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For inflation acts as a gigantic corporate tapeworm. That tapeworm preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism. Whatever the level of reported profits (even if nil), more dollars for receivables, inventory and fixed assets are continuously required by the business in order to merely match the unit volume of the previous year. The less prosperous the enterprise, the greater the proportion of available sustenance claimed by the tapeworm. - Warren Buffett, Shareholder Letter - 1981
That's an extra headwind that many might not realize. Inflation can hurt corporations just like it hurts individuals. Therefore, sitting in stocks doesn't necessarily protect us from inflation (especially if it spirals out of control).
This shows the growth in the CPI-U over the last ten years. This chart also shows the inflation adjusted growth in the S&P 500 index over those same ten years (annualized to show the average annual growth).
Here's the scatter chart. Pretty crazy looking, huh? Upon further reflection in the first chart, there appears to be a lag. Let's see what happens if we scoot that inflation data backwards in time by four years. Why four years? Just looks about right to me.
Say, that's looking pretty good, huh? Needless to say my jaw dropped when I first saw it. It was definitely an "Aha!" moment at the very least. This implies that problems in the stock market proceed problems in the inflation data by about four years. That's not something I would have guessed. It also implies the inflation some of us have been waiting for but never seems to arrive simply requires a bit more patience.
Where is that red line likely to head in the future? Is it going to follow that black line like it has for four decades or more? Oil is past $90 a barrel. Gold is past $800. The dollar is tanking. The Fed is being asked to cut interest rates. Inflation protected securities have outperformed their non-inflation protected counterparts this year. Growth is slowing. And now this? I think it is safe to say I'm remaining stagflationary until proven otherwise.
Talk about a tight correlation. Oh oh.
Once again, this is most certainly not investment advice. In my opinion, our economy is in uncharted waters. Therefore, charts of the past might not help much. It is possible that the Fed has learned some valuable lessons from the 1970s and will be more vigilant this time. One thing is certainly different. Unlike the 1970s, we've embraced debt in a major way (and if history is any indicator, that will offer plenty of deflationary pressure).
Keep in mind I'm just a random Internet blogger posting my thoughts in public. The data is certainly available. I would very much welcome any confirmation that these charts are accurate.
I should also add that mining the data for information is always risky. Patterns can be found in even random data if one goes looking hard enough. I'd feel somewhat more confident with these charts if I would have started with a four year lag theory and ended with the confirmation. Instead, I have started with a confirmation and ended with a four year lag theory. In general, that isn't nearly as solid.
See Also:
Warren Buffett on 1970's Inflation
Source Data:
St. Louis Fed: Consumer Price Index For All Urban Consumers: All Items
Yahoo Finance: S&P 500 Historical Data
As seen on Yahoo's website, historical chart data and daily updates provided by Commodity Systems, Inc. (CSI).
Disclaimer: Yahoo provided a spreadsheet download link so it is fairly clear that I was free to download the data. Since I am not actually sharing the raw data and I am crediting the sources, I am assuming that I am not infringing on anyone's copyright.
5 comments:
1) "inflation adjusted growth in the S&P 500 index over those same ten years (annualized to show the average annual growth)"...don't understand. Does a point on the chart in (say) 2001 mean: the real index growth from 2000 to 2001, or does it mean the annualized real growth since some intitial period? And why does it say "last 10 years" when the X axis starts in 1964?
2)If there actually is a correlation between stock market downturns and 4-years-later inflation, any speculations as to what the mechanism might be? There's a more common belief that *strong* stock markets are inflationary, which makes sense since these are generally correlated with high capacity utilization.
David,
I certainly had a hard time wording the charts so I can understand the confusion (especially since I'm still up from last night, lol).
Does a point on the chart in (say) 2001 mean: the real index growth from 2000 to 2001, or does it mean the annualized real growth since some intitial period?
The 2001 point is how the index did from 1991 (10 years prior). If it was up 10% after adjusting for inflation, I annualized it to roughly 1% per year (1.1^(1/10)).
And why does it say "last 10 years" when the X axis starts in 1964?
The X axis starts in 1960. The data I have goes back to 1950 though, so the 1960 data point is showing how the index did from 1950 (and the CPI-U growth shows the inflation from 1950 to 1960, on average per year).
If there actually is a correlation between stock market downturns and 4-years-later inflation, any speculations as to what the mechanism might be?
Pure speculation mode. An infinite amount of money can flood into stocks and there won't be one bit of inflation (as reported by the government anyway). If that money floods into commodities and/or hoarding tendencies, eventually there's a problem though. That's my thinking anyway. I'm also thinking it takes time to change your mindset and stop embracing what worked in the past (so it does seem likely there might be a lag).
There's a more common belief that *strong* stock markets are inflationary, which makes sense since these are generally correlated with high capacity utilization.
I'm thinking the common belief might be wrong at this point (at least with a fiat currency and a Fed willing to print more). The stock market was strong throughout the 1980s and 1990s. Inflation was low as the stock market sopped up excess dollars. The stock market was weak throughout the 1970s though. Inflation was high. The stock market was not sopping up enough excess dollars. People were genuinely afraid of stocks (and with inflation so high, for good reason).
Then there's debt. We've got a lot more of it and none of these charts I've done here factor that in at all. We also fell off the gold standard in these charts. There's a lot to think about.
Just theories of course. Hope this helps. Thanks for the comments!
good post. i had to think about it a bit.
When CPI is low, the Fed cuts rates