Finagling
the CPI; S&P 500 at New High with Ultra Complacency
By Victor Sperandeo
with the Curmudgeon
CPI Forecasts:
Wall Street correctly believes that inflation is a critical factor which moves markets. Therefore, it’s keenly focused on the CPI rate of change which will be reported his Tuesday, February 13th by the BLS. Here’s what to expect:
- Forecasters recently surveyed by the Federal Reserve Bank of Philadelphia expect current-quarter headline CPI inflation to average 2.5% at an annual rate, down from their prediction of 2.8% in the previous survey.
- Economists polled by The Wall Street Journal forecast a mild 0.2% increase in consumer prices in January 2024. The inflation rate in the past 12 months would decelerate to 2.9% from the prior 3.4%.
- A firm known as “Truflation” [1.] claims they offer a more reliable view of inflation, contrasting with U.S. government (i.e. BLS) metrics that have outdated methodologies and limited transparency. With over 10 million data points, it updates daily and has a dynamic methodology that responds to global market conditions. As of February 11th, Truflation’s one year inflation rate is 1.35% vs the BLS reported rate of 3.4%. For the first seven days of February, Truflation averaged only 1.41%.
Note 1. Truflation has a 97% correlation to the CPI since 2012, according to a tweet by Danielle DiMartino Booth. The Curmudgeon could not find any other evidence that Truflation’s block chain-based inflation calculations were accurate or correlated with the CPI. Here’s a graph showing the Truflation rate for the last 12 months:
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Victor: Recently, Fed Chair Jerome Powell said he needs more confidence to lower rates. Perhaps he should look at the Truflation Index for added confidence that the CPI is trending down.
CPI Calculation Emphasizes Shelter:
Wall Street certainly knows that inflation is trending down, but reality has nothing to do with U.S. government statistics. Here’s one example.
The CPI is heavily weighted to shelter, which makes up about 30% of the value of the basket of goods used by the BLS to calculate the CPI. Shelter uses a “Medicine Man” statistic called “Owners’ Equivalent Rent (OER),” which is the amount of rent that a homeowner would be paid if they were renting out their own home in the market. It accounts for 23~24% of the CPI and is calculated by splitting the non-recurring cost of buying a home real estate into rental payments. increases.
This is a uniquely subjective and even outrageous way to measure rent increases. It can be made up to be anything the BLS desires. Victor thinks that the shelter calculation and weighting keeps the CPI higher than it really is.
Victor also believes that OER allows the Fed to coordinate with BLS to do whatever it wishes on short term interest rates. It is a major “control” mechanism of how government can do whatever they wish to affect the politics and people of the U.S.
S&P Makes All Time High:
The S&P 500 is certainly discounting a lower CPI number, closing up the last four consecutive trading days and at an all-time high of 5,027 as of Friday. The S&P closed higher for 14 of the last 15 weeks, which hasn’t occurred since 1972. According to Barron’s, the S&P 52-week trailing P/E is 27.28 vs 21.86 one year ago. At 20.4, its forward P/E is discounting significantly higher earnings in a very uncertain environment.
Complacency Reigns Supreme:
Complacency can be seen everywhere in the markets. The CBOE volatility index (VIX) is at 12.8 vs its 20 year average of 17.7 and down from 21.7 on October 20th, junk bond credit spreads are at an all-time low, and the U.S. tech stock sector is worth a third of the total U.S. equity market which topped the previous peak in July 2000 at the height of the dot com boom (source: Barron’s Feb 12, 2023 print edition).
Market breadth has been lagging and breadth oscillators are on sell signals. This has been the case even with the S&P 500 at new all-time highs. A related indicator, Cumulative Volume Breadth, is also showing a negative divergence with the S&P 500. But the beat goes on and the music hasn’t stopped playing yet.
Victor’s Short Story:
Here’s the story of an actual trade I was personally involved in on the long side of stocks in mid-1985. The market was booming due to strong earnings resulting from President Reagan tax cuts, with very bullish momentum due to his pro-business policies. Inflation had declined from 8.92% in 1981 to 3.83% in 1982, 3.79% in 1983, 3.96% in 1984, and 3.80% in 1985. That was largely due to the Reagan administration switching from “monetizing the debt” in the 1970’s (via “printing money”) to U.S. government borrowing to fund large federal budget deficits.
In June 1985, with GDP running at + 4.2%, the Fed called an unscheduled FOMC conference, where it said it would be raising the Fed Funds rate due to a decline in the Capacity Utilization Rate. That excuse was never used before or since! It caused the S&P to decline for several months, and my stock market gains evaporated.
Curmudgeon Comment and Analysis:
In 1985, the Paul Volker led Fed targeted the money supply (M1 and M2), rather than announcing changes in the Fed Funds rate at FOMC meetings. There is a discrepancy between the monthly Fed Funds rate (%) reported by the St. Louis Fed (effective Fed Funds rate) and the FDIC (Fed Funds Target Rate) in 1985:
· St Louis Fed: June 7.53, July 7.88, August 7.90, September 7.92
· FDIC: June 7.75, July 7.75, August 7.88, September 8.0
The official
account of ALL FOMC meetings in 1985 is reported here.
On June 18, 1985, the Federal Reserve reported that the capacity utilization rate dropped 0.4% in May to 80.3%. It was the fifth decline in the last six months. According to the Federal Reserve official website, the Fed Funds rate was: cut by 50bps to 7.75% on May 20, 1985; ranged from 7.58 to 7.75% in mid-July, 1985; was 8% on September 6, 1985; and 7.75% on December 18. 1985.
Victor’s Conclusions:
The BLS calculation of the CPI is absurdly subjective. The bottom line is the Fed can make up any excuse to accomplish their agenda and we are all pawns in this game.
End Quote – a Thought to Ponder:
“There are two ways to be fooled. One is to believe what isn't true; the other is to refuse to believe what is true.”
Soren Kierkegaard was a Danish theologian, philosopher, poet, social critic, and religious author who is widely considered to be the first existentialist philosopher.
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Success, good health, and good luck. Till next time……..
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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