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Restructuring the Inflation Guy Content Offering
For many years, I’ve been producing a blog and pushing free content. Before that, I wrote Sales and Trading commentary for Natixis, and before that Barclays, and before that Deutsche Bank, and before that, Bankers Trust. I never charged for any of that and neither did the banks, at least directly.
Writing, at least with respect to the blog itself, was part of my process of thinking through the economic and investing environment. I had to do that anyway, so distributing those thoughts was easy and the feedback/pushback I got was important and useful as well. It still is.
But over the years, my content offering (which is congruent to the set of Enduring Investments’ content offering) has widened to different channels and even different media. There is now an Inflation Guy podcast, an Inflation Guy mobile app, and even an Inflation Guy album of ‘80s hits. (Okay, not that one.) I’ve written two books and am contemplating a third. And then there’s Twitter. And as the number of content outlets and offerings metastasized, it has also become clear that I have gone way beyond just the idle penning of my musings and that this takes a lot of time. Some other things I would like to do would take even more time. So there needs to be a business purpose!
The hope has always been that some people who find these thoughts useful would become investing or consulting clients of Enduring Investments. Some have! And more will, in the future. But others may want some content and be willing to pay for the value, but not be willing or able to become clients. Consequently, I’ve been discussing with a bunch of my advisors how to capture the value that people are willing to pay, but not in the single avenue we presently offer (that is, becoming a client).
So I took a survey, and many of you participated. I want to tell you that I really appreciate the answers you gave and the time you took to answer the survey. It was well worth the two Visa gift cards (which, incidentally, haven’t yet been claimed – check your spam folders, folks, as I have written to two of you who are winners!). There were some very thoughtful comments and some good ideas. There was also some humor: one person put my address in for the raffle (I didn’t win). And then there was a bot! All of a sudden, one day I received a deluge of hundreds of responses. Some of these responses indicated that Inflation Guy content was worth $50,000 per month. I am flattered, robot, but money means different things to humans I guess. Fortunately, it was easy enough to cleanse the data of bot responses, which were fairly obvious…and, in retrospect, there is probably a thriving business out there of people pouring bot responses into raffles to tilt the odds. Live and learn.
On the basis of the responses, this is what we have decided to do with “Inflation Guy/Enduring Investments” content going forward.
First of all, free stuff:
- The E-piphany Blog, which was at https://mikeashton.wordpress.com and now can be reached at https://inflationguy.blog . It has always been free, and will remain free. You can subscribe to email alerts of the content. The monthly summary of my CPI-day tweets will continue to appear here, a couple of hours after the release.
- Cents and Sensibility: the Inflation Guy podcast. Free wherever good podcasts are found. There may someday be advertisements but the podcast itself will remain free.
- My weekly Investing.com column, which is unique to http://www.investing.com . They have subsidized it so that you don’t have to.
- The Inflation Guy mobile app. While there may be “premium content” on the app, the app itself will remain free as well as will a goodly amount of its content.
- @inflation_guy on Twitter will remain a free follow. My blog columns and podcasts and other free content will funnel through that channel. The monthly CPI tweets, though, will not (see below).
And now, the new offerings. These, and any others we add in the future, are available on the blog site at https://inflationguy.blog/shop/ . Please note that Enduring Investments clients pay nothing for these offerings.
- Inflation Guy Plus on Twitter – Private Twitter account subscription. I am moving the real-time analysis of the CPI report to a private, subscription-only Twitter account. I will release my charts as soon as possible after the number, and will also have a private live audio broadcast as I comb through the charts and data. (I haven’t figured out whether this will be on Discord, Google meet, Zoom/Skype, but will probably start as a simple conference number). @InflGuyPlus will also have other daily/weekly charts and commentary not available on @Inflation_Guy. The cost of a monthly subscription will be $99/month with a discount for an annual subscription. This is in line with other private Twitter offerings. For example, Damped Spring offers a private Twitter feed for $80/mo with similar content though of course less concentrated on inflation. And the results of the survey we took suggested this price is not inappropriate for the people who require the real-time analysis to make trading decisions.
I do know that some people will be disappointed this isn’t cheaper. It’s an unfortunate characteristic of walls: unless there are people on both sides, you don’t need a wall. (Again, Enduring Investments clients are automatically catapulted over the wall. Although that is an unfortunate metaphor come to think of it.)
