Connect with us

Economics

Do Bonds Accurately Price Inflation? Since Before Any of Us Were Born

Many, likely the vast majority believe that the recent wave of consumer price increases is going to stick around. It’s already painful and even if it…

Published

on

This article was originally published by Alhambra Investment Market Research

Many, likely the vast majority believe that the recent wave of consumer price increases is going to stick around. It’s already painful and even if it isn’t inflation, they’re thinking, it soon will be. Maybe not 1970’s bad, not yet, at the very least something like then.

The bond market doesn’t just disagree, it keeps doing so vehemently. Nothing new, bond yields have signaled distrust and skepticism each and every time we go through one of these inflation panics. There was 2008’s fiasco today remembered for ending up more like the thirties than the seventies; renewal under QE “money printing” which very quickly deflated by 2011 and forgotten; then 2014’s “best jobs market in decades” simply vanished; finally, the 2018 “globally synchronized” comedy of hawkish errors.

Low yields aren’t just expressing some cynical opinion that we can quantitatively measure, the implications have been repeatedly proven true because those prices are largely made by those inside the shadows doing all the money. Or not enough, as the case has been.

Inflation, real inflation which lasts, is always and everywhere a monetary phenomenon. There hasn’t been the money for a long time, therefore there hasn’t been inflation. Instead, consumer prices, at times, have increased even jumped if only due to other factors which uniformly get verified as transitory.

That’s why I (and a very few others) become remorseless about being obsessively specific and demand full accuracy as to whether or not to call something inflation. Without the money, it won’t be so whatever else has to be responsible for consumer prices can only ever be transitory.

This time is different, everyone now says. Screw bonds! Sure, they’ve been on the spot predicting the Fed’s downfall since before 2008 (see: below) but more and more of late the Federal Reserve itself says you can’t rely on yields if or when the real inflation their QE policies have been desperate to inflict does arrive.

There’s been a curious uptick in scholarship purporting to study the best inflation prediction combinations. Most of them are just absurd fantasy, transparent attempts to discredit policymakers’ bond market nemesis. I’ll even give you a recent example, just a few days ago, published by the Cleveland Fed.

The study’s findings unsurprisingly disparage consumers, estimating that consumer surveys of inflation are the least helpful. Those conducted from businesses aren’t really any better, according to the Cleveland branch, while, predictably, the authors extol the virtuous capacities of “professional forecasters” as modern-day inflation oracles.

Professionals who just so happen to be – pure coincidence, I’m sure – formally trained Economists like the researchers in Cleveland and the rest of the Federal Reserve.

One other inflation predicting method included “financial markets.” This didn’t score so hotly, according to the paper:

Based on in-sample and out-of-sample predictive exercises, we find that the expectations of professional economists and businesses, as demonstrated by the Blue Chip and Atlanta Fed measures, have provided substantially more accurate predictions of CPI inflation one-year out compared to those of households. The accuracy of the Cleveland Fed inflation expectations model, which could be viewed as reflecting the expectations of the financial markets, is somewhat behind these other two measures.

Wait, back up; the Fed’s branch used an “inflation expectations model?” This is supposed to be a proxy for financial markets, but instead is:

Inflation expectations of financial markets, as captured by the model behind the one-year-ahead Federal Reserve Bank of Cleveland inflation expectations series. The Cleveland model (Haubrich, Pennacchi, and Ritchken (2012)) estimates inflation expectations using data that include nominal yields from US Treasury securities, survey forecasts, and inflation swap rate data.

It’s bad enough they’ve thrown a bunch of things into the wash and hope to extract something useful via subjective stochastics, but one of those things purportedly of financial markets is “survey forecasts.” I absolutely hate having to point out the implication of what sure seems like an intentional act of dirty pool.

Truth is, we don’t need all the fancy econometrics to evaluate these things; after all, these Economists have been employing exactly those for a very long time and they understand, appreciate, and can usefully forecast less and less by the year. On the contrary, we’ll just draw some simple charts and rely on nothing more than our eyes and common sense.

