Five Things You Need to Know: No One Is Driving the Train
Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. The Return of Stagflation?
Bloomberg Headline: Housing, Price Reports Raise Stagflation Fears
Grim as expected, housing starts fell 11% in July as builders broke ground on the fewest homes in 17 years. That's good. It demonstrates that even blind faith optimists have a pain threshold that cuts against denial. I was beginning to think some of these builders lacked the spasmodic gulping reflex that prevents normal human beings from drowning themselves to death while simply trying to get rid of the hiccups.
Meanwhile, the Labor Department reported producer prices soared nearly 10% higher than last year. The snap judgment that follows is that this cocktail of data has plunged us deep into Stagflation.
"There's no doubt we're in a period of stagflation now," Bank of America (BAC) senior economist Peter Kretzmer told Bloomberg. For all I know he's probably right, but stagflation is a transfer station, not a hub, and we have a long, long way to... Holy Mother of Mary and Revelations!!! There's this bizarre news on the wire RIGHT NOW about a Dallas fisherman claiming something about snagging a feverish BEAST with digestive problems and some kind of ooze seeping from bursting pustules...
Never mind all that. I misread something in the story. It was not a Dallas fisherman at all. It was the President of the Dallas Federal Reserve, Richard Fisher, who in a speech earlier today said, "The recent burst of cost-push inflation is giving the beast digestion problems that might manifest themselves in the form of a lingering inflationary fever."
Clearly, things are even worse than I thought. When GOVERNMENT officials talk publicly and openly about strange BEASTS and FEVERS and things BURSTING open it means the whole train is off the rails. There's no stuffing talk of beasts back into the bottle and pretending you were joking. I once read a study claiming that the average person hears only about every seventh or eighth word of a 2,000 word speech. But they will latch onto something like BEAST and FEVER and ACT accordingly.
This can only mean terrible things are in store for Dallas. But I am only one man, and so from here in New York City I have no choice but to focus on the things within my immediate reach that I can control; various liquids and food items, scissors, assorted gels and the raw data release from the Labor Department focusing on the Producer Price Indexes.
2. Inside the Producer Price Index
I've always had a thing for numbers, a fascination with how dangerous they are, how easily they can be used to both shade the harshness of truth and char the eyeballs of bald-faced liars. Make no mistake, when a cop shines a Pelican 7060 LED Flashlight (130 lumens) in your eyes and asks how many drinks you've had, there's nothing haphazard or hollow about the question. Years of intensive psychological and physical training have gone into that tactical procedure, and the only answer under such dire circumstances is the right one, the truth.
So what's the truth behind these Producer Price Index numbers? Highest annual rate in 27 years? We better stop the car before we get the full-on Pelican 7060 treatment. Twenty-seven years? 1981? That's probably a felony. Clearly, there are some things we need to understand about this datapoint, so let's take a look.
The Producer Price Index tracks the prices producers receive for the stuff they make. It used to be called the "Wholesale Price Index" up until the late 1970s, but the name was changed to "Producer Price Index," probably because advertisers created widespread confusion and hysteria among government data collectors by offering stereos and eight track tapes at wholesale prices instead of retail prices.
Think about it. If you are the poor bastard at the Labor Department charged with collecting producer and consumer price data, you can't have retailers selling Uriah Heap eight tracks for wholesale - $6.99, maybe even less. That's the kind of steep price discounting that confuses the numbers and ruins everything. But that's neither here nor there. We're supposed to be focusing on the Producer Price Index... and what it all means.
3. How to Read Between the Lines
The Bureau of Labor Statistics tracks Producer Price Index data through a sampling of producers in the manufacturing, mining and service industries. Together, we're going to comb through this thing like the professionals we are. Then, you can feel free to abuse yourself at your own discretion, on your own time, by looking at the report each month here.
First, there is the so-called "headline" number, which is typically the first sentence in the Labor Department's release:
"The Producer Price Index for Finished Goods advanced 1.2 percent in June, seasonally adjusted..."
Because food and energy prices are volatile and show large fluctuations month-to-month, most economists pay closest attention to the "core" Producer Price Index, which excludes food and energy. The "core" reading today was an increase of 0.7%.
Believe me, although there is widespread vicious antagonism and demented hatred toward the Federal Reserve and economists for their reliance on the use of "core readings," you'll want to think long and hard before hitching your cart to that strange tractor.
Trying to forecast inflation based on data that includes food and energy is like trying to judge how drunk you will be this evening by how much whiskey you had last night. It simply can't be done. There are too many competing factors involved, notably how much food you are going to eat today and how much energy you are willing to expend tonight in your efforts at intoxication.
4. The Three Stages of Processing
In addition to the headline and the core reading, the PPI breaks down price data based on the stages of processing: Finished Goods, Intermediate Goods and Crude Goods. Why? For one thing, this helps sort out where pricing pressure - or the lack of pricing power - are building in the so-called "pipeline," a fancy term for the many different stages of production - from obtaining the raw materials, to processing the raw materials, to products that are finally "finished" and ready for sale.