- Quarterly Inflation Outlook – I have been writing the QIO for more than a decade now. It comes out on the ‘refunding’ cycle: February, May, August, and November, within a couple of days after the CPI reports in those months. I decided to make single-issue subscriptions available, at least for now, hoping that after trying an issue people will sign up for the discounted monthly subscription. The current issue is $80 (right now, you can buy the August issue, which will be delivered via email when it is published); the preceding issue is $70 (in this case, that is the May issue) for an immediate download; earlier issues may be made available once I have time to sort through them and find ones with staying power. To test whether there’s any demand, I listed the Feb 2022 issue for $50. I also listed the 2020Q4 QIO, in which I look prospectively at the incoming Biden/Harris Administration, for $40. A recurring subscription gets a discount to $75/issue, which seemed to be acceptable to most of the respondents to the survey.
We are going to start with those two paid offerings, and see how it goes. There seemed to be some interest in a $2.99 monthly subscription which would update your personally-weighted inflation index, and in a $20 monthly subscription to a collection of model portfolios, but we will see how the response is to these products before adding other options.
One other quick comment about the prices: being a markets person, I will be attentive to dynamics that suggest I should raise or lower the price. But for you, if the price is acceptable there is no reason to delay subscribing. That’s because if I raise the price, all existing subscribers will be grandfathered at the original price; if I lower the price, I will lower it for all existing subscribers as well. So there is no price risk to you in deciding to buy now.
Now, let me mention one final offering. This has a very narrow audience but which audience seemed, in the survey, to be enthusiastic about deeper access to Inflation Guy.
“You take the blue pill—the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill—you stay in Wonderland, and I show you how deep the rabbit hole goes. Remember: all I’m offering is the truth. Nothing more.”
Morpheus, The Matrix
Let’s call this “Inflation Guy Prime.” It is really for the institutional investors and traders who want regular forecast updates and detail, some relative-value metrics and possibly trading signals, subcomponent forecasts/curves, and two-way communication with the Inflation Guy. Because of the two-way communication bit, this offering is capacity-constrained and so will be capped at a yet-to-be determined number of subscribers; the price will increase as we get more subscribers who want to be “Prime.” The current price is shown on the shop.
And so now…we see what happens. Thanks again to everyone who participated in the survey and offered independent, helpful suggestions. The offering will change and hopefully improve over time. We will add other offerings for readers/investors who have different needs. And we will figure out the right price points, eventually…but we had to start somewhere. Please let me know of any questions and/or suggestions you may have!
Inflation Guy Inaugural Podcast Published
I wrote recently about the new (free!) Inflation Guy app, which you can get in your app store.
Now, there’s also a podcast for the Inflation Guy. It is called “Cents and Sensibility: The Inflation Guy Podcast,” and you can get it on PodBean here.
I’ve got a long list of topics, but I am always adding more. Follow, and let me know if you have a request/idea for a topic!
Ride ’em Cowboy
One disease that afflicts writers of financial commentary…actually, probably commentators in all fields come to think of it…is that when the landscape gets in a ‘rut’ so does our writing. Eventually, if nothing changes about the economy or the market landscape, there isn’t much left to say and thus we (and I really mean “I”) are left repeating ourselves. For those of us who – despite all efforts – aren’t paid for our work, it means that sometimes the right thing to do is to just shut up.
And so that’s what I have done over the last year. As the equity market melted up in somnambulant sameness, as the economy chugged along without major crises or roadblocks…or, anyway, no change in those roadblocks…I wrote less and less. To be sure, part of that was because business was picking up, and this remains an impediment to me writing as frequently as I used to, but much of the reason I didn’t write so much was that not much was changing. There just aren’t many ways you can keep saying “stocks are too expensive, commodities are too cheap, interest rates aren’t at neutral levels, the Fed is screwing up, inflation markets are too low and inflation is rising,” so I took the time to work on other important things.
Well, things are changing. Finally.
The stock market is going down for sensible reasons – which is a major change from when stocks were going up, for nonsensical reasons. President Trump’s trade war, which he promised would hurt China more than the US while every mainstream economist said the opposite, is in fact hurting China more than the US. But the frostiness of global trade relations is hurting growth globally, and pushing inflation higher just as we always knew it would. Domestic growth is slowing; although I’ve said for a while I thought there was a good chance that the US would be in recession sometime in 2019 – which suggestion was scoffed at roundly and regularly – it is starting to look like the US might actually be in recession sometime in 2019. In these events, there is something worth writing about! Guiding a canoe across a placid lake is boring (although lots of equity analysts make a ton of money telling you to buy stocks when they’re going up – good for them!), but guiding a boat through rapids is fun stuff. So, let’s go ride those rapids. I won’t write every day, and I might not even write every week. I’m not sure how often I’ll do my live CPI breakdown…when I asked people to pay for that analysis, the resounding answer was that it wasn’t worth a ton, so I’ll do it when I feel it!