And we’ll start back in history with the last true bout of unbridled inflation, the supposed template for what so many people have been led to believe is about to make its ugly reappearance: The Great Inflation.

This part is exceedingly easy and straightforward since the bond market does all the work; you just need to be freed from the grasp of illiterate Economics.

Yields went down, not up, during the Great Depression (not pictured but I went into detail why here). They did so because of generally tight money (interest rate fallacy) that the Federal Reserve and its bank reserves (even based on gold flows) couldn’t manage. Banks, not central banks, are where the money comes from.

This deflationary situation did not change through and after World War II. Even during those three periods when consumer prices surged (sounds familiar), to the left of the red arrow above, bond yields didn’t budge an inch (I’ve already covered how it wasn’t the Fed’s yield caps which had kept yields low here). The financial market looked past those as temporary deviations which wouldn’t last because they weren’t actual inflation.

Transitory supply shocks don’t bother yields especially at the long end of the curve which measures money conditions through the prism of longer run inflation and growth perceptions. If it isn’t money, therefore transitory, longer bonds don’t price it.

Starting in the second half of the fifties, though, yields began at first gently rising (late fifties, eurodollar?), indicating that the tide was turning and whatever leftover remainders from the deflationary Great Depression were finally, mercifully being overcome.

What followed a double dip recession in 1958 then 1960 was a few years of low inflation. Yet, even during those, bond yields were moving higher anticipating what was about to come.

The 3-month bill rate bottomed out in July 1961 while longer end Treasuries would gently increase from January 1963. These then accelerated sharply in July 1965 well ahead of the first main eruption of consumer prices by February 1966.

That’s not all; a near-recession in 1967 granted a minor reprieve to consumers, a slowdown (slack) which Economists and central bankers mistakenly judged the end of the inflationary trend. The bond market, by contrast, picked up on the renewal of inflation three-quarters of a year ahead of time (bills almost half a year).

Bonds vs. Economists isn’t a new thing in the same way the Harlem Globetrotters didn’t just start pounding the Washington Generals yesterday.

Adding the Fed’s Discount Rate policy to the above chart (below) just highlights how bonds were way ahead as policymaker actions repeatedly fell behind:


The whole process repeated during and following the 1969-70 recession, too. LT yields bottomed out in March 1971, began moving higher even as the CPI leveled off and continued to decelerate for another fifteen months until June 1972.

Furthermore, this upward move in yields presaged a spike in consumer prices around early 1973 which itself predated the OPEC embargo’s painful inflationary oil contributions later that same year. As you can see on the chart above, bond yields incorporated the inflation part of the 1973 jump while trading underneath (CPI rates above yields) the embargo/crude oil components of it; in the same way as yields undercut those earlier pre-inflation supply shocks after WWII.

In other words, the bond market neatly and expertly compartmentalized inflation from other consumer price factors at the same time as helpfully foreseeing the former.

Contrary to what some Economists have claimed, the “financial markets” of little more than simply Treasury yields absolutely nailed the Great Inflation even as policymakers and experts fumbled around searching for answers and clues they would never find. Then-Federal Reserve Chairman Arthur Burns in August of 1971 had the nerve to say to Congress:

The rules of economics are not working in quite the way they used to.

The rules were always fine; Burns and those like him just didn’t understand how the monetary system had changed the way money worked within them. The bond market, the banks doing all the money, they had no problem sorting everything out.

OK, fine. This was a half century ago. What about something closer to today, the 21st century?

To start with, we’ve got yields moving higher in the middle of 2003 a year before the Fed’s eventual “rate hikes” which only then created confusion (“conundrum”) for Alan Greenspan when bond long end rates began to bunch up in anticipation of the decidedly high deflationary probabilities of the late eurodollar mania period.

The yield curve flattened, and then nominal rates began to fall by June 2007 long before any minus signs showed up in the CPI early in 2009.

What’s perhaps most powerful about the chart above is how the bond market (correctly) has treated each of the subsequent consumer price deviations dating back to the monetary breakdown during 2007: first in 2008, then again in 2011, and now in 2021.

