Thus, in whimpering fashion, have the July Inflation numbers dropped. Both CPI and PPI, much to the delight of investors, came in below-expectations. Those not rushing to take credit are racing to buy every financial instrument under the sun.
Let us therefore collectively rejoice that “Peak Inflation” has come and gone. Never to be observed again – on these shores, or, indeed, in this galaxy.
We won’t miss it. Peak Inflation, that is. However, and while I don’t want to ruin the waning days of summer for any of y’all, I believe we should keep a watchful lookout for its possible re-emergence. Like MacArthur in the Philippines. Like Napoleon from Elba. I don’t know that this will transpire, but, on the other hand, I don’t know that it won’t.
But as always, I digress, as time-honored protocols impel me to first pay obeisance to my theme, which, as is often the case, wants both explanation and justification.
Humble Pie is both a colloquialism and the name of a classic rock band. As to the latter, it’s a group in which I take very scant interest and about which I have very little to say. With respect to the former, by truncating it to Pi, I make reference to the Greek Letter that immediately follows my beloved Omicron. It is most commonly linked to the divine constant that resolves the linear with the circular. Measure the length of any straight line, multiply it by Pi, and damned if you haven’t hit upon its precise circumference. Pi is an irrational number, meaning that it has an infinite string of digits to the right of the decimal place. A year ago, this coming Wednesday, some characteristically fastidious Swiss scientist carried the calculation out to 62.8 Trillion digits, and my guess is that they ain’t done yet. In fact, I wonder if they stopped at this figure because it is precisely 20 trillion times the value of Pi itself. It would be pretty cool of them Swiss if this were the case.
The calculation required 108 days and 9 hours of processing time, executed on what we can assume was a very powerful box. But they have barely scratched Pi’s circuitous surface, as its full, precise value cannot, by definition, be known by anyone other than the Good Lord himself.
The first recorded use of Pi is by the Babylonians, roughly around 2,000 B.C. Since that time, though, the pilfering field of economics has purloined the term and applied it to the rate at which the value of a fixed amount of currency fluctuates against a basket of goods and services; in other words: Inflation. The meanderings of which are the current obsession of those with vested interests in the fortunes of the Capital Economy.
One might be tempted to deem the Economic Pi an irrational number as well. It’s calculated in dozens of ways, each one hated more than the next by those that that monitor its whimsical path. Best case, it is a patchy indication of the cost of goods and services within the economy, but – particularly in these troubled times, it’ll have to do.
We all knew that the shocking numbers generated in Q2 were not likely to extend themselves. I myself was convinced of this and opined accordingly. Mostly, this was due to my focus on commodities markets, and my observance that critical sectors such as Energy and Grains were backing off like little bitches. And I continue to believe that the twists and turns within these markets will be the key determinant of Inflation on a going forward basis.
But I also think this: once Inflation has reached a critical mass, it takes on a life of its own. I won’t plague you with the indignities through which I was forced to slog during my econ grad school days, but I will state, briefly, that the triumphs and tragedies in these realms are driven not by Inflation itself, but rather by an even more obtuse concept called Inflationary Expectations – the expected level of future price changes — embedded in the actions and decisions of economic agents.
Such things are, of course, unobservable, unknowable. But for our purposes, it is important to bear in mind that the inflation rate anticipated by commercial and consumer interests informs the critical decisions they make. If Expectations are high, these entities are deeply incentivized to spend and borrow, as they assume the value of both their purchases and borrowings will diminish over time. Conversely, if Expectations are low (or worse yet, negative), agents hold off on economic activity and are more comfortable deferring transactions in hopes of better pricing down the road.
Rendering an accurate monitoring of Inflationary Expectations is more difficult in the modern environment, for about 62.8 trillion reasons. But let’s focus on a couple. First, the Developed World’s Central Banks have tinkered (read: goosed) the money supply (against which prices are measured) as aggressively as any point since at least those blissful days between the two world wars. And no one, no one, knows what the long-term impacts of this will be (lotta spit ballers guessing, though). Beyond this, with persistence of real-world problems such as the not-yet conquered global health crisis, an observable and arguably crippling deterioration of international trade flows, all as overseen by what seems to be the least capable set of policy makers in my lifetime, who’s to know how goods and services will be priced in the coming months and years?