But that brings up another important point I want to be sure to mention: I am very grateful for those of you who did support my various experiments trying to establish the monetary value of my commentary. Some of you subscribed to my private Twitter feed, or the chart package, or bought my book. I really appreciate your voting with your dollars (or yen, or euros, or rupiah, etc) on my behalf. Moreover, I really value the feedback from readers of all persuasions – agreeing, disagreeing, or just expanding on the topic. Most of all, I appreciate those of you who have visited Enduring Investments or Enduring Intellectual Properties and have become clients. You know who you are!
We live, as they say, in interesting times. They’re about to get even more interesting, I’m sorry to say. But it gives me reason to write. Stay tuned.
The Changing Face of Free Stuff
Today’s article isn’t about inflation, or the bond market, or the Federal Reserve. It is more of a meta-article: an article about articles or, more precisely, research.
I started my career as a technical and quantitative analyst back when we were still doing point-and-figure charting on large sheets of graph paper tacked to the wall. After coming to Wall Street in the early 1990s, I went to JP Morgan in 1994 as a futures researcher. Subsequently, I became the lead US fixed-income researcher at Bankers Trust before gradually parlaying my research skills into a trading position at Barclays.[1]
In those years, and really until now, compensation of researchers was pretty reasonable. While few researchers – especially in fixed-income – earn seven-figure compensation packages, they still earn an awfully nice living and get to go home at night and not worry about whether their short options position is blowing up in Japan while they sleep. Researchers in general don’t need to wake up at 2am to talk to Hong Kong and delta-hedge the book.
However, there is a downside to being a researcher and that is that historically there hasn’t been a very good connection between the quality of the research (and the eyeballs it commands) and the bonus at the end of the year. On Wall Street, if you don’t have a P&L attached to your name then you don’t have much ammunition when it comes to the bonus discussion. If you can point to a trade that you recommended, the sales force sold, and the trading desk profited from (as well as, hopefully, the clients…since if the clients don’t profit they don’t listen to your next recommendation), and you can compute how much money you made the desk; or if you can claim responsibility for a bond tip that happened as a customer reward for help you gave them on some other matter; or you are a “star” analyst who is the “axe” on some company or market and clients clearly give the firm business so as to have access to you (this is more likely to be the case at a small shop that would otherwise not get such business), then you’re in good shape. But the vast majority of analysts have nothing to say when they sit down with management to discuss their bonuses, because the research bonus pool is essentially a gift from Sales & Trading and not an allocation from their own profits.
Enter the second chapter of the “Markets in Financial Instruments Directive,” aka MiFID II, a product of the European Securities and Markets Authority (ESMA).
I don’t claim to understand everything, or even very much, about MiFID II. I’ve spent a lot of time talking to people who understand more, but no one is really sure what the ultimate impact of MiFID II is going to be, just like no one was sure how bad Dodd-Frank would be for the financial markets. But I want to focus here on the impact of MiFID II on the provision of sell-side and, more to the point, independent research.
Part of MiFID II essentially requires broker-dealers (in Europe, but practically speaking it’s hard to ring fence a global B/D’s activities and clients to just one jurisdiction) to separate the fees for execution and for research. Previously, research – including access to research analysts, for good clients – was provided free to clients in almost all cases. The European regulator, observing that this meant that research must be an ancillary benefit to clients paid for by dealers from their trading profits, reasoned that bid/offer spreads must be wider than they would be if dealers didn’t have to bear this invisible charge.
It is a risible argument, even if it must technically be true. But no trader ever, I am sure, adjusted his bid/offer spread wider to cover the cost of research being provided. Traders think of the bid/offer as being a price for liquidity, period. So I would be shocked if the effort to split these charges resulted in (as is intended) lower trading costs for clients.
Anyway, the bottom line is that now if clients want to get research from their dealers they need to explicitly pay for it, and disclose to the clients what the client is being charged for the research. (We have vaguely similar rules here regarding how ‘soft dollars’ must be used and disclosed, but research that is “free” is not subject to that measurement and reporting.) And so dealers have been announcing what they will charge for research starting on January 1, 2018.
So here’s the interesting side-effect on independent research. Previously, it was virtually impossible for quality independent research providers to make a living. There are a very few who have succeeded at this – Bianco research, Medley, etc – but those numbers are small and those folks have been having a more difficult time of it in recent years. It’s really hard to compete with “free” research coming from the sell side. And so – to bring this home – people like me have had to give away content, hoping to someday recoup the cost of writing and researching by attracting more clients to other lines of business or to a paid research product. Honestly, I’ve tried ten different ways and haven’t figured it out, and I’m the only person I’m aware of with deep domain knowledge in inflation that’s putting out commentary or research.
