Gov't is lying, there is Inflation - Rates will rise when Fed loses control!

[tooqk4u22]

See the BLS table https://www.bls.gov/news.release/cpi.t01.htm
 
CPI at 1.4% with food (at home and out) up 3.9%, good thing gas & oil are down 15%, apparel down 3.5% (no office attire), auto insurance down 4.8% (all those pandemic no drive discounts), and airfare down 18% (no shit, should be even lower).     Most of these things will likely not repeat going forward. 

Other indications of things to come:

One year performance of commodities:

Copper - up 27%
Corn (Corn) - up 13%
Soybeans (SOYB) - up 34%
Wheat (WEAT) - up 9%
Cotton (BAL) - up 10%

It goes on, but these will be cost inputs of things to come.   Sure, no inflation.   Good thing Owners Equivalent Rent is 25% of the index and only went up 2.2% (which is BS in actual increase but not really bc interest rates went way down so the expected monthly outlay only ticked up)

[lifeanon269]

Yes, CPI is a garbage indicator of inflation and has always been that way. It is highly manipulated. Further more, inflation is different for different people depending on what their needs are. Like you've shown, inflation hits different goods and commodities differently and depending on what someone wants or needs, inflation will have a different impact on their life. We live in a highly technical world now and many of the "goods" that people consume now are digital and therefore their overhead costs are extremely low and can be duplicated extremely easily. Therefore inflation will hit many of these goods negligibly. So if a person in life is largely just consuming these goods, inflation won't impact them much. But, if a person instead wishes to own scarce goods or services that are much harder to duplicate (real estate, equities, metals, art, etc, etc) there is very much real inflation taking place there that is well beyond what CPI indicates. You also have different rates of inflation based on where you are living, so I don't think it is fair to apply one single magic inflation number across the whole nation and have that capture accurately how inflation is hitting Americans.

There was also the Chapwood index which has come out that has shown much larger rates of inflation, but that also has its own questionable claims like CPI does. I feel there is likely inflation taking place somewhere between what CPI claims and what the Chapwood index is claiming.

In the end, I think it is naive to think that with all the money supply increases that have taken place over the last year as well as direct stimulus to citizens, that there won't be inflation at much larger rates than there has been historically.

[waltworks]

I've heard some variant of this for 20 years (or maybe longer) now. So far it hasn't happened. Could it? Sure.

But here's the thing, setting aside economy-destroying hyperinflation, it's not very hard to hedge against inflation risk. Just own some stocks, real estate, and if you're extra paranoid, some gold. Taking out a big mortgage is a good idea for other reasons but also makes a great inflation hedge.

So it's:
-Outside of my control
-Relatively easy to hedge against

Sounds like not something to worry about.

-W

[ChpBstrd]

CPI always has some categories that are high and some that are low. What exactly is being lied about if they break down all these categories for us?

Yes, the headline CPI number is for a basket of goods and services thought to reflect a mythical “average” consumer who doesn’t resemble you or me. That doesn’t make it “highly manipulated”, it’s the only way to create a relevant weighted average of all the categories. Those concerned about their personal experience of inflation, or trying to analyze how much of their spending increase comes from inflation vs. buying more things, can simply create a personal price index by categorizing their own spending and assigning their own weighted average to the categories.

Increasing commodity prices will certainly influence inflation. However labor expenses are a much bigger percentage of our grocery, clothing, housing, manufactured objects, etc. bill than raw materials, and then there’s the huge chunk of money we spend on services. If wage increases stay low, commodity prices can be volatile without a big effect on CPI - and that’s usually the case. Purchasers hedge so that they don’t have to whipsaw their prices as commodities fluctuate.

In 2019 when unemployment was <4% I worried about wage pressures, but I’m not concerned about that today, at 6.7%, which is where we were in 2013. Come to think of it, the price of copper, corn, wheat, cotton, and soybeans are all also at 2013 levels, so another narrative one could draw from these highly volatile data is that we’ve seen no commodity inflation in 8 years!

The final nail in the inflation coffin is the personal savings rate, which as recently as November was the highest seen since the early 1980s (12.9%). Those trillions of dollars flowing into savings and investments will reduce monetary velocity. This hunch is confirmed in the Fed’s measure of “velocity of m2 monetary stock” which remains at lows not seen in the history of the data series.

[lifeanon269]

CPI always has some categories that are high and some that are low. What exactly is being lied about if they break down all these categories for us?

Yes, the headline CPI number is for a basket of goods and services thought to reflect a mythical “average” consumer who doesn’t resemble you or me. That doesn’t make it “highly manipulated”, it’s the only way to create a relevant weighted average of all the categories. Those concerned about their personal experience of inflation, or trying to analyze how much of their spending increase comes from inflation vs. buying more things, can simply create a personal price index by categorizing their own spending and assigning their own weighted average to the categories.

Increasing commodity prices will certainly influence inflation. However labor expenses are a much bigger percentage of our grocery, clothing, housing, manufactured objects, etc. bill than raw materials, and then there’s the huge chunk of money we spend on services. If wage increases stay low, commodity prices can be volatile without a big effect on CPI - and that’s usually the case. Purchasers hedge so that they don’t have to whipsaw their prices as commodities fluctuate.

In 2019 when unemployment was <4% I worried about wage pressures, but I’m not concerned about that today, at 6.7%, which is where we were in 2013. Come to think of it, the price of copper, corn, wheat, cotton, and soybeans are all also at 2013 levels, so another narrative one could draw from these highly volatile data is that we’ve seen no commodity inflation in 8 years!

The final nail in the inflation coffin is the personal savings rate, which as recently as November was the highest seen since the early 1980s (12.9%). Those trillions of dollars flowing into savings and investments will reduce monetary velocity. This hunch is confirmed in the Fed’s measure of “velocity of m2 monetary stock” which remains at lows not seen in the history of the data series.

