As anyone who has recently filled up their gas tank, made improvements to their home, built a house, or bought an appliance will tell you, inflation is back in full force. Their receipts don’t lie. Neither do commodities prices, as crude oil, lumber, and others have soared since this time last year.
Even so, neither Washington or the Federal Reserve seem to care. It is as though inflation doesn’t exist. I half expect Jay Powell to tell us: “There is NO inflation hiding under your bed. It is only a figment of your imagination. Now, go to sleep.” Those assurances didn’t work when I was a kid worried about monsters, and they don’t work for everyone now. More money out is more money out, and that is all there is to it. Right?
I suppose so. You see, inflation is where you want to look for it, and even how you want to calculate it.
For instance, as I have written here in the past, old recipes often call for 16 oz. cans of tomatoes. However, some time ago, the companies that produce canned tomatoes shrank the amount to 14.5 oz while keeping the price the same. So, the same price for a lesser amount? I would call that inflationary, wouldn’t you? Also, what is it when you have to buy 3 jerseys for your child’s soccer team, as opposed to 2 in the past. While the price of each might not have changed, you are paying more for soccer jerseys in aggregate. Although that technically isn’t inflation, it sure feels like it, doesn’t it?
However, my all-time favorite example is Apple Music, which is a service I use and love. The family plan sets me back $14.99, and hasn’t budged in a couple of years. For that amount, I can listen to just about any song I want. As such, my ‘cost’ per song is next to nothing. At first blush, that would seem deflationary NOT inflationary. Right? Well, prior to signing up for Apple Music a couple of years ago, I had never spent $180/year on music in my entire life…not even close. I spend way more on music now. Although that technically isn’t inflation, just liked canned tomatoes, it sure feels like it.
Then, there is the way the Bureau of Labor Statistics (BLS) calculates the Consumer Price Index (CPI), which is the de facto official inflation rate in the United States.
Say what you want about the Federal government, the folks at the BLS put in a lot of legwork trying to determine the CPI. Heck, you have probably even seen some of them at the grocery, and elsewhere, tracking prices on a lot of products/services. For instance, televisions make up 0.09% of the equation, and were down 0.7% for the 12-months ending this past March. Dishes & flatware, a mere 0.05% of the CPI, were down 2.0% over that same time frame. Clothes? Thanks to COVID-19, and maybe a tip of the cap to Jos A. Bank, Apparel prices were also negative, (2.5%).
Conversely, gasoline was up 22.5% from the end of last March through 3/31/2021. Major appliances, like washer & dryers, are up 14.5% since this time last year. And then, whew, take a look at what has happened to housing prices, both primary residences and vacation properties! Like a rocket to moon, as the S&P Corelogic Case-Shiller US National Home Price Index (NSA) is up over 11.2% since 3/31/2020!
The only problem is, drum roll please, home prices aren’t in the CPI; neither are construction or building costs. The reason being the CPI is attempting to capture ‘typical’ budgetary items for the ‘average’ American consumer. While fluctuations in the market value of your house might impact your balance sheet, they don’t really have much impact on the old monthly budget, do they?
So, as crazy as it may seem in today’s housing market, soaring housing prices technically aren’t inflationary unless they impact something the BLS calls the ‘owners’ equivalent rent of residencies,’ which makes up…get this…24.115% of the inflation gauge. I bet you had never heard of it, huh? Throw in hotels, dorms, and actual rent rates, and ‘rent of shelter’ makes up a whopping 32.765% of the CPI, and the BLS estimates this segment of the equation is up about 1.7% over the last 12-months.
That probably isn’t that bad of a guess, as apartment rent rates have stabilized over the last year for a variety of reasons. According to statista.com, they haven’t budged. So, for all of the apparent inflation in the housing market, home prices, construction costs, and all that jazz, there officially isn’t any. Well, very little, just that 1.7% from the previous paragraph.
In setting monetary policy, the Federal Reserve wants see inflationary pressures across the board before determining it is ‘systemic.’ As of the most recent CPI report, yes, some aspects of the equation have gone through the roof, notably energy, appliances, furniture, and animal proteins. We notice that stuff, and even fixate on it. However, we just kind of expect the sale at the clothing store, and who wants to pay up for bananas? Am I right? Further, why not just wait a month or two to buy the television or other audiovisual equipment? Those prices seem to always be going down.
As a result, you can think of the inflationary pressures in the economy as being how William Blair at seekingalpha.com described them: “When I say I expect inflation to occur cross-sectionally, I mean price increases are occurring at various points in time for different goods and services around the world.”
For instance, right now, commodity prices are up sharply, almost across the board, almost. This is largely due to a sudden sharp spike in demand during the second half of last year after the collapse in global economic activity at the start of 2020. Think of it this way. Did you ever play in a creek or stream when you were a kid? If so, did you ever make little dams with rocks and pebbles? What happened to the water when you did that? It backed up, right? And what happened when you took the biggest stones away?
In so many ways, that is what has happened to the global supply chain. All of the economic shutdowns and restrictions politicians imposed on their populations were like plopping a dam in the middle of a stream. So, all of that demand backed up, just as water in a stream would. Then, they started taking away the bigger stones, if you will, and the water/demand which surged forth swamped the global economy’s ability to get the right product to the right place at the right time. As such, prices for certain commodities and products have soared, as businesses are scrambling to meet orders and make deadlines.
With this little scenario in mind, has the overall amount of water in the entire creek changed, its capacity? Probably not any more than removing a rock from a cup of water would alter the actual volume of water in it. As a result, it is too early to tell whether these recent increases in prices will be permanent. I hope this makes sense.
As I type, it seems the powers that be are prepared to let these recent inflationary pressures work their way through the system without addressing them. This makes sense, all the more so when the ‘shelter’ component of the official inflation gauges is sitting on the CPI like an anvil. Why crush something which may or may not exist? At least that is what Jay Powell seems to be saying.
Therefore, let me close today with how I started this week’s missive: “You see, inflation is where you want to look for it, and even how you want to calculate it.” Yep, that about sums it up.
Take care, have a great weekend, and be sure to tune into our podcast “Trading Perspectives.”
John Norris
Chief Economist
As always, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, are subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the reset of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.