Like those temporary supply shocks caught in the CPI’s of the immediate post-war aftermath, or the peak CPI created by the oil supply shock of 1973-74, bond yields also undercut each of those post-2007/broken eurodollar consumer price spikes…and are doing so yet again in 2021.

To really drive home this point, here are the two main charts one after the other, each one expertly sorting inflation from not-inflation by way of shadow money. 

Quite simply, if it is actual inflation, yields go up as the market will price the real thing before it makes it into the CPI levels.

If there isn’t money for inflation, and those trading Treasuries know about shadow money that central bankers and Economists don’t and haven’t for more than half a century, then bond yields won’t chase these other CPI’s because those spikes aren’t inflation meaning they must be something else which, without the money, won’t last.

Historically consistent. 

One of the key mistakes that Cleveland researchers and indeed all Economists make is treating all CPI increases as if they are the same; they keep searching for the best way to predict the annual CPI, rather than the proper way to sort out consumer prices! The reason officials keep committing such an egregious error is that Economics doesn’t even consider money. How could Economists? They haven’t taken the monetary system seriously since the Great Inflation shoved their ignorance into the limelight (criminally, the very same money ignorance the Great Depression had paraded before the world in a different way just a few decades earlier).

In lieu of this great deficiency, Economics has made it seem as if inflation is some voodoo mystery only its priestly class can describe from complicated mathematics rituals. You don’t need any of that, or them. All of this is publicly available, data, prices, everything, and it doesn’t take anything more than common sense divorced from that corrupted worldview.










Economics

Waning Term Premiums And The Riddle Of Surging Inflation

Waning Term Premiums And The Riddle Of Surging Inflation

By Ven Ram, Bloomberg macro commentator and reporter

If you asked your bank manager…

Waning Term Premiums And The Riddle Of Surging Inflation

By Ven Ram, Bloomberg macro commentator and reporter

If you asked your bank manager for a loan, the rate you will be offered will vary proportionally with not only how much you borrow, but also how long you borrow for. That, of course, is a no-brainer since the longer the bank is willing to lend to an individual, the greater the risk of something going wrong. Mainly, they encompass credit and inflation risks, and in the case of institutional investments, liquidity as well.

Yet, in the market for Treasuries and several other major developed markets, investors have recently become indifferent to the risk surrounding the longevity of their loans to governments. In other words, they are essentially saying, there is no more inflation risk in lending to Uncle Sam over, say, 10 years than there is when lending for a far shorter period. That is a massive irony against a backdrop where inflation is Le probleme du jour.

Shrinking term premiums is one major reason why Treasury long-dated yields have fallen after the brisk first quarter that, back then, resembled a juggernaut on the move. (The issue isn’t peculiar to the U.S. by any stretch: investors are willing to loan the U.K. for a 30-year period for well less than 1%, but will readily settle for even less — at around 50 basis points — if the Chancellor of the Exchequer will agree to keep the sum in his state’s coffers for 50 years, thank you. Sure, there are reasons such as demand for ultra-long debt from pension funds, but that’s a discussion for another day.)

Why is it that investors couldn’t seem to care less about earning a decent term premium?

A combination of liquidity, declining natural rates of interest and unbridled expansion of balance sheets — and that’s not an exhaustive list — have got us to where we are now. Getting out of it, though, isn’t going to be easy. Getting into quicksand takes a trice, but last I checked no one had found a way yet to come out of it in one swift ascent.

Tyler Durden
Thu, 12/09/2021 – 08:20

Author: Tyler Durden

Continue Reading

Economics

3 Growth Stocks to Buy Before The End of the Year

Recently, the market has experienced increased volatility, with a major factor being the Federal Reserve’s hawkish pivot. The Fed seems to be more focused…

Recently, the market has experienced increased volatility, with a major factor being the Federal Reserve’s hawkish pivot. The Fed seems to be more focused on combating inflation, and the market is now expecting at least two rate hikes next year. As a result, the yield on the two-year Treasury Note has moved up from 0.15% in June to 0.65%. Rising short-term rates are a headwind for growth stocks, which perform their best in environments where rates are declining. 