CPI is not a price index of a basket of goods. It is more a cost of living index and the way they derive it is, IMO, suspect and inaccurate as a measure of actual real world inflation. Take how they measure housing costs, for example.

https://www.investopedia.com/articles/07/consumerpriceindex.asp

I also wouldn't put much weight into that "personal savings rate" as an indicator of future money velocity considering the fact that people's typical lifestyles have been locked down for the last year. So obviously their savings rate, without much else to spend money on at the moment, is going to be higher than it has been historically. I'm not sure how you can look at M2 money stock over the last year and say that there won't be an increase in inflation at some point. Especially considering that there has been a big increase in money flowing to citizens directly (obviously needed during the pandemic) as opposed to the QE that took place in 2008. Unless we see a massive spike in production and goods and services over the next several years, then I don't see how we'd avoid an increase in inflation. Maybe there will be a boom in green energy that propels the economy, IDK.

A very good read on monetary policy is this article by Lyn Alden:

https://www.lynalden.com/money-printing/

Also, I'm not saying that there isn't a way to hedge against inflation or protect yourself from it. But I also don't think inflation is good for the economy nor do I think the monetary policies that are common place around the world today are sustainable. I think inflation harms the lower class more than it does the upper class even when there isn't a large increase in the price of goods (which is really just a masking of monetary inflation through an increase in production).

[tooqk4u22]

I've heard some variant of this for 20 years (or maybe longer) now. So far it hasn't happened. Could it? Sure.

But here's the thing, setting aside economy-destroying hyperinflation, it's not very hard to hedge against inflation risk. Just own some stocks, real estate, and if you're extra paranoid, some gold. Taking out a big mortgage is a good idea for other reasons but also makes a great inflation hedge.

So it's:
-Outside of my control
-Relatively easy to hedge against

Sounds like not something to worry about.



-W

Fed has a dual mandate - inflation and employment.  Employment and inflation.  Employment sucks right now bc of of covid not because of economic stagnation outside of covid (retail, restaurants, travel, etc.) so low rates have no impact on this.  Part of their argument on low rates is that inflation is well below its target of 2%, which isn't really true overall (1.5%) but is completely aided by the categories above. 

I am not worried about runaway inflation but if inflation is currently and will likely run hotter than expected at 2-2.5% then 10 year will rise and that will have an impact on markets.  Add to that increased supply of treasuries due to forthcoming stimulus bills and possibly improving international trades the US growth trade could get stalled.

As for the mortgage argument, does it really make sense if you aren't 100% equities (i.e. any bonds/cash one has offsets the inflationary hedge of having a mortgage).?

[waltworks]

As for the mortgage argument, does it really make sense if you aren't 100% equities (i.e. any bonds/cash one has offsets the inflationary hedge of having a mortgage).?

You don't need to make it any more complex than:
-You can have a low fixed rate mortgage for 30 years thanks to gov't control of the mortgage market.
-That rate is, as of right now, about right at what historic inflation rates over the long term have been.
-If you expect higher inflation, your real cost to service the debt will decline, perhaps a lot, over 30 years.
-If you expect hyperinflation, you'll have a free house (assuming you can defend it from the zombies), just walk to the bank with your wheelbarrow of cash and settle up.

I've never been able to figure out the folks who are simultaneously worried about currency collapse/hyperinflation and want to pay off their mortgage/not carry any debt. If money is going to be worth nothing, I want to owe a lot of it!

-W

[ChpBstrd]

I'm not sure how you can look at M2 money stock over the last year and say that there won't be an increase in inflation at some point. Especially considering that there has been a big increase in money flowing to citizens directly (obviously needed during the pandemic) as opposed to the QE that took place in 2008. 

I was going to say look at M2 Monetary Stock vs. M2 Velocity of Money Stock and determine which one accurately predicted the past dozen years of stubbornly low inflation.

https://fred.stlouisfed.org/series/M2
https://fred.stlouisfed.org/series/M2V

But then I realized that if a person truly believes, like the economists cited in the Investopedia article, that inflation should be measured as 6-8% in years when CPI is quoted around 2% then the monetary stock metric might seem a closer fit. If inflation was actually running at, let's pick, 6% per year, it would be a big problem that hourly wages have gone up around 30% over the past 10 years because prices rose ((1.06^10)-1=) 79% in that same time. The population would be something like (1.79-1.3/1.3=) 38% poorer, not buying $1,000 iPhones. Are non-investment things 79% more expensive than in 2011?

https://fred.stlouisfed.org/series/AHETPI#0

[bacchi]

The MIT Billion Prices data closely matches the CPI through 2016, when they stopped publishing data. It did deviate in late 2013 but then aligned again, albeit at a slightly higher level.

http://www.thebillionpricesproject.com/

It did not, however, track housing or medical bills.

But for shit bought online, the CPI is pretty damn good.

[American GenX]

Yes, CPI is a garbage indicator of inflation and has always been that way. It is highly manipulated.

Yes, I've pointed this out multiple times myself.  Despite my frugal spending, my personal inflation is much higher than the government inflation figures (and there are different ones)  Government CPI figures are pretty much meaningless for my future spending projections.

Some of my biggest expenses:
Health insurance premiums up 62% this year with much higher out of pocket costs.
Property tax up about 7% every year.
Homeowners insurance up 7% about every year.
Car insurance fairly steady, but car is much older, so I'm paying the same for less coverage. (COVID discount was $5/six-months)
Also, state income tax rate up 65% since 2011 (on top of the inflationary effect from higher incomes).

The 4% rule is based on non-reality inflation figures from the government for calculating future inflation as used to calculate future "real" returns.

[PDXTabs]

But then I realized that if a person truly believes, like the economists cited in the Investopedia article, that inflation should be measured as 6-8% in years when CPI is quoted around 2% then the monetary stock metric might seem a closer fit. If inflation was actually running at, let's pick, 6% per year, it would be a big problem that hourly wages have gone up around 30% over the past 10 years because prices rose ((1.06^10)-1=) 79% in that same time. The population would be something like (1.79-1.3/1.3=) 38% poorer, not buying $1,000 iPhones. Are non-investment things 79% more expensive than in 2011?

100%

If inflation had really been 7% for the last decade plus there would be riots in the streets. I don't see riots, but I do see a bunch of 16 year-olds with phones that cost more than mine.