MiFID II may change that. If buy-side institutions no longer get research for free from the Street, they may be more discerning about what they spend money on. Why pay dealer X for research that used to be free – and was worth about what you paid for it – when independent researcher Y is charging $100 for research that is twice as good? Buy side firms have been wrestling with this question, and there have also arisen several platforms for research providers to hawk their wares – Alpha Exchange, ERI-C, and RSRCHXchange, just to name three. In fact, my company is posting our research on those platforms as well, and in January we will see if anyone is willing to pay for it.
Here is where we make it really personal.
I never wanted to be a ‘blogger.’ I get value from the process of writing my thoughts down, and I get value from feedback from readers. Lots of value. But it takes a ton of time, and it’s hard to justify the time and effort to the fellow stakeholders in my company if there is no revenue attached, ever. And so over the years I have stopped allowing platforms to publish my articles (such as Seeking Alpha) if they weren’t willing to allow me to mention my company, for example; I have also gone from publishing daily (as I did for years) to once or twice per week.
I intend to continue to produce these articles, and distribute them freely on my blog (http://mikeashton.wordpress.com ), on Investing.com, Harvest, and TalkMarkets as well as other places where it is picked up from time to time. And I hope you like them. But my CPI-day tweets, and some other occasional content, will be moving to a new channel. You can go to PremoSocial and subscribe to get access to that “premium content” for only $10 per month. Here is the link.
You can help make sure that this column remains free, by subscribing to that channel. If you think my out-of-the-box viewpoint on markets and especially inflation is valuable, please consider signing up. If the response is very good, it may even justify my spending more time on the research-for-public-consumption (as opposed to R&D) part of the business, and writing more frequent articles. I am eager to see what the response is. Surely my work is worth more than zero. Anyway, I hope so.
Thanks in advance!
[1] I don’t recommend that path for any new graduate starting off on Wall Street. It is quite hard to get from the research desk to a risk-taking role and I got lucky.
Targeting Tuition as a Long Run Goal
A few months ago, in a couple of articles entitled “The Bias in Investor Perceptions” and “What’s Wrong With the Long Run?”, I started to lay out the case for individuals and family offices to approach the investment challenge like a well-run pension fund or endowment would. Most well-run pensions and endowments these days are run in a “liability-driven” manner, which means that instead of maximizing the performance of the fund’s assets, subject to the risk of those assets – classic “mean variance optimization” based on “Modern Portfolio Theory” – the manager aims to maximize the funded status of the plan subject to the variance in the funded status. That is, the manager recognizes that having assets which mimic the behavior of the liabilities is valuable and worth at least some sacrifice in expected return. Many such portfolios, especially when they are fully funded, have two “buckets” for assets, one that is designated as the “liability immunizing” portfolio and one that is designated the “return-seeking” portfolio.
The reason this is a valuable mode of thought for an individual or family office is that it tends to force a focus on the long run, since the “liabilities” in question (such as retirement, college education, bequests, etc) tend to be long-term in nature. But there are a couple of challenges.
One such challenge is to get the client to focus on that long run, rather than on the brokerage statement that shows up in the mail every month and is always one mouse-click away. And that’s what I discussed/lamented on in those prior two articles.
The other challenge is that, unlike a pension fund or endowment, an individual has a kaleidoscope of different liabilities that behave differently from each other. Some of these, like saving for retirement, can be approximated by general consumer price inflation (CPI). But some, like saving for college or saving for future health care costs, behave in their own unique ways. And so the conundrum for many years has been “sure, personal Liability-Driven-Investing makes sense, but what assets do I hold against those liabilities?”
This has driven calls for “goal-appropriate financial instruments,” led by people like Arun Muralidhar (who specifically used that term in “Goals Based Investing, the KISS Principle, and the Case for New Financial Instruments”) and Robert Shiller, who muses on making “previously untradable risks tradable” in Finance and the Good Society, and has a history of innovative enterprises to attempt the same.
What I am excited about is a step forward in creating these instruments…one that my company Enduring Intellectual Properties has had a key role in. Last week, S&P Dow Jones Indices announced the launch of the “S&P Target Tuition Inflation Index,” which is designed to reflect inflation of college tuition and fees over long-term periods. The index was designed by S&P on the basis of a method that we developed a very long time ago but could never figure out how to commercialize. It involves liquid securities, and so can easily be made into investible products such as mutual funds, ETFs, UITs, and other structured products that individual investors can buy. The chart below shows the index, alongside CPI for College Tuition and Fees (NSA).
As with any liquid markets-based index compared to a periodic economic indicator, the tracking error on a day to day basis is not necessarily good. But it is also not terribly relevant – how your fund does next week should not affect how you feel about your college fund! The strategy is built on an understanding of what the main drivers of college tuition are, and these turn out to be fairly simple (unlike is the case with, say, Medical Care). Because the main drivers of college tuition inflation are the same as the drivers of the index, the errors tend to be “mean-reverting,” meaning that the longer you hold the index the closer (in annualized terms) you tend to be to the target.