So, it’s not surprising that growth stocks led the market to the downside last week. A good example is the ARK Innovation ETF (NYSEARCA:ARKK) which is down more than 19% in just the past month. In contrast, the S&P 500 and Nasdaq are down 0.64% and 2.25%, respectively. 

However, I believe this pullback in growth stocks offers investors an opportunity.  The rise in short-term rates may soon be over, as forward-looking inflation measures are moderating at a rapid pace. Further, after the recent steep pullback, many growth stocks have reached more attractive valuation levels. Therefore, investors should consider buying the dip in these three top growth stocks:

Growth Stocks to Buy: Alphabet (GOOGL)

Source: Castleski / Shutterstock.com

Alphabet recently became the third-most-valuable company in the world with a market capitalization of over $1.9 trillion. The company’s primary source of revenue and income remains Search which is very profitable and maintains a dominant market share. Over the years, GOOGL has expanded into other areas like Google Cloud, Android, Chrome, Google Docs, YouTube, and its venture bets like autonomous driving venture Waymo. 

GOOGL stock was initially an underperformer during the pandemic as ad spending decreased. Further, ads from travel companies were put on hold, and those comprise a meaningful chunk of revenue. However, ad rates and ad spending are now well above pre-pandemic levels as the economy reopens and gradually normalizes. 

The company’s momentum is evident in its results for Q3. Revenue increased by 41% to $65.1 billion, while operating income increased by 32% to $21 billion. For the full year, analysts project EPS growth of 85% and 39% revenue growth. Not surprisingly, GOOGL’s stock is up more than 60% year to date and the company has shown impressive relative strength during this period of market stress. 

GOOGL’s POWR Ratings reflect this promising outlook. The stock has an overall B rating, which equates to a “Buy” in our proprietary rating system. B-rated stocks have posted an average annual performance of 19.7% which compares favorably to the S&P 500’s annual return of 7.1%. To see more information about GOOGL’s POWR Ratings, click here.

Workday (WDAY)

A close-up view of a Workday (WDAY) sign in Pleasanton, California.Source: Sundry Photography / Shutterstock.com

Workday provides enterprise cloud applications with offerings that include financial management applications, cloud spending management solutions, and Workday applications for planning. YTD, WDAY’s stock is up 17%, and that number surges to almost 500% since its IPO in 2013.

Cloud and enterprise software stocks have been among the best performers of the last decade. It’s not surprising when considering that companies are increasing spending on their IT systems, software and cloud systems at a strong rate which is expected to continue over the next decade.

For investors, these companies are fantastic, because they tend to have high margins and recurring revenue. Once companies choose a software or cloud provider, they are unlikely to change often given the cost and complexity of changing systems. Further, once companies have people on their platforms, they are able to unlock more opportunities for monetization. 

Despite the stock’s recent underperformance, the business continues to gain momentum. Its last earnings report showed a 20% increase in revenue to $1.3 billion with over 90% of revenue coming from recurring subscriptions. It also made a new milestone in terms of EPS going from a loss of 10 cents per share last year to a profit of 17 cents per share this year’s Q3.

WDAY has an overall B rating, which equates to a “Buy” in our POWR Rating system. The POWR Ratings also evaluate stocks by various components to give more insight. In terms of its component grades, the stock has an A grade for Growth and a B grade for Sentiment and Quality. Click here to see the complete POWR Ratings for WDAY. 

Growth Stocks to Buy: Expedia (EXPE)

building facade with expedia (EXPE) group logoSource: VDB Photos / Shutterstock.com

Expedia is an online travel company that operates through multiple segments. Some of its most well-known brands include Expedia, Vrbo, Hotels.com, Orbitz, Travelocity and Wotif. In addition, it offers a range of travel and non-travel verticals, including corporate travel management, airlines, travel agents, online retailers, and financial institutions.