Animal Spirits did a great episode on this called Inflation Truthers. It's worth a listen.

[lifeanon269]

Inflation isn't hitting consumer products in the same way it is hitting scarce assets and commodities. If you have an original Van Gogh painting, the cost of that painting price/value of that painting is going to go way up with massive increases in the monetary supply that makes its way through the economy (not just QE). However, a manufacturer of copies of that painting that gets mass produced for consumers to purchase is not going to go up in price much under that same economy.

Price increases are not going to hit things like technology, computers, phones, TVs, digital services (very little overhead costs to produce), clothing, household goods, etc. The cost to produce those things goes down and they can all be mass produced easily. An increase in money supply isn't going to impact or raise the price of these goods since their production is inherently tied to economic expansion. The only way you'd ever see an massive increase in the cost of those goods is under a hyper-inflation scenario where the supply of money far surpasses the production of goods. We're nowhere close to that. But, I would not use "seeing a 16 yr old with an iPhone" as your benchmark for inflation.

Let's not even get into "shrinkflation" which we all know is very real too. lol

https://www.forbes.com/sites/perianneboring/2014/02/03/if-you-want-to-know-the-real-rate-of-inflation-dont-bother-with-the-cpi/

Long story short, the M2 money supply (inflation) was out of control this year and a ton of it went straight into citizen hands. Expecting that the velocity of this money is going to continue to stagnate as the economy recovers and thinking there won't be an increase in prices is naive, IMO.

[maizefolk]

Other indications of things to come:

One year performance of commodities:

Copper - up 27%
Corn (Corn) - up 13%
Soybeans (SOYB) - up 34%
Wheat (WEAT) - up 9%
Cotton (BAL) - up 10%

Aside from copper these are all agricultural commodities.

Corn was eight dollars a bushel in 2012. Today it's bouncing around a little over $5/bushel. And the reason it's back up that far is short supply. Do you remember hearing about the derecho that leveled cornfields all through Iowa? (Maybe not, it didn't get a huge amount of national play). Damaged close to 40M acres of corn, soybeans and wheat throughout the midwest. We just don't have as much corn and soybeans to go around this year, so prices have to rise.

[PDXTabs]

Classic maizefolk, posting about corn.

But yea, I never see anyone posting here about the horrible corn deflation of the last decade.

[waltworks]

Long story short, the M2 money supply (inflation) was out of control this year and a ton of it went straight into citizen hands. Expecting that the velocity of this money is going to continue to stagnate as the economy recovers and thinking there won't be an increase in prices is naive, IMO.

Well, sure, we handed out a half-month's worth of rent to everyone. But 10's of millions of people don't have any income from jobs right now, either. The actual numbers show people saving money more than usual, not spending it like mad. I guess eventually that could change, but I'd bet on deflation for a lot of goods rather than inflation in the medium term. We're an old country and getting older.

-W

[tsukuba]

I for one am concerned about the possibility of inflation.
2020, there were very few people worried about it
Now 2021, it made Fidelity's front page with product placements:
https://www.fidelity.com/learning-center/trading-investing/markets-sectors/2021-stock-market

From my point of view, there are supply chain problems associated with covid, some products are getting harder to come by.  Where available, the price goes up due to lack of supply.

The gov't is in full printing press mode.  Though I cannot quantify the effect, the handing out of free money is dissincentivizing people to work to some extent while feeding demand, not supply: double bad.

So I have been reading up what to do, web searching around
https://www.moneycrashers.com/investments-protect-against-inflation/
https://www.kiplinger.com/investing/601115/protect-your-portfolio-from-inflation
https://investorplace.com/2020/03/7-inflation-beating-reits-to-ground-your-income-portfolio/
https://seekingalpha.com/article/4178571-rethinking-inflation-3-ways-to-protect-your-portfolio

[waltworks]

Actually, a lot of people have been saying what you're saying for the last 20 years. Hell, Ron Paul has been predicting hyperinflation his whole life as far as I can tell, and he's 85.

The inflation concerns tend to spike when a democrat gets elected president. Time to buy gold and guns!

-W

[American GenX]

In the end, I think it is naive to think that with all the money supply increases that have taken place over the last year as well as direct stimulus to citizens, that there won't be inflation at much larger rates than there has been historically.

Of course, "true" inflation is already much higher than the government figures which are setup to downplay rising costs to Americans.

With these recent massive government stimuli, I expect to see inflation ramp up even further.  There's a lag, so it's not immediate, but we are going to see it really tick up.

And now, Biden wants to increase minimum wage to $15/hr across the country.  This will put many existing minimum wage increases on steroids and really hit small businesses when they are down (from the pandemic).  There's no common sense there.  This is the worst time to raise minimum wage, when many small businesses are already going under or hanging on by a thread.  They will need to raise prices to say afloat.  I've been seeing that in my own state which has had a few increased to minimum wage in recent years.  So if Biden gets his way,  that's yet another inflationary pressure on top of all the others, and on top of the higher "true" inflation we are seeing.

It's going to get ugly - high inflation, even higher "true" inflation.

[American GenX]

Alan Greenspan lists inflation and the budget deficit as his biggest concerns

https://www.cnbc.com/2020/09/10/alan-greenspan-lists-inflation-and-the-budget-deficit-as-his-biggest-concerns.html

[PDXTabs]

From my point of view, there are supply chain problems associated with covid, some products are getting harder to come by.  Where available, the price goes up due to lack of supply.

I do agree with this point. By reducing supply (or making the supply chain more expensive) during a round of fiscal and monetary stimulus we might see some real inflation. Because finally there will be increased dollars and no slack for additional production. But that wasn't really the assertion of the OP and it would be transitory.

[ChpBstrd]

The gov't is in full printing press mode.  Though I cannot quantify the effect, the handing out of free money is dissincentivizing people to work to some extent while feeding demand, not supply: double bad.

