The Expectations Game
Inflation isn’t just about empirical economic data; it also involves behavioral psychology. Despite the economic forecasting tools in our arsenal, we’re always mindful of how inflation can become a self-fulfilling prophecy.
If workers expect higher inflation, they demand higher wages and drive prices higher. However, over the past few years, high unemployment and low capacity utilization haven’t given workers the leverage to demand wage increases—in fact, wages have dipped.
But the US economy is now taking up that slack.
While unemployment is still elevated, it has fallen from a high of 10 percent in October 2009 to 7.6 percent today. At the same time, thanks to continued improvements in efficiency and automation, capacity utilization—a measure of slack in the economy—has risen to 77.8 percent and is still rising. Right now, it’s less than 3 percent below the 2008 peak and, when it hits 80 percent, it will be back into the “normal” range.
Unfortunately, this trend hasn’t translated into real growth for the US economy. After the first quarter’s downward revision to US gross domestic product (GDP), the latest consensus shows that we’ll be lucky to eke out 1.5 percent growth this year.
That poses a conundrum for US policy makers.
Accommodative monetary policies have been propping up the US economy’s meager pace of growth since 2009. Consequently, whenever folks such as Federal Reserve Chairman Ben Bernanke hint at curbing that support, the market acts as if the rug’s been pulled out from under it. But largely as a result of that stimulus, longer-term inflation expectations have been on the rise.
The Federal Reserve Bank of Atlanta runs what it calls the “Inflation Project,” which tracks just about any and every metric having to do with inflation. According to its data, US households are expecting inflation of 3.1 percent over the year ahead.
Typically, when inflation expectations are on the rise, the government would react by reducing monetary and fiscal supports or increasing interest rates. But with such anemic GDP growth, that could very well trigger another recession.
If an inflation hawk such Paul Volcker were sitting in the Fed’s head office, we should probably worry that the government might do just that. But with Bernanke’s term as Fed chairman soon to end and the shortlist of his replacements made up primarily of monetary “doves,” odds are the public’s inflation expectations will only worsen.
Last month, US consumer prices posted their biggest jump since February, rising by 0.5 percent. Prices were up across the board for almost all of the consumer price index’s components, including gasoline, housing, medical care, food and clothing.
The US producer price index, which measures the cost of the raw materials that keep the American economy running, also posted a large 0.8 percent jump in June, the second straight month of big increases. A 2.8 percent increase in energy prices helped drive that gain, most notably a 7.2 percent spike in the wholesale price of gas. That’s about the best indication you can get that we’re still susceptible to outside shocks, since much of that jump was driven by continued unrest in the Middle East.
So while we may be a bit early to the inflation story, it’s a problem clearly looming large on the horizon.
Portfolio Updates
The National Association of Homebuilder’s Confidence Index shot up to a seven-year high in June, blowing the consensus expectation for a reading of 45 out of the water when it hit 52. It was the biggest monthly move since 2002. In addition, measures of current sales conditions and customer traffic also hit their highest levels since 2006.
That’s bullish news for iShares S&P Global Timber & Forestry Index (NSDQ: WOOD). While 17.3 percent of its assets are allocated to Europe and 19.3 percent to Asia, the remainder is dedicated to timber and forestry plays here in the Americas. As a result, the US construction industry is a major driver of earnings for many of the fund’s holdings. With improving confidence and firming home prices, the US housing recovery is looking increasingly sustainable.
Continue buying iShares S&P Global Timber & Forestry Index up to 55.
While Mitsubishi Estate (Tokyo: 8802, OTC: MITEY) has sold off recently along with the broader Japanese market, it has gotten some good news from Moody’s Japanese arm, which changed the company’s rating outlook from negative to stable.
The ratings agency expects the company’s leverage to decrease in the coming quarters as rental rates and property prices in the Tokyo office market continue to improve, pushing operating profit to between JPY160 – JPY180 billion by the first quarter of next year. The company is expected to apply some of those higher profits to debt reduction, paying down about JPY200 million of debt over the next two years.