In today's PPI report, the Finished Goods PPI was up 1.2%. The Intermediate Goods PPI was up 2.7%. The Crude Goods PPI was up 4.2%. What does this mean? Think about it for a moment.
If the prices you receive for your finished goods are rising at 1.2% month-over-month, while the prices for intermediate and crude goods are rising at a faster level - as they have been for almost six consecutive years now - then that means you are finding it difficult to pass through price increases to your customers.
Below is a chart showing the spread between the Crude Goods PPI and the Finished Goods PPI.
The important thing to take away from this from a forecasting sense is the implied deflationary pressures that continue to build. The spread is now at its greatest point, a new high, which means that despite the "inflation" in the headline, there is an inability to pass through costs. Marry that inability to pass through costs with ongoing housing price deflation, the balance sheet restructuring going on with banks, the reduction in credit availability to both Wall Street and Main Street and you can begin to understand how the obsessive focus on inflation is like a weird obsessive focus on the sun setting in your rear view mirror while you drive straight over a cliff.
5. No One is Driving the Train
So you can see why all this talk about beasts is dangerous and disturbing, a sign the train is off the rails. A train derailment is an awful, unexpected tragedy. The parallel lines of the steel track run strong and true, a geometrically precise mandate for containment. The feeling among those who have never seen the inside of a locomotive is that the things pretty much drive themselves.
Of course, nothing could be further from the truth. It takes skill to operate an 8,000 ton train at 45 mph, which reminds me of a chart I put together a little over a year ago, just before these Fed officials began using all their "powers" to rescue the financial sector and, by extension, the economy. To go from "well contained" to FEVERISH BEASTS in one year tells us all we need to know about who is driving this train. No one.
Click to enlarge
And here's the updated chart since: 
CLICK IMAGE TO ENLARGE
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That, and that the train appears to be headed for that cliff. Diesel train as well, not electric although an electric train would likely consume electricity from something other than nuclear.
That is one of my favorite MV charts.
I think we kinda work on the 'good and decent' man theory. That is, the people running the show have intrinsic ability, energy, and integrity. If someone constantly bends the truth, or maybe twists it into balloon animals (BLS statistics - using substitution, weighting, and hedonics to decrease inflation) are they really 'good and decent' or something less?
Just sayin'...
MYSTERY
BABYLON THE GREAT
THE MOTHER OF PROSTITUTES
AND OF THE ABOMINATIONS OF THE EARTH. 6I saw that the woman was drunk with the blood of the saints"
So now we can combine Pres. Bush's comments about Wall Street getting drunk with Fisher's comments about the feverish beast and draw a conclusion:
The end of the world. For the next chapter we see:
"The merchants of the earth will weep and mourn over her because no one buys their cargoes any more— 12cargoes of gold, silver, precious stones and pearls; fine linen, purple, silk and scarlet cloth; every sort of citron wood, and articles of every kind made of ivory, costly wood, bronze, iron and marble; 13cargoes of cinnamon and spice, of incense, myrrh and frankincense, of wine and olive oil, of fine flour and wheat; cattle and sheep; horses and carriages; and bodies and souls of men."
That sounds like the NERB might declare a recession.
Professor Depew,
I enjoy reading your comments as much for their humor and literary license as I do for the information.
However, I just want to clear up one point. The reason there is "widespread vicious antagonism and demented hatred toward the Federal Reserve and economists for their reliance on the use of core readings" is because in times like these most of us are much more concerned with living in the present than predicting the future. Food an energy may only represent a small percentage of your monthly expenditures but for us members of the unwashed masses they represent survival.
As the interest on my savings dwindles and my wages stagnate while my living expenses soar it provides little solace that your new big screen plasma TV was still a bargain.
No new stimulus package! What's another 165 billion? Chump change according to our current leadership. Zeros, Decimals, prime numbers. A billion, a trillion, bazillions. CDO it and fiat it off to China to finance.
Makes no sense to pour this money into our infrastructure and create jobs for those unemployed or about to be. Especially when most of it would go to keeping the illegal's employed under the table so they can money order it back to their homeland.
We need a team of forceps specialist to go through Congress the Senate and the White House. The public is tired of our political leaders maintaining their tan lines just south of the neck lines. Our fecal faced leaders need to be replaced.
On second thought maybe they would be easier to herd out the door if we left their heads where they are. Doesn't that paint a picture?
JPM
In the shuffling madess
Of the locomotive breath,
Runs the all-time loser,
Headlong to his death.
He feels the piston scraping --
Steam breaking on his brow --
Old charlie stole the handle and
The train won't stop going --
No way to slow down.
Too late, we find out otherwise. Then, we are shocked, shocked I tell ya.
When will the population wake up and smell the coffee? Never, until it's too late. It's a form a self deception or denial we all want to play.
The bottom line is that the dishonest person fully expects to begin the game with the advantage of their victims expecting honesty from them. All honest people are at a disadvantage when dealing with dishonest and evil practices.
Particularly when it comes from people we expect to be honest.
The final insult is that when we finally wake up, we still stay in denial for a little while longer because we don't want anyone else to figure out we've been scamed. This last delay usually allows the guilty to make a clean getaway.