So I have been reading up what to do, web searching around
https://www.moneycrashers.com/investments-protect-against-inflation/
https://www.kiplinger.com/investing/601115/protect-your-portfolio-from-inflation
https://investorplace.com/2020/03/7-inflation-beating-reits-to-ground-your-income-portfolio/
https://seekingalpha.com/article/4178571-rethinking-inflation-3-ways-to-protect-your-portfolio

Not if the stimulus payments went into bitcoin!

Also, be very careful about two types of economic information known to be highly unreliable: 1) financial "journalism" and 2) social media.

[nereo]

Morgan Housel wrote an apt response to the OP's conviction back in 2012. 
Worth reading again here:
https://www.fool.com/investing/general/2012/03/13/the-cpi-is-a-conspiracy-or-maybe-you-just-dont-un.aspx

Interesting to note that there was rampant speculation that high inflation was imminent back in 2012 due to QE 1, 2, 3 and 4.  Contrary to predictions, inflation remained below historical levels of ~3%.  Will it spike above 3% now?  ::shrug::  A sustained period of ~3% might benefit a whole lot of people, while harming others.

[maizefolk]

Matt Yglesias' column this morning made what I thought was an interesting point which is that, even though inflation has been low for a long time, that's in part because of big relative price shifts (childcare, healthcare and education have increased much more than average, cars, computers, and other electronics have decreased in price significantly, while housing has basically just tracked inflation).

So people who have significant numbers of children, and so spend more of their total income on those first three categories have experienced more and more trouble being able to pay their bills and so are more likely to see official inflation as under stated, while people without fewer than average children or no children probably haven't even experienced the full headline inflation number, let alone more than the official number, and so it's really hard for us to understand how people can get sucked into the idea that inflation is being  understated.

But this disconnect would be equally present is "true" inflation were 0%, -3%, or 10%. It's not a question of inflation itself, it's that some people inherently have a lot more of their spending in categories where prices are growing faster and some people have less.

[Roland of Gilead]

We started building a house ourselves in 2020 and saw first hand the inflation in lumber, although hopefully it was a supply issue and not a long term reality.

OSB went from $7 a sheet to $30 a sheet (still at $21 a sheet for 7/16")

2x6 studs went from $5 each to $11

Maybe the prices will settle back down but if not, expect home prices to increase even more this year.

[MustacheAndaHalf]

The gov't is in full printing press mode.  Though I cannot quantify the effect, the handing out of free money is dissincentivizing people to work to some extent while feeding demand, not supply: double bad.

Correct me if I'm interpreting this wrong, but I think you're saying the Fed's printing of money will lead to a situation the Fed can't control?  If you definite high inflation as 2.5%, I don't think that's out of control.

"The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability."
https://www.federalreserve.gov/faqs/economy_14400.htm

There's also news articles saying the Fed plans to allow inflation above 2% to balance out low inflation.  Maybe that contradicts the thread title - the Fed would be happy to have inflation rise from 1.5% to 2.5%.

[nereo]

Maybe the prices will settle back down but if not, expect home prices to increase even more this year.

I've seen the same price spikes in lumber as we've been renovating our SFH.  But (honest question) what percentage of a new-home build is lumber or other raw materials currently seeing huge spikes due to supply constraints?  I'm guessing it's somewhere close to 10%.  What would that do to the final cost of a home selling for, say, $300k?

[PDXTabs]

Maybe the prices will settle back down but if not, expect home prices to increase even more this year.

I've seen the same price spikes in lumber as we've been renovating our SFH.  But (honest question) what percentage of a new-home build is lumber or other raw materials currently seeing huge spikes due to supply constraints?  I'm guessing it's somewhere close to 10%.  What would that do to the final cost of a home selling for, say, $300k?

As a random wild guess I'd imagine closer to 1/6th or the purchase price to be raw materials if you are in a high tax/fee/permit region and as much as 1/4 of the cost if you are in a low fee region, probably more if you land is particularly cheap.

EDITed to add - I think that basically all the raw materials are going up right now, and some random link: https://www.daveramsey.com/blog/how-much-does-it-cost-to-build-a-house

[thd7t]

We started building a house ourselves in 2020 and saw first hand the inflation in lumber, although hopefully it was a supply issue and not a long term reality.

OSB went from $7 a sheet to $30 a sheet (still at $21 a sheet for 7/16")

2x6 studs went from $5 each to $11

Maybe the prices will settle back down but if not, expect home prices to increase even more this year.

I work in the construction industry and receive quarterly reports on materials, their costs and their availability.  There were huge supply issues over the last year.  Most projections (I haven't seen the first quarter ones for this year) expected things to come back down late spring to early summer, but with the cost of lending being so low and demand from last year pent up, it may take longer.  However, this wasn't inflation driven.  There were just fewer materials available (for really obvious reasons).

[dang1]

https://yieldpro.com/2021/01/construction-materials-prices-edge-higher-as-lumber-rebounds/
prices of these items seem to be continuing their recent trend of growing at a rate that is slightly above the general rate of inflation in the economy

https://www.woodbusiness.ca/new-year-2021-starts-off-with-rising-lumber-prices/
indicators for future home building, and remodelling, are rosy. Macroeconomic conditions in the U.S. remain murky; however, there are two things that can be solidly stated even at this part of the year: one is that home builders are reporting difficulty in finding lots for purchase. The other is that there are challenges finding additional workers to hire.

https://www.cnbc.com/2020/12/30/inflation-is-poised-to-rear-its-head-in-2021-but-may-not-stick-around-long.html
“Several categories should bounce back from the direct and indirect disinflationary effects of the pandemic, including airfares, hotels, apparel, and financial services,” they added. “But the pandemic has also had temporary inflationary effects in categories such as used cars and medical services, and the full impact of a weaker economy on shelter and other slack-sensitive core services categories has probably not yet materialized.”
The Goldman team said only a “very tight labor market” would cause a sustainable inflation push that then would lead the Fed to raise rates, and that isn’t likely soon

[Telecaster]

I'm old enough to remember [kaff, wheeze] when there was actual inflation.  Prices on everything were going up all around you.  It was noticeable.  This is not like that.  Prices on some stuff have gone up.  Prices on other stuff have gone down. 