EXPE’s business took a big hit during the pandemic for obvious reasons. However, travel volumes are increasing and during the Thanksgiving holiday were at 90% of 2019 levels. It’s very possible that the recent rise in coronavirus cases and the emergence of the omicron strain could have a short-term impact. However, in the longer-term, vaccination rates and effective therapeutics are signs that the pandemic is close to an end.

The company’s recent earnings report also confirms the recovery in travel. The company topped expectations with revenue increasing by 97% to $3 billion. In total, it had $553 million in net income, a big turnaround from last year’s $31 million loss.  For Q4, analysts are projecting $2.3 billion, a 148%increase and a big jump in EPS to $6.89 per share.

EXPE’s strong fundamentals are reflected in its POWR Ratings. The stock has an overall C rating, which equates to a “Neutral” rating in our proprietary rating system. The POWR Ratings are calculated by considering 118 distinct factors, with each factor weighted to an optimal degree. 

EXPE has a B grade for Growth and Quality which isn’t surprising considering its Q3 results and status as one of the top online travel companies. To see EXPE’s complete POWR Ratings, click here.

On the date of publication, Jaimini Desai did not have (either directly or indirectly) positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Jaimini Desai has been a financial writer and reporter for nearly a decade. He has helped countless investors take profitable rides on some of the hottest growth trends. His previous experience includes writing for Investopedia, Seeking Alpha, and MT Newswires. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters.

More From InvestorPlace

The post 3 Growth Stocks to Buy Before The End of the Year appeared first on InvestorPlace.



Author: Jaimini Desai

Continue Reading

Economics

US Economy Remains On Track For Strong Rebound in Q4

With the end of the year in sight, the US economy continues to show signs of a sharp pickup in growth in the fourth quarter, based on several nowcasts….

With the end of the year in sight, the US economy continues to show signs of a sharp pickup in growth in the fourth quarter, based on several nowcasts.

The US Bureau of Economic Analysis is expected to report in late-January that output rose 5.4% (annualized real rate) in Q4, via the median of several nowcasts compiled by CapitalSpectator.com. The estimate marks a dramatic upside reversal from the slowdown in Q3 that cut growth to a modest 2.1%.

Although roughly a third of the fourth quarter’s economic data has not yet been published, the available numbers to date suggest that the final quarter of 2021 will deliver upbeat news for the US. The fact that recent nowcast revisions have been relatively steady at the 5%-plus level strengthens the outlook that output has accelerated. Today’s revised median 5.6% nowcast is up from 5.0% in the Nov. 16 update.

Recent survey data aligns with the firmer expectations for Q4 economic activity. “The US economy continues to run hot,” observed Chris Williamson, chief business economist at IHS Markit, on Nov. 23, citing the consultancy’s US Composite Output Index, a GDP proxy. “Despite a slower rate of expansion of business activity in November, growth remains above the survey’s long-run pre-pandemic average as companies continue to focus on boosting capacity to meet rising demand.”

Supply-chain and worker-shortage issues continue to create headwinds, but a rebound in economic activity overall appears increasingly likely when the government publishes its initial Q4 GDP estimate next month.

The main question is whether the rebound proves fleeting? Looking ahead to 2022 suggests that economic activity could slow in the new year due to potential blowback from the omicron variant of the coronavirus, higher inflation and other factors.

Goldman Sachs, an investment bank, recently cut its forecast for US growth in the new year. “While many questions remain unanswered, we now think a moderate downside scenario where the virus spreads more quickly but immunity against severe disease is only slightly weakened is most likely,” says Joseph Briggs, an economist at the firm.

This week’s update of the UCLA Anderson Forecast has also trimmed the outlook for early next year, revising its Q1 2022 growth estimate down substantially to a 2.6% gain from the 4.2% predicted in September. The key assumption: the omicron variant “might be disruptive, while acknowledging that its effects cannot be predicted.”

Perhaps, but the good news is that economic momentum looks set to deliver a strong tailwind going into 2022.  


How is recession risk evolving? Monitor the outlook with a subscription to:
The US Business Cycle Risk Report


Author: James Picerno

Continue Reading

Trending