I have commented before in this blog that until Covid came along I could count the number of investors who SERIOUSLY worried about inflation on one hand after chopping off a few fingers. Of course, the gold bug brigade have been frothing about inflation for a decade – and maybe at some point they’ll be proved right – but everyone else seemed to be more worried about Japanese style deflation.
Everything changed with Covid, for better and worse. The obvious deflationary pulse does not need elaborating, but the inflation worriers have grown in number. Two processes seem to be at work. The first, little commented on, is that a large number of ordinary household stuff seems to be costing MORE! I’ve certainly noticed it anecdotally. But this process is patchy as some stuff is obviously costing a great deal less and will probably get cheaper as retailers for instance gear up sales to boost revenue.
The other process is much more dangerous – the expectation problem. As money supply, rightly, increases and central banks splurge like never before investors perception of inflation risk is increasing. My guess is that most of these worriers are focused more on 2021 and 2022 when the rebound should be more aggressive and all that capacity destroyed in the last few months is crowbarred back into action again, at a higher cost. My instinct tells me that this is over blown and that we really, really need to worry about deflation as the economic crisis intensifies in the Autumn but what matters here is investor perception not necessarily reality.
Anyway, back to that first inflation fear – actual prices in the here and now. As I noted above, quite a few things seem to be costing a lot more and I have a funny feeling that official CPI numbers might be underestimating these price increases.
A new paper, Inflation with COVID Consumption Baskets, by Alberto Cavallo, Edgerley Family Associate Professor at Harvard Business School, academic partner of State Street Associates and Co-Founder of PriceStats*, provides some evidence on both sides of this debate. Overall the paper argues that “existing CPI weights do not reflect current spending patterns during the COVID crisis. In fact, they overweigh current spending on segments like transportation, airfares, eating out and lodging, all of which have non-trivial weights in the CPI calculation….Alberto found that more than half of the fall in measured inflation rate seen since January is due to this ‘basket’ distortion. As a result, the current risk of deflation looks to be more illusory than real and the ‘true’ rate of inflation is arguably higher than reported. “
The chart below sums up this view. So, maybe inflation rates are more of a problem than we first thought and my observations echo in the wider economy?
Source: State Street Global Markets, PriceStats
But it is worth digging around inside the academic paper behind this press release today. You can download it here – https://www.statestreet.com/content/dam/statestreet/documents/Articles/Paper_Covid_Price.pdf
The paper looks at measures of CPI inflation in 17 countries. The clever twist is to use “use high-frequency estimates of spending based on transactional data to build updated CPI [sector series] weights and compute alternative “Covid Basket” price indices”. Specifically the author uses “estimates of the changes in consumption expenditures, obtained from US credit and debit card transactions by Chetty et al. (2020), to update the basket of CPI weights and study the effect on US inflation”.
Using this data set the paper finds that by “ April 2020, the annual inflation rate of the US Covid index was 1.06%, compared to only 0.35% of the equivalent CPI (all-items, US city average, not seasonally adjusted). The difference is significant and growing over time, as new social-distancing rules and preferences prevent consumer spending in categories that are experiencing deflation, such as transportation, and induce more expenditure in food and other groceries, where prices are increasing over time.”
But the paper also looks at another 16 countries and finds that in 10 of those, “the Covid inflation rate is higher than that of the official CPI. In the other 6 cases, however, the inflation rate is lower, highlighting the fact that the CPI bias can go in any direction”. The table below outlines these inflation numbers. And the UK ? Here’s the sting in the tail. The “e UK is the only country that is still experiencing deflation in “Food and Beverages,” where the weight has increased significantly”. So, maybe we should generally be worried about inflation in the developed world economy but worry more about deflation here in the UK. If that is the case, this might be bad news for UK equities.
Just following up on my note yesterday which plucked some interesting data from the Edison Gold report. In VanEck have produced another set of data points via their monthly Gold Commentary, by Joe Foster, Portfolio Manager and Strategist. Some positive and negative observations here.
- “Silver mounted a comeback in May, gaining 18.3%, amid some of the strongest inflows into silver bullion exchange traded funds since their inception.”
- “Guidance is now being reinstated and early reports suggest 2020 production for individual companies will decline between 0-5%. The pandemic has not affected the long-term outlook for the industry.”
- “In a bull market, large-cap companies typically move first, followed by stronger performance by mid-tiers and juniors as the market advances. The lag in performance between the large and smaller companies is normally measured in weeks. However, after a year we are still waiting for the smaller companies to outperform.”
The Slow Death of Cash
Another week, another signpost on the slow death of cash. Obviously there’s a rear-guard action by some to plan this transition more sensibly. Good luck with that I say as in my experience cash is crashing at an alarming rate. Even my 80 something mother has started using her £45 limit on her debt card most days rather than a handful of tenners. The latest indicator ? “According to data gathered by BuyShares, the monthly number of ATM transactions in the United Kingdom plunged by 40% year-on-year reaching 110.4 million as of May.” In addition, this survey showed that the value of ATM Cash Withdrawals “Dropped Almost 45% in Six Months”. I give us five years before we all have an e-money wallet with the BoE.