It stands to reason that printing lots of money would drive inflation up, but keep in mind also we have high unemployment, which pushes wages and prices down.   Absent other factors we shouldn't see significant inflation until employment returns to something like normal.  The Fed's main inflation fighting tool is interest rates.  Interest rates could go up a lot before they get to the averages we've seen in the last few decades. 

And you really believe we're in for some serious inflation, you may wish to access the greatest inflation hedging tool ever invented:  A 30-year fixed mortgage at 3.0% or less.   

[nereo]

And you really believe we're in for some serious inflation, you may wish to access the greatest inflation hedging tool ever invented:  A 30-year fixed mortgage at 3.0% or less.

To me, the hedge on inflation is one of the most important and underrated powers of the fixed 30y. Since it’s been 30+ years since we’ve seen a true, sustained inflationary spike we’ve collectively forgotten what it feels like, or what we can do individually to offset the effects.

[daverobev]

I believe the lumber inflation issue was because the US again called Canada the baddie and slapped tariffs on stuff, but again it was found that Canada wasn't doing anything bad...

https://www.bloomberg.com/news/articles/2020-07-06/a-forgotten-trade-spat-with-canada-is-costing-u-s-homebuilders

https://globalnews.ca/news/7482775/canada-us-softwood-lumber-duties-reduced/

[stoaX]

I'm old enough to remember [kaff, wheeze] when there was actual inflation.  Prices on everything were going up all around you.  It was noticeable.  This is not like that.  Prices on some stuff have gone up.  Prices on other stuff have gone down. 

It stands to reason that printing lots of money would drive inflation up, but keep in mind also we have high unemployment, which pushes wages and prices down.   Absent other factors we shouldn't see significant inflation until employment returns to something like normal.  The Fed's main inflation fighting tool is interest rates.  Interest rates could go up a lot before they get to the averages we've seen in the last few decades. 

And you really believe we're in for some serious inflation, you may wish to access the greatest inflation hedging tool ever invented:  A 30-year fixed mortgage at 3.0% or less.

I'm old enough to remember as well.  In the US from 1973 to 1983 or so saw rates of inflation at 6% or higher.  It was definitely a problem with wage increases lagging and retirees on fixed incomes suffering from it.

[ChpBstrd]

And you really believe we're in for some serious inflation, you may wish to access the greatest inflation hedging tool ever invented:  A 30-year fixed mortgage at 3.0% or less.

To me, the hedge on inflation is one of the most important and underrated powers of the fixed 30y. Since it’s been 30+ years since we’ve seen a true, sustained inflationary spike we’ve collectively forgotten what it feels like, or what we can do individually to offset the effects.

Of course, in today’s high valuation environment, low inflation is cited as justification for a CAPE of 34 for stocks, real estate prices at >10x incomes in some places, and of course trillions of dollars in treasuries yielding around 1% for the next decade, with corporate bonds not far behind. If the inflation winds ever shifted, the collapse of the everything bubble would create a major financial crisis.

One would not come out ahead by having mortgaged the house at 3% and plowing the proceeds into any kind of market asset. If inflation hits 5% anytime in the next decade, it would mean double digit losses for stocks, bonds, and RE.

TL;DR: There is no longer a way to hedge inflation with a mortgage due to valuations. We’re better off hedging with derivatives.

[waltworks]

CAPE 34 is still well within the zone of positive expected 10 year real returns, so actually, yes, you can still benefit from plowing RE equity into the market.

CAPE would need to be ~50 before you'd expect zero real returns on a 10 year horizon.

-W

[Telecaster]

Of course, in today’s high valuation environment, low inflation is cited as justification for a CAPE of 34 for stocks, real estate prices at >10x incomes in some places, and of course trillions of dollars in treasuries yielding around 1% for the next decade, with corporate bonds not far behind. If the inflation winds ever shifted, the collapse of the everything bubble would create a major financial crisis.

One would not come out ahead by having mortgaged the house at 3% and plowing the proceeds into any kind of market asset. If inflation hits 5% anytime in the next decade, it would mean double digit losses for stocks, bonds, and RE.

TL;DR: There is no longer a way to hedge inflation with a mortgage due to valuations. We’re better off hedging with derivatives.

Your mortgage doesn't know about the stock market.  If there is say, 7% inflation for 10 years, that effectively cuts your real mortgage payment in half.    To put it another way, you bought a house priced in fully valued dollars and you are paying it off in puny, inflation-ravaged dollars.   The mortgage interest rate is supposed to keep the dollars fully valued in the future.   But if inflation is higher than the mortgage rate, the mortgage becomes cheaper over time in real terms. 

[PDXTabs]

Of course, in today’s high valuation environment, low inflation is cited as justification for a CAPE of 34 for stocks, real estate prices at >10x incomes in some places, and of course trillions of dollars in treasuries yielding around 1% for the next decade, with corporate bonds not far behind. If the inflation winds ever shifted, the collapse of the everything bubble would create a major financial crisis.

One would not come out ahead by having mortgaged the house at 3% and plowing the proceeds into any kind of market asset. If inflation hits 5% anytime in the next decade, it would mean double digit losses for stocks, bonds, and RE.

TL;DR: There is no longer a way to hedge inflation with a mortgage due to valuations. We’re better off hedging with derivatives.

Your mortgage doesn't know about the stock market.  If there is say, 7% inflation for 10 years, that effectively cuts your real mortgage payment in half.    To put it another way, you bought a house priced in fully valued dollars and you are paying it off in puny, inflation-ravaged dollars.   The mortgage interest rate is supposed to keep the dollars fully valued in the future.   But if inflation is higher than the mortgage rate, the mortgage becomes cheaper over time in real terms.

Yea, but the purchase prices would go down if there was a sudden shock to rates. I still think that it is a good idea, but you could easily end up underwater for a while.