Mitsubishi Estate continues to rate a buy up to JPY2,900.
If workers expect higher inflation, they demand higher wages and drive prices higher. However, over the past few years, high unemployment and low capacity utilization haven’t given workers the leverage to demand wage increases—in fact, wages have dipped.
But the US economy is now taking up that slack.
While unemployment is still elevated, it has fallen from a high of 10 percent in October 2009 to 7.6 percent today. At the same time, thanks to continued improvements in efficiency and automation, capacity utilization—a measure of slack in the economy—has risen to 77.8 percent and is still rising. Right now, it’s less than 3 percent below the 2008 peak and, when it hits 80 percent, it will be back into the “normal” range.
Unfortunately, this trend hasn’t translated into real growth for the US economy. After the first quarter’s downward revision to US gross domestic product (GDP), the latest consensus shows that we’ll be lucky to eke out 1.5 percent growth this year.
That poses a conundrum for US policy makers.
Accommodative monetary policies have been propping up the US economy’s meager pace of growth since 2009. Consequently, whenever folks such as Federal Reserve Chairman Ben Bernanke hint at curbing that support, the market acts as if the rug’s been pulled out from under it. But largely as a result of that stimulus, longer-term inflation expectations have been on the rise.
The Federal Reserve Bank of Atlanta runs what it calls the “Inflation Project,” which tracks just about any and every metric having to do with inflation. According to its data, US households are expecting inflation of 3.1 percent over the year ahead.
Typically, when inflation expectations are on the rise, the government would react by reducing monetary and fiscal supports or increasing interest rates. But with such anemic GDP growth, that could very well trigger another recession.
If an inflation hawk such Paul Volcker were sitting in the Fed’s head office, we should probably worry that the government might do just that. But with Bernanke’s term as Fed chairman soon to end and the shortlist of his replacements made up primarily of monetary “doves,” odds are the public’s inflation expectations will only worsen.
Last month, US consumer prices posted their biggest jump since February, rising by 0.5 percent. Prices were up across the board for almost all of the consumer price index’s components, including gasoline, housing, medical care, food and clothing.
The US producer price index, which measures the cost of the raw materials that keep the American economy running, also posted a large 0.8 percent jump in June, the second straight month of big increases. A 2.8 percent increase in energy prices helped drive that gain, most notably a 7.2 percent spike in the wholesale price of gas. That’s about the best indication you can get that we’re still susceptible to outside shocks, since much of that jump was driven by continued unrest in the Middle East.
So while we may be a bit early to the inflation story, it’s a problem clearly looming large on the horizon.
Portfolio Updates
The National Association of Homebuilder’s Confidence Index shot up to a seven-year high in June, blowing the consensus expectation for a reading of 45 out of the water when it hit 52. It was the biggest monthly move since 2002. In addition, measures of current sales conditions and customer traffic also hit their highest levels since 2006.
That’s bullish news for iShares S&P Global Timber & Forestry Index (NSDQ: WOOD). While 17.3 percent of its assets are allocated to Europe and 19.3 percent to Asia, the remainder is dedicated to timber and forestry plays here in the Americas. As a result, the US construction industry is a major driver of earnings for many of the fund’s holdings. With improving confidence and firming home prices, the US housing recovery is looking increasingly sustainable.
Continue buying iShares S&P Global Timber & Forestry Index up to 55.
While Mitsubishi Estate (Tokyo: 8802, OTC: MITEY) has sold off recently along with the broader Japanese market, it has gotten some good news from Moody’s Japanese arm, which changed the company’s rating outlook from negative to stable.
The ratings agency expects the company’s leverage to decrease in the coming quarters as rental rates and property prices in the Tokyo office market continue to improve, pushing operating profit to between JPY160 – JPY180 billion by the first quarter of next year. The company is expected to apply some of those higher profits to debt reduction, paying down about JPY200 million of debt over the next two years.
Mitsubishi Estate continues to rate a buy up to JPY2,900.