Investing in a product linked to this index will not be a substitute for saving money in the first place. But, having saved, investing in such a product should help to reduce the risk that the money saved for college suddenly evaporates, as it did for many parents in 2000-2002 and 2007-2009.
I am ecstatic that we were able to team up with S&P to create such an important index – one that will help investors save in a goal-driven way, with their eyes turned to the future rather than to the latest wiggle in the markets.
Not So Fast on the Trump Bull Market
**NOTE – please see the announcement at the end of this article, regarding a series of free webinars that begins next Monday.**
Whatever else the election of Donald Trump to be President of the United States has meant, it has meant a lot of excitement in precincts that worry about inflation. This is usually attributed, among the chattering classes, to the faster growth expected if Mr. Trump’s expressed preference for tax cuts and spending increases obtains. However, since growth doesn’t cause inflation that isn’t the part of a Trump Presidency that concerns me with respect to a continuing rise in inflation.
In our latest Quarterly Inflation Outlook, I wrote a short piece on the significance of the de-globalization movement for inflation. That is an area where, if the President-Elect delivers on his promises, a lot of damage could be done in the growth/inflation tradeoff. I have written before about how a big part of the reason for the generous growth/inflation tradeoff of the 1990s was the rapid globalization of many industries following the end of the Cold War. Deutsche Bank recently produced a research piece (I don’t recall whether it had anything to do with inflation, weirdly) that contained the following chart (Source: as cited).
This chart is the “smoking gun” that supports this version of events, in terms of why the inflation dynamic shifted in the early 1990s. Free trade helped to restrain prices in certain goods (apparel is a great example – prices are essentially unchanged over the last 25 years), by allowing the possibility of significant cost savings on production.
The flip side of a cost savings on production, though, is a loss of domestic manufacturing jobs; it is this loss that Mr. Trump took productive advantage of. If Mr. Trump moves to increase tariffs and other barriers to trade, and to reverse some of the globalization trend that has driven lower prices for the last quarter-century, it is potentially very negative news for inflation. While there was some evidence that the globalization dividend was beginning to get ‘tapped out’ as all of the low-hanging fruit had been harvested – and such a development would cause inflation to be higher than otherwise it would have been – I had not expected the possibility of a reversal of the globalization dividend except as a possible and minor side-effect of tensions with Russia over the Ukraine, or the effect the Syrian refugee problem could have on open borders. The election of Mr. Trump, however, creates the very real possibility that the reversal of this dividend might be a direct consequence of conscious policy choices.
I don’t think that’s the main reason that people are worried about inflation, though. Today, one contributor is the news that OPEC actually agreed to cut production, in January, and that some non-OPEC producers agreed to an additional cut. U.S. shale oil producers are clicking their heels in delight, because oil prices were already high enough that production was increasing again and they are more than happy to take more market share back. Oil prices are up about 15% since the announcement.
But that’s near-term, and I don’t expect the oil rally has legs much beyond current levels. Breakevens have been rallying, though, for weeks. Some of it isn’t related to Trump at all but to other initiatives. One correspondent of mine, who owns an office-cleaning business, sent me this note today:
“Think of you often lately as I’m on the front line out here of the “instant” 25% increase in min wage. Voters decided to move min wage out here from 8.05 to $10 jan 1. Anyone close to 10/hr is looking for a big raise. You want to talk about fast dollars, hand a janitor a 25% pay bump and watch the money move. Big inflation numbers pending from the southwest. I’m passing some through but market is understandably reacting slower than the legislation.”
Those increases will definitely increase measured inflation further, though by a lot less than it increases my friend’s costs. Again, it’s an arrow pointing the wrong way for inflation. And, really, there aren’t many pointing the right way. M2 growth continues to accelerate; it is now at 7.8% y/y. That is too fast for price stability, especially as rates rise.
All of these arrows add up to substantial moves in inflation breakevens. 10-year breaks are up 55bps since September and 30bps since the election. Ten-year inflation expectations as measured more accurately by inflation swaps are now at 2.33%. Almost all of that rise has been in expectations for core inflation. The oft-watched 5y5y forward inflation (which takes us away from that part of the curve which is most impacted by energy movements) is above 2.5% again and, while still below the “normal” 2.75%-3.25% range, is at 2-year highs (see Chart, source Bloomberg).
So what is an investor to do – other than to study, which there is an excellent opportunity to do for the next three Mondays with a series of educational webinars I am conducting (see details below)? There are a few good answers. At 0.46%, 10-year TIPS still represent a poor real return but a guaranteed positive 1/2% real return beats what is available from many risky assets right now. Commodities remain cheap, although less so. You can invest in a company that specializes in inflation, if you are an accredited investor: Enduring Investments is raising a small amount of money for the management company in a 506(c) offering and is still taking subscriptions. Unfortunately, it is difficult to own inflation expectations directly – and in any event, the easy money there has been made.