[kenmoremmm]

I believe the lumber inflation issue was because the US again called Canada the baddie and slapped tariffs on stuff, but again it was found that Canada wasn't doing anything bad...

https://www.bloomberg.com/news/articles/2020-07-06/a-forgotten-trade-spat-with-canada-is-costing-u-s-homebuilders

https://globalnews.ca/news/7482775/canada-us-softwood-lumber-duties-reduced/

IIRC, this guy (who works in lumber) has been all over the lumber prices and i believe the reason the prices spiked so high is that when the pandemic hit and lockdowns started, the lumber industry scaled back production b/c it thought demand would decrease. demand didn't decrease, and as a result, there is now a huge imbalance between supply/demand.
https://www.youtube.com/channel/UCkB8eF4ATHl4Jm1BeCZgQ9A

[ChpBstrd]

Of course, in today’s high valuation environment, low inflation is cited as justification for a CAPE of 34 for stocks, real estate prices at >10x incomes in some places, and of course trillions of dollars in treasuries yielding around 1% for the next decade, with corporate bonds not far behind. If the inflation winds ever shifted, the collapse of the everything bubble would create a major financial crisis.

One would not come out ahead by having mortgaged the house at 3% and plowing the proceeds into any kind of market asset. If inflation hits 5% anytime in the next decade, it would mean double digit losses for stocks, bonds, and RE.

TL;DR: There is no longer a way to hedge inflation with a mortgage due to valuations. We’re better off hedging with derivatives.

Your mortgage doesn't know about the stock market.  If there is say, 7% inflation for 10 years, that effectively cuts your real mortgage payment in half.    To put it another way, you bought a house priced in fully valued dollars and you are paying it off in puny, inflation-ravaged dollars.   The mortgage interest rate is supposed to keep the dollars fully valued in the future.   But if inflation is higher than the mortgage rate, the mortgage becomes cheaper over time in real terms.

One only gets the inflation-adjusted wage in the future if one is not retired in the future. Otherwise one is making mortgage payments with savings, whose value was decimated by inflation, or investments in stocks, bonds, etc, whose value was decimated by inflation. Yes, there’s a small COLA with Social Security, but we all know that won’t be big enough to do anything.

Really the best hedge against inflation is a commitment to work the entirety of one’s life, so that one’s salary increases to offset the increase in living expenses. The increase in living expenses could be smaller than the wage increase if one has a fixed mortgage OR a paid off house. These strategies can freeze some expense categories but the remaining ~75% of spending is vulnerable to increases. Additionally, committing to work one’s entire life is not a perfect hedge either, because wages can and often do fail to keep up with inflation.

People with their entire portfolios in rental properties might do well unless they need to refinance, remodel, or expand. This isn’t perfect either because rents can fail to keep up with the landlord’s living expenses among lots of other risks.

[maizefolk]

One only gets the inflation-adjusted wage in the future if one is not retired in the future. Otherwise one is making mortgage payments with savings, whose value was decimated by inflation, or investments in stocks, bonds, etc, whose value was decimated by inflation. Yes, there’s a small COLA with Social Security, but we all know that won’t be big enough to do anything.

Stocks tend to go down in high inflation environments because high inflation is bad for the economy. But unlike bonds and cash savings, stocks as an asset class also recover from inflation, in real terms.

[ChpBstrd]

One only gets the inflation-adjusted wage in the future if one is not retired in the future. Otherwise one is making mortgage payments with savings, whose value was decimated by inflation, or investments in stocks, bonds, etc, whose value was decimated by inflation. Yes, there’s a small COLA with Social Security, but we all know that won’t be big enough to do anything.

Stocks tend to go down in high inflation environments because high inflation is bad for the economy. But unlike bonds and cash savings, stocks as an asset class also recover from inflation, in real terms.

But do they recover when their starting point is a PE ratio in the mid 30’s (I.e. an earnings yield around 3%) that was only justified in a world of no good alternatives and a 1% ten year treasury yield?

Suppose in three years the risk-free rate is 5% like it was in the mid-2000’s, and there is a mere 2% risk premium added onto that for the stock earnings yield, as it is today. A 7% earnings yield would equate to a PE of (1/7=) 14.3. For the stock market to go from a PE of 35 to a PE of 14.3 while maintaining the same price, earnings would have to increase by 145%. And even then, after 3 years of the entire stock indices somehow growing their earnings an average of 40%+ per year, investors would still lose purchasing power because their returns were 0% nominal (and dividends were far less than inflation).

In 1970, on the cusp of a dozen years of high inflation, the S&P 500 had a PE of 15.76. That PE declined to 7.4 by 1980. The market only went slightly up in that time due to a dozen years of earnings growth making up for the halving of the PE ratio. Imagine if the PE in 1970 had been in the 30’s instead of the teens. Between 1/1/1970 and 1/1/1980 10y treasury rates rose by an entire 3%.

/camp fire ghost story

Inflation would be devastating if it happened, but I don’t think it can happen. The Fed’s balance sheet is too large to let it happen. They’d somehow have to avoid unwinding a decade of QE.

[maizefolk]

One only gets the inflation-adjusted wage in the future if one is not retired in the future. Otherwise one is making mortgage payments with savings, whose value was decimated by inflation, or investments in stocks, bonds, etc, whose value was decimated by inflation. Yes, there’s a small COLA with Social Security, but we all know that won’t be big enough to do anything.

Stocks tend to go down in high inflation environments because high inflation is bad for the economy. But unlike bonds and cash savings, stocks as an asset class also recover from inflation, in real terms.

But do they recover when their starting point is a PE ratio in the mid 30’s (I.e. an earnings yield around 3%) that was only justified in a world of no good alternatives and a 1% ten year treasury yield?

Suppose in three years the risk-free rate is 5% like it was in the mid-2000’s, and there is a mere 2% risk premium added onto that for the stock earnings yield, as it is today. A 7% earnings yield would equate to a PE of (1/7=) 14.3. For the stock market to go from a PE of 35 to a PE of 14.3 while maintaining the same price, earnings would have to increase by 145%. And even then, after 3 years of the entire stock indices somehow growing their earnings an average of 40%+ per year, investors would still lose purchasing power because their returns were 0% nominal (and dividends were far less than inflation).