Finally, economic history is rife with examples of surging Inflation that subsequently abetted, only to re-emerge in stronger force just as everyone began to believe we had licked the thing:
Pi Over the Last 50 Years:
The most vexing action transpired back in the ‘70s. We was going along OK until, sometime after the ’73 Yom Kippur War, our Middle Eastern relations began to deteriorate. But we got over that. Until, that is, all that OPEC embargo nonsense and the Iranian hostage crisis took hold. At which point Inflation surged to unthinkable levels, and it took crippling, recession-inducing interest rate hikes to, so to speak, right the pricing ship.
The technicians among you may recognize a double top/head and shoulders formation during this period. If we were to extrapolate to our current circumstance, it seems likely that even with a serious dip in the pricing surveys, we may require another double top to achieve normalization.
And just as was the case in the ‘70s, I believe it all centers around the Energy Complex. It’s been heartening indeed to bear witness to a ~25% drop in Crude Oil prices (during the peak driving season, no less) and a Nat Gas decline of approximately 1/3rd. But both commodities are back on the rise, with Nat Gas knocking on the threshold of all-time highs (before Winter, no less). Meanwhile, the price in Europe is more than 5x that of the U.S.
All of which has caused a shift in Continental heating protocols – away from Nat Gas and towards other Crude Oil byproducts. And if you don’t believe me, just check with the (impressively named) International Energy Association.
Meanwhile, the mighty vessel of domestic energy production remains moored in drydock. We continue to press on our good buddies in Iran and Venezuela to open their spigots, but neither they, nor the Saudis, are likely to do our bidding. Russia (from whence the Continent derives nearly half of its energy supplies) may very well up the ante by shutting down Euro business altogether.
All of which could send Energy prices to heretofore un-breached highs. On the other hand, maybe not. Maybe we’ve seen “Peak Oil”, which would do a great deal to cure a multitude of our (P)ills.
On the other hand; maybe not. At which point Pi may resume its baking ways, it will be, optically at any rate, up to the Fed to cool its ovens. There are worse places to afix this solemn responsibility, but other than with their colleagues across The District, none come immediately to mind.
But now, we enter something of a data/liquidity vacuum. Not much of import is set to be released between now and a (late-arriving) Labor Day, and, as August melts away, so too, I suspect, will the liquidity.
So, I reckon we’re gonna have to wait a spell to obtain any clarity – on Inflation, Interest Rates and the general health of risk assets. And then, in all probability, wait some more.
While I continue to urge caution in terms of portfolio construction, I don’t mind if you do a bit of celebrating on the Humble Pi numbers released last week. After all, we survived pretty well through the August data onslaught. In addition to tamer-than-expected Inflation, we have boffo employment stats. Earnings, while mixed, were hardly the disaster some prophesied. True, GDP was negative, but investors can be forgiven for believing the main impact of this will be to dampen the hawkish hisses currently emanating from the Fed.
So, if investors, in their extensive-but-finite wisdom, want to keep up the “game-on” vibe, I am no position to quarrel. I don’t think it will last forever. The Capital Economy strikes me as being drained, strained, disrupted and latently despondent. It is ill-prepared to absorb much in the way of distemper or disappointment. But I see nothing of this sort on the visible horizon. And if investors wish to use the remaining days of sunshine and warm breezes to play around a bit more, they have my blessing to do so.
Of course, I could be mistaken, and if so, I am fully prepared to swallow as much Humble Pie as will legitimately help the cause, with the only hope I can hold out that it doesn’t rise anything close to the 62.8 trillion units of Pi served up by the Swiss last year.
And bringing these linear musings into their full, circular symmetry, I’d also like to avoid spending Thirty Days in the Hole.
Maybe some small set of my readership will understand.
TIMSHEL