As far as govt. goes here is what I encourage everyone to do.
1. Vote out incumbants - across the board
2. Vote for president goes to ......... NONE-OF-THE-ABOVE
this is my write in candidate - please do the same
3. hope that the socialism coming down the pike won't leave us pennyless(or is it 2 cents - the cost to make it)
4. PLEASE RAISE TAXES on corporations by 100%
Today they pay less than 19% in 1980 they paid their fair share of 49%
It's really very simple, though. In the end the good guys win and the bad guys lose. Before that, though, there is suffering.
The applications to timing the market are obvious. Well-run companies with solid fundamentals will return more value in the long run than the Enrons. The process of price discovery can be painful, though, and dishonest CEOs will attempt to place the Mark of the Beast on their SEC filings.
Could it be that, after so many years of absorbing cost increases (due to the availability of so much easy credit?) the time is coming for those pent-up costs to be reflected in prices? Unfortunately when the prices go up, consumption will go down, which may reduce economies of scale resulting in still higher prices going forward...
If that's the case, then the potential for rather sudden price inflation is more likely than your article acknowledges.
That's not to say that we don't still have an awful lot to be concerned about. Thanks for the article.
Second, I have long been fascinated with the approach to "core" prices vs non-core...
In the world of statistics, signals and systems, when one has a "noisy" variable in the system which is volatile, one filters this to reduce the noise using any number of techniques, but when it comes to economics, usually a moving average or exponential moving average will do the trick...
While I understand why you might want to "smooth" the food/energy component as it swings around wildly - rather than "smooth" it, they seem content to IGNORE it... Whatever you might have to say about the near term volatility of food/energy costs, the long term moving average has a pretty high signal-to-noise ratio and it says MUCH HIGHER!...
The original decision to exclude them, based on FED ramblings was that they were outside the realm of the FED's control and as such, they did not bother reading them - looking only at items which were influenced by monetary policy...
Two things have happened:
1. the FED/Treasury is the primary source of inflation which drives the price of everything (UP)
2. the FED now claims control over everything including the intensity of the sun and CO2 emissions from cattle through monetary policy...
In short, why not just "smooth" the food+energy components and stuff them back into the *PI reports where they belong... That would be a more reasonable number...
Because the government must adjust entitlements to the cost of living. Can you imagine what would happen to SS payments if they reflected the actual cost of living even over the 2 years?
The government has a huge incentive to massage that number until it screams uncle and comes down to around 1% while printing at the other end to try to take some pressure off the debt/entitlement programs.
Sorry, I know why "they" do it, I guess I was wondering why anyone with a clue listened? I should have been more clear on that point...
The headline writers take the Kremlin's (er, Washington's) reports and read them verbatim as if there is a gun pointed to their head off camera...
You know, as in: "What a relief - the government has reported again that inflation is only about 1%, the same number it has reported for the last several years. Thankfully, we don't need to spend the effort to write a new story other than to change the actual number they reported. We will continue to assume that the government slightly changes the number on regular basis because it's based on Math and Economic Theories, and lots of other things we don't understand because we majored in journalism and they don't make us learn that stuff. We did learn, in between some awesome parties, that we're supposed to be unbiased, so we'll always have a free pass to just report whatever the powers that be tell us without much critical thought.
So all is well because the government says so (again!). Please go back to your normal life and continue buying stuff from our advertisers. "
Taking the discussion further in regards to scale there is a curious obsession with investments in large scale. Talk about a group delusion. Scale operations have not always been such an unambiguously "good" thing as they are today. I suspect this is tied up with cheap energy, but that is a whole different topic.
Ask any ecologist about "big" organisms and they'll tell you that they are notoriously unstable compared to the small in nature. Given that nature has a much longer history than our "free" markets I have to believe that there will likely be some serious mean reversion with respect to scale on that basis. I take the moral to be that it's great to be big when times are good, but when they are tough the bigger they are the harder they fall.
Some small production businesses have very attractive returns today as long as they don't have to be funded with debt. Much more attractive risk/reward profile in fact than any public market vehicle I have found to this point. I'm talking cash return times on the order of 1-2 years. However, these “investments” take more work than clicking a buy or sell button on a terminal so it is clear to see why there isn't any mania regarding this activity.
The cash return time for an investment in the SPX is over 35 years at the measly 2% dividend rate – and that's not even adjusting for inflation. I'm of course holding to the maxim that it isn't an investment if you have to factor in capital gains so I have not as I think we are seeing why now in real-time. Some will say security, but with so many public market vehicles gyrating at over +/-25-50% on an annual basis that must be a joke unless someone can choose when they need the cash. Most of us can't really do that.
It seems reasonable that as long as energy scarcity is rising the appropriate investment at this juncture is NOT large scale or publicly traded, but small. The primary advantages I see are: transparent, can be funded with cash, easy(ier) to predict variables and flexible.
When Enron closed up stockholders couldn't even take home a stapler to ease their pain. At least if my own business goes bust I'll get some utility from the assets I purchased for the business and have the benefit of the experience.