If real interest rates are at 5% I agree that would drive stock prices down relative from where they are today (and frankly stock prices will go down at some point sooner or later regardless). If inflation goes up the interest rates will almost certainly go up in nominal terms but that doesn't necessarily mean they will go up in real terms. Both are valid discussions, I'd argue a discussion of what a change in real interest rates would do to stock prices is a separate one from what a change in inflation.

The key difference between stocks and bonds is that in the long term inflation grows corporate earnings in nominal terms, but erodes bond returns in real terms.

In 1970, on the cusp of a dozen years of high inflation, the S&P 500 had a PE of 15.76. That PE declined to 7.4 by 1980. The market only went slightly up in that time due to a dozen years of earnings growth making up for the halving of the PE ratio. Imagine if the PE in 1970 had been in the 30’s instead of the teens. Between 1/1/1970 and 1/1/1980 10y treasury rates rose by an entire 3%.

This is the danger of looking only at inflation adjusted numbers. Between 1/1/1970 and 12/31/1979 the S&P returned 5.8%/year in nominal terms. That's pretty explosive earnings growth (in nominal terms). If the PE ratios were cut in half in that same interval that equates to 13.3% earnings growth (in nominal terms) per year in the middle of a decade when the economy was a complete mess.

It's also worth noting that the federal funds rate was negative in real terms in seven of the 10 years of that decade.

[tooqk4u22]

One only gets the inflation-adjusted wage in the future if one is not retired in the future. Otherwise one is making mortgage payments with savings, whose value was decimated by inflation, or investments in stocks, bonds, etc, whose value was decimated by inflation. Yes, there’s a small COLA with Social Security, but we all know that won’t be big enough to do anything.

Stocks tend to go down in high inflation environments because high inflation is bad for the economy. But unlike bonds and cash savings, stocks as an asset class also recover from inflation, in real terms.

But do they recover when their starting point is a PE ratio in the mid 30’s (I.e. an earnings yield around 3%) that was only justified in a world of no good alternatives and a 1% ten year treasury yield?

Suppose in three years the risk-free rate is 5% like it was in the mid-2000’s, and there is a mere 2% risk premium added onto that for the stock earnings yield, as it is today. A 7% earnings yield would equate to a PE of (1/7=) 14.3. For the stock market to go from a PE of 35 to a PE of 14.3 while maintaining the same price, earnings would have to increase by 145%. And even then, after 3 years of the entire stock indices somehow growing their earnings an average of 40%+ per year, investors would still lose purchasing power because their returns were 0% nominal (and dividends were far less than inflation).

In 1970, on the cusp of a dozen years of high inflation, the S&P 500 had a PE of 15.76. That PE declined to 7.4 by 1980. The market only went slightly up in that time due to a dozen years of earnings growth making up for the halving of the PE ratio. Imagine if the PE in 1970 had been in the 30’s instead of the teens. Between 1/1/1970 and 1/1/1980 10y treasury rates rose by an entire 3%.

/camp fire ghost story

Inflation would be devastating if it happened, but I don’t think it can happen. The Fed’s balance sheet is too large to let it happen. They’d somehow have to avoid unwinding a decade of QE.

Yes.  Stocks can rise in a low interest rate environment with low or med inflation, stocks can also rise in a modest rate rising environment if inflation is also modest.  But the trouble is (and the reason for the OP) is when there is a disconnect between actual rates, expected rates and inflation which is where we are at/heading.  The FED is and will do everything it can to keep rates low, I mean its been doing it for over 10 years now (not to mention the other monetary and fiscal stimulus).   But if inflation starts coming in at 2-2.5% (core, not temporary - ie excluding supply/demand imbalances such as the lumber discussion due to a variety reasons) 10yr rates have to and will rise and the fed won't be able to do much about it and because they will play catch up it will cause market turbulence.   Not suggesting a melt down, just a bit of normalization/regression to the mean.   I am also not talking about hyperinflation, just normal inflation that may be higher than we have been accustomed with the backdrop of interest rates that are out of whack comparatively.   I don't see a 5% rate anytime soon or even medium term but I agree that would be catastrophic if it happened quickly.

So prior to covid the forward earnings estimates going into 2019 was I think $168, didn't happen.  Ended up being $141, 3% over 2018 and probably flat when factoring share buybacks.  Going into 2020 it was the same story, going to $168 - didn't happen for obvious reasons.  Now it is expected to get to a $160 run rate starting in 3Q 2021 - maybe, seems reasonable as its about 6% per year over 2019 numbers.   

So $160/$3850sp = 24 forward PE - not crazy.   So earnings have to be spot on and price can't rise anymore.  Add in a 1% increase in rates and you dial that back to a 20 PE which sucks but would bring it back to 2019 levels of $3200.

Aside from everything has to work out well, there is the potential for tax increases - remember that in 2018 the tax cut added about 16% to earnings. So a reversal would not be good.   

[ChpBstrd]

... the trouble is (and the reason for the OP) is when there is a disconnect between actual rates, expected rates and inflation which is where we are at/heading.  The FED is and will do everything it can to keep rates low, I mean its been doing it for over 10 years now (not to mention the other monetary and fiscal stimulus).   But if inflation starts coming in at 2-2.5% (core, not temporary - ie excluding supply/demand imbalances such as the lumber discussion due to a variety reasons) 10yr rates have to and will rise and the fed won't be able to do much about it and because they will play catch up it will cause market turbulence.   Not suggesting a melt down, just a bit of normalization/regression to the mean.   I am also not talking about hyperinflation, just normal inflation that may be higher than we have been accustomed with the backdrop of interest rates that are out of whack comparatively.   I don't see a 5% rate anytime soon or even medium term but I agree that would be catastrophic if it happened quickly.

Yes, in the 70's the Federal Reserve made a multi-year mistake of trying to keep rates low in order to not drive up unemployment. Therefore a disconnect appeared between too-low interest rates and inflation, and this just fueled the velocity of money (e.g. why keep your money in your savings account yielding 6% if inflation is 9%, buy something before your wealth evaporates!).