What you don’t want to do if you are worried about inflation is own stocks as a “hedge.” Multiples move inversely with inflation.
Unlike prior equity market rallies, I understand this one. It is plausible to me that a very business-friendly President, who cuts corporate and personal taxes and reduces regulatory burdens, might be good for corporate earnings and even for the economic growth rate (although the bad things coming on trade will blunt some of that). But before getting too ebullient about the potential for higher corporate earnings, consider this: if Trump is business-friendly, then surely the opposite must be said about President Obama who did essentially the reverse. But what happened to equities? They tripled over his eight years (perhaps they “only” doubled, depending on when you measure from). That’s because lower interest rates and the Fed’s removal of safe securities in search of a stimulus from the “portfolio balance channel” caused equity multiples to expand drastically. So, valuations went from low, to extremely high. Multiples matter a lot, and right now even if you think corporate earnings over the next four years might be stronger than over the last four you still have to confront the fact that multiples are more likely to move in reverse. In short: if stocks could triple under Obama, there is no reason on earth they can’t halve under a “business-friendly” President. That’s not a prediction. (But here is one: equities four years from now will be no more than 20% higher than they are now, and might well be lower.)
Also, remember Ronald Reagan? He who created the great bull market of the 1980s? Well, stocks rallied in the November he was elected, too. The S&P closed November 1980 at 140.52. Over the next 20 months, the index lost 24%. It wasn’t until almost 1983 before Reagan had a bull market on his hands.
An administrative announcement about upcoming (free!) webinars:
On consecutive Mondays spanning December 5, December 12, and December 19 at 11:00ET, I will be doing a series of one-hour educational seminars on inflation. The first is “How Inflation Works;” the second is “Inflation and Asset Classes;” and the third is “Inflation-aware Investing.” These webinars will also have live Q&A. After each session, a recording will be available on Investing.com.
Each of these webinars is financially sponsored by Enduring Investments.
Me and MoneyLife (with Chuck Jaffe)
Had a great interview with Chuck Jaffe on MoneyLife today! Interview is streamed at moneylifeshow.com/upcomingGuests… Look for me in the Wednesday, April 6th edition – about halfway down. Or click directly to the stream here.
Crowded Shorts and Stupid Math
(**Administrative Note: My new book What’s Wrong with Money: The Biggest Bubble of All has been launched. Here is the Amazon link. Please kindly consider buying a copy for yourself, for your neighbor, and for your library! If you are moved to write a review, or if you wander across a review that you think I may not have seen, please let me know. And thanks in advance for your support.)
With today’s trade, WTI Crude oil is now up 45% from the lows set last month! That’s great news for the people who had endured a 75% fall from the 2014 highs to last month’s low. More than half of the selloff has been recouped, right?
Well…not exactly.
Stupid math.
In a nutshell, a 45% rally from $110 would be a bit more impressive than 45% from $26.05, which was the low print for front Crude. And energy markets, in both technical and fundamental terms, have a lot of wood to chop before prices return to the former highs, or even the $40-60 range on crude that many people think reflects fundamental value.
So why the dramatic rally? Oil bulls will say it is because rig counts are down, so that supply destruction is happening and helping to balance the market. Perhaps, although rig counts have been falling for some time. Also, some producers have been talking about reining in production…again, perhaps this is important although since the US is the world’s largest producer of oil and neither Saudi Arabia (#2) nor Russia (#3) are in a good economic position to reduce revenues further than they already have been reduced by falling prices this would seem to be a marginal effect. And I might also add the point that thanks to the very long fall in prices, energy commodities are much cheaper than other commodities – which have also fallen, but far less – on a value metric. But no one trades commodities on value.
The real reason is that being short energy has become a very crowded trade. This is partly because of the large overhang of crude and other products in storage, but also partly because the energy futures curves are enormously in contango, which means there are large roll returns to be earned on the short side by being short – because, when the delivery month approaches, the short position buys back the front month and sells the next, higher-priced, contract. In this way, the seller is continuously selling higher prices and rolling down into a well-supplied spot market. See the chart below (source: Enduring Investments), which shows the return you would earn if you shorted the one-year-out Crude contract and rolled it in to the current spot price.
Obviously, the main risk is if spot prices suddenly rally, say, 45%, leaving you with a heavy mark-to-market loss and the prospect of only making some of it back through carry. That is what has started to happen over the last couple of weeks in crude (and some other contracts). It was a crowded carry trade that is now somewhat less crowded.
