the overall market has had time to adjust to the new economic realities, and rational investment allocation decisions begin to resume.
Overall, deflationary economic environments require investors to position their portfolios into more liquid, easily transferred securities. Deleveraging while there is still some semblance of market normality is often prudent as once a full scale deflationary spiral starts to unravel its often hard to avoid being caught up in increasingly irrational market moves.
The U.S. economy got a little economic boost today with a stronger-than-expected CPI reading for February, and a strong Purchasing Manager’s Index (PMI) that continued to project GDP growth.
Headline CPI and core CPI both came in 0.2% higher than January, as slight price hikes at the pump for refined products balanced out a general breather in the declines in some of the base commodities. The headline numbers had been tracking negative for the past three months, which everyone was pretty much ok with chalking up to crude oil. Just so long as GDP growth came in respectably, there wasn’t any reason to panic.
But core CPI (ex-food and energy costs) was already lagging behind Fed goals of around 2%, and already in the midst of sending deflationary ripples up the global goods chain, into…well, just about everything.
Muddled Waters for First Rate Hike
It’s created a tense chess match between investors and the Fed the past few weeks. It started just after the stellar (as in +295,000) February jobs report last month, when the consensus started to form that the Fed would have to act sooner rather than later in creating a interest rate normalization cycle.
The key first step of that cycle is getting us off the floor of zero percent rates – a stance that doesn’t befit a growing economy and presents what Yellen herself has called an “asymmetrical risk”.
U.S. Definitely Growing…But How Much?
Just as soon as we seemed to have some headway into a summer rate increase, nearly every economic indicator in the U.S. started been printing well below analyst estimates. In fact, the depth of our misses has hit a multi-year high, according to Bloomberg analysis:
In light of this reversal, both investors and the Fed have had to take stock of things. First quarter GDP estimates continue to be ratcheted down – from the 2.5% – 3.0% level I highlighted last month (a number that was freshly lowered at the time) to an average Q1 GDP estimate of about 1.5% today.
Cranky Markets are Volatile Markets
It’s why we’ve seen a spike in volatility around every asset class – fixed income, forex, commodities, and equities have all been bumping around trying to align their compass to the next clear trend line. Would the Fed remove “patient” in the March FOMC meeting? Was September the new June (for the first rate hike)? Was 2015 off the table entirely?
Answering these questions is challenging enough in isolation, but it’s been exacerbated by the stunning rise the the USD index, which alters true price action in commodities and long bonds. The surging U.S. dollar is a de facto rate hike. It lowers the cost of imports dramatically (a deflationary force), and it makes our exports more expensive overseas.
And while the realities of pricier U.S. exports certainly hurt some companies more than others, the simple fact is that close to 50% of the total revenues of the S&P 500 member companies is derived in a currency other than the U.S. dollar.
2014, Part Deux?
It’s quite astonishing how much the first quarter of this year is looking like the first quarter of last year. Tick by tick, indicator by indicator, we seem to be replicating that market environment.
This time last year we were watching interest rates hit new lows, but convinced the party had to end any moment – inflation was coming, and we needed to position ourselves away from fixed income and into equities, gold, and other commodities. Fixed income turned out to deliver stronger returns than even equities did.
GDP looked to be on track for a good start to the year, but then a bout of really bad whether caused us to actually contract as an economy in Q1. Most of the top analysts said “don’t worry, we’ll be strong in the back half of the year”, and sure enough we were. The U.S. turned in over 4.5% growth in the next two quarters.
Looking around today, it’s much the same setup – so far. The key differences between then and now are this:
1) the unemployment rate is lower than last year; we have clearly moved close enough to full unemployment in the Fed’s eyes that it’s no longer an impediment to a rate increase. That box is checked off.
2) the USD is much stronger (10-20% or more) against every major global currency. As I’ve discussed, this move alone is the equivalent of a 25-50 bps rate hike.
In fact, if the dollar hadn’t been zooming so hard the past six months, there’s a chance the Fed would’ve put a token 25bp hike out there last week. Instead, Yellen reminded us that the Fed isn’t there to make things easy for investors, saying the Fed “can’t provide and shouldn’t provide” certainly to markets when it comes to the timing of rate hikes.
We don’t seem to be in any danger of that.