Here's why I think that won't necessarily happen again. The Federal Reserve has $7 Trillion of assets on its balance sheet. By comparison, M2 is currently $19 Trillion. I.e. 38% of all M2 can be yanked back by the Federal Reserve with the click of some buttons, and that gives them huge disinflationary power. If inflation comes in high, you can expect them to in effect withdraw money from the economy by selling assets to investors. A trillion or two would put the brakes on monetary velocity. Ten trillion or so means there are the means extinguish any fire. This could happen without a large effect on interest rates because it would only affect the money supply component of monetary velocity (i.e. inflation). So in this way, interest rates could remain below inflation without sparking further increases in inflation, like in the 70s, because money supply is simultaneously being yanked out of the market.

You alluded to valid concerns about the QT coming too-little-too-late, or being mismanaged for the sake of propping up unemployment or asset prices. I agree with these concerns and would like to see the Fed mechanize QT or at least articulate their parameters for when investors can expect QT to start. My biggest concern is an inflation blip to 3-4% that is not big enough to trigger a QT decision but is big enough to affect investors' willingness to pay 35x earnings for stock indexes, or loan their money for 1-2%. Experience shows these sagas play out over the course of years. However I'm staying invested because all the factors that led to disinflation in the 2010's - demographics, wealth inequality, high asset prices, insatiable foreign demand for dollars and liquidty - are still in place and we still look to be on a Japan circa 1992 economic trajectory - short term bumpy and long term flat for a long time.

[daverobev]

So what do people think about inflation linked bonds, or rate reset preferred shares, or anything else (other than stuff like gold... nothing against it but not what I'm interested in here) that explicitly links to some inflation rate?

I've got some Canadian rate-reset preferreds, thinking about putting some into European index-linked bonds... already have a nice fixed rate French mortgage for the next couple of decades.

[Telecaster]

So what do people think about inflation linked bonds, or rate reset preferred shares, or anything else (other than stuff like gold... nothing against it but not what I'm interested in here) that explicitly links to some inflation rate?

I've got some Canadian rate-reset preferreds, thinking about putting some into European index-linked bonds... already have a nice fixed rate French mortgage for the next couple of decades.

If you think there will be inflation in the future, then it is a great idea.  I have no idea about Canadian bonds, but TIPS in this country are extremely expensive right now.  But if inflation were to jump up to 7% or whatever you'd look smart in hindsight. 

[maizefolk]

So what do people think about inflation linked bonds, or rate reset preferred shares, or anything else (other than stuff like gold... nothing against it but not what I'm interested in here) that explicitly links to some inflation rate?

In the USA right now the interest rates on inflation linked bonds are negative (https://fred.stlouisfed.org/series/DFII10). The other thing to keep in mind about these is that you'll be paying your regular income tax rate on the changes in inflation-adjusted principal each year. That means if inflation really kicks in you're much less protected than it might initially seem.

If there is 10% inflation next year (just to make the math easier), and you have $100,000 in TIPs:

You'll be down $1,000 from negative interest.
You'll receive $10,000 of income from the inflation adjustment to your principal
You'll owe federal and state taxes on your $10,000 of income.
Let's say you're in the 22% federal tax bracket and an 8% income tax bracket at the state level.
So you own $2,200 in extra federal tax and $800 in state tax.

After the dust settles you have $100,000-$1000+$10,000-$2,200-$800 = $106,000 in next year dollars, which, after 10% inflation, is worth $96,363 in today's dollars.

If inflation is 20%, we can do the same math and you end up with $94,167 in today's dollars after a year. In either case you're better off than someone who bought a regular not inflation linked bond, but you're still losing a lot of money in after-tax dollars.

At least that's how I understand it. Someone who has either first hand experience or expertise in the tax system may be able to step in and tell me I've missed something important.

[daverobev]

Thanks for the replies - yeah I was aware that TIPs are negative return. I believe the EU version is the same (I mean, how could it not be with negative rates...).

I guess the best thing to do is leave it all alone. It isn't even a 'sleep well at night' thing, more 'I like looking at numbers and tinkering'. I am clearly not a genius, not smarter than the average when it comes to my investing let alone smart enough to predict what the future will hold.

[ChpBstrd]

If inflation rises, that means interest rates will eventually have to rise. That means the discount rate on stocks will increase, which means investors will be willing to pay lower multiples than they are willing to pay currently. So to restate the above, if inflation rises, stocks will go down.

For illustration, a 20-year stream of $100 payments has a present value of $1,805 at a 1% discount rate (=PV(0.01,20,-100)). If the discount rate changes from 1% to 2%, that stream of payments is worth 9.4% less. If the discount rate goes to 3% (still historically low) the present value drops another 9%, or a cumulative drop of 17.6%. If one's portfolio consisting of 25X annual spending went down 25% over the course of a few years because the discount rate hit a whopping 4%, that would be a much bigger effect on one's wealth than the inflation itself - i.e. a loss of $250k on a previously $1M portfolio, compared to spending an extra $1,600/year.

Thus, if one hedges their all-stock portfolio by using options, they are protected from the main consequence of inflation, as well as innumerable other scenarios that could cause stocks to go down. This protection can be bought for 2-3% a year in the case of protected puts, or around 0% if a collar is used. I would expect this price to be cheaper in the long term than a hyper-conservative AA.

If one puts a big chunk of wealth into negative-yielding inflation-indexed bonds that actually lag behind even today's low inflation, then maybe that particular portion of their portfolio avoids the damage from inflation, but it will never compensate for the losses in the other components of one's AA. If the AA is set to 100% inflation-indexed bonds, then one merely loses money to tax inefficiency and the gap between inflation and portfolio performance that @maizefolk pointed out. Even worse, the sustainable withdraw rate of such a portfolio would be in the 1-2% range (cannot find research on the SWR for hedged portfolios, but it is probably better due to mitigating sequence of returns risk).

TL;DR: Why not use a hedged stock portfolio to protect against the risk of rising inflation, plus any other risk? The expected cost of hedging is similar to or less than the expected losses of inflation-indexed bonds, which only protect against inflation risk.

[daverobev]

I don't think I'm smart enough for options.. I've tried reading up a couple of times and it just hasn't clicked for me.