What happens over time, though, is that it is hard to sustain these flushes unless the carry situation changes markedly. Once oil prices rise enough that the short on fundamentals is at least a not-horrible bet, the carry trade re-asserts. It is, simply put, much easier to be short this contract than long it. What changes the picture eventually is that the fundamental picture changes, either lowering future expected prices (flattening the energy curve relative to spot, and reducing the contango) or raising spot prices as the supply overhang is actually absorbed (raising the front end, and reducing the contango). In the meantime, this is just a crowded-trade rally and likely limited in scope.
Tomorrow, I will mention another crowded-short trade that has recently rebounded, but which is less likely to re-assert itself aggressively going forward.
Credit Where Credit is Due, Maybe
I will give the Fed this much. Although they have historically been lousy forecasters, I think that at least a few of them may be dovish at this moment not just because they are always dovish, but because they believe there is a legitimate reason right now to be dovish. That is, they are afraid that the recent global retreat in equities is not merely a correction from lofty multiples – it is that, at least, of course – but signs of something more fundamentally amiss. Heck, a member of the FOMC suggested in the most-recent “dot plot” that negative policy interest rates may be appropriate this year and next year!
Probably, China scares them quite a bit; I am not sure it should because I think China’s impact is generally exaggerated in terms of its effect on the US, given the relatively small amount of trade that we do with China, but it is reasonable to be concerned about that large economy right now.
The recent plunge in domestic manufacturing indices may also be disconcerting. While many of these are relative indices (are conditions better or worse than they were last month?) rather than absolute indices (how are conditions now, compared to what they were in some fixed base period?), it is difficult to ignore that today the Richmond Fed index dropped to -5 from 0, when +2 was expected, which puts it at the lowest level in a couple of years. Actually, the Richmond Fed Index alone would be quite easy to ignore, but last week’s surprise in Empire Manufacturing (-14.67, versus expectations for a bounce to -0.50) made back-to-back months that were the worst since 2009; the Philly Fed Index fell to -6 when +6 was expected (and -6 is the lowest level since 2012); and both Capacity Utilization and the Michigan Sentiment index have continued their decline from highs set late last year.
At some point, even if these are all small fry, one begins to sense a pattern. Even if one has a Ph.D. in economics and works at the Fed!
So I will give the Fed credit, or perhaps I ought to say the benefit of the doubt, that they are delaying tightening because they perceive weakness on the horizon. I believe that they are likely correct in that. In my view, this does not mean the Fed ought not to tighten but merely means they are so far overdue that they completely missed the opportunity to normalize policy during the expansion and now face another recession with no bullets. Policy still needs to be normalized, but in this case that perhaps means returning rates not to the mid-expansion norm but the recession norm (say, 3% on Fed funds rather than 5% on Fed funds). However, I will give them credit at least for recognizing at last that they are in a box. I wonder how long it will take them to understand that the box is of their own making; that the Fed ought long ago to have led the world’s central banks in raising rates rather than pursuing more and bigger QE to do what monetary policy cannot do well, if at all: buoy real variables.
And I will give credit to Governor Bullard, who is not always perhaps the sharpest knife in the drawer (why is it that whenever I give credit to the Fed it doesn’t sound like a good thing?) but was spot-on when he dissed Jim Cramer on CNBC on Monday. Not that Jim Cramer is the only cheerleader for permanent easing to permanently support equities, but he certainly is a standard-bearer. Bullard said:
“I’ve got a message for your friend Jim Cramer. The Fed cannot permanently raise stock prices. The idea that the Fed is going one way or the other, and this is what’s driving the stock market, is not true. He’s one of the great people at looking at businesses, how good is this business, what’s the profitability of the business, what’s this thing worth? And to have him cheerleading for lower rates 24-hours a day is, I think, unsavory.”
Unsavory, indeed.
A the least, I can empathize with the Fed’s dilemma. They have missed a whole cycle by over-easing the last time around. Okay, that was all in the past. “Mistakes were made.” So now what? What does the Fed do with growth evidently slowing, but inflation at the target and employment below the target?
What they should do, probably, is tighten with all due haste, but as I said above tighten to what is still an easy policy. The problem, as I have pointed out before, is that (a) this will cause a further acceleration in inflation, by tending to raise money velocity without a corresponding decline in money growth, and (b) there isn’t a chance of them actually doing that. At this point, they may be stuck. Ray Dalio may be right. More QE…more disastrous QE…may be the next step. But let us hope that, having tried and failed by doing too much, our central bankers might attempt to succeed by doing as little as possible.
Administrative Note: For those who missed my appearance on Bloomberg TV’s “What’d You Miss” program last Wednesday, here is a link to my segment: http://bloom.bg/1Jo7DDb Hope you enjoy!
Summary of My Post-CPI Tweets
Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments. And sign up to receive notice when my book is published! The title of the book is What’s Wrong with Money?: The Biggest Bubble of All – and How to Invest with it in Mind, and if you would like to be on the notification list to receive an email when the book is published, simply send an email to WWWM@enduringinvestments.com.
Also note that I have been invited to be a guest on “What’d You Miss?” today at 4pm ET. Catch it!
- Core CPI +0.1%, but y/y stays at +1.8% as it was a “soft” 0.1%. Specifically 0.07%, weaker than expected.
- Core services remains +2.6%; core goods -0.5% y/y.
- The -0.5% drag in core goods remains about what we can expect from the dollar’s current strength.
- But remember core goods is the smaller part of core inflation (and the more volatile part).
- Bottom line on Fed has been: plenty of argument either way. This number doesn’t affect the argument either way. Doves will be doves.
- No idea if Fed hikes tomorrow, but SHOULD have removed extraordinary accommodation when extraordinary risks were past. Years ago.
- Speaking of housing: Primary rents 3.62% from 3.56%; OER at 3.02% from 3.00%. This acceleration will continue.
- Lodging away from home is a small piece (0.8% of total CPI) but always fascinates me. 1.7% y/y versus 5.7% six months ago.
- Medical care was unch, 2.47% vs 2.49%, but pharmaceuticals was 3.5% vs 3.2% while professional services 1.7% vs 2.1%.
- The weakness in medical care continues to be the main story holding down core vs median, since 2013.
- Motor fuel of course a big drag on headline, but New and used motor vehicles also still weak (a dollar effect): -0.1% vs +0.2%.
- I actually think Median stands a decent chance of an 0.2% month, based on my back-of-the-envelope calculation.
- If I am right, then Median may be at the highest level since the crisis ended. Currently 2.28%; 2012 high was 2.38%.
- We won’t know for a few hours and my calculator doesn’t seasonally adjust the regional housing indexes so don’t take that to the bank.
- But even if median just stays at 2.3%, that’s consistent with PCE inflation being at the Fed’s target.
- Really looking forward to this: On Bloomberg TV at 4pm ET with Joe and Alix.
- Good time to mention my book “What’s Wrong with Money: The Biggest Bubble of All” due out in Feb. Can preorder: http://amzn.to/1YbJT0p
- We don’t even have cover art yet! But the manuscript is done.
- Much more interesting discussion [than OER] is medical care. MUCH harder to measure than OER, because consumers don’t pay for it directly.
- We all know insurance costs are going up, but part of this is a price effect and part is a utilization effect.
- Part of the effect of the ACA is to get people to consume less health care by making them pay for smaller costs directly.
- …of course, that lessens overall welfare since your tradeoffs are worse. But I don’t want to get too ‘inside baseball’ in 140 char.
- BTW, it occurs to me I never mentioned y/y core CPI is 1.83% from 1.80%, so it rose a smidge even though a weak core #.
There wasn’t a lot that was new or different in this figure. Housing continues to be the main strain on consumer budgets, as housing costs continue to rise and, given the rise in housing prices generally, this ought to continue. On the other hand, the main drag to core continues to be in the core goods component, and this ought to continue for a while. However, I don’t believe it will intensify, so for a while core (and more importantly, median) inflation will just creep up gradually. At some point, core goods will revert higher, and at that point core inflation will move with more alacrity. The timing on this appears somewhat far off, however.
That said, two other points need to be made today.
The first point is that the Federal Reserve will either raise rates tomorrow, or they will not, and this number has virtually no bearing on that. This Fed does not care very much about inflation, which is why they focus on a number (core PCE) which is not only the softest of the available series but also currently is very clearly too low based on a number of temporary effects. Core PCE has a lot to recommend it theoretically. But myopic focus on it (and any discussion at all of headline inflation, which is near zero only because of the oil price crash) can only mean that Federal Reserve policymakers are biased to be doves. But we already knew that. Moreover, if the Fed raises rates tomorrow and does it without removing the quantities of excess reserves in the system, they really aren’t doing much. At least, not much that is helpful.
The second point is that the inflation market continues to price dramatically different inflation over the next few years than we are likely to get. Either energy prices are going to continue to crash – in which case buoyant core inflation will still result in low headline inflation, which is what trades in the market – or they are going to stop crashing, in which case inflation expectations are far too low. There is virtually no chance that core inflation declines any time soon. I can make a case that core will only converge to near median, and then go flat, but unless housing collapses suddenly and unexpectedly core inflation is not going lower. (Of course, one-off effects like the medical care effect can still pervert the core numbers from time to time, which is why I focus on median, but this is inherently difficult to forecast and the one-off effects of course might also be in the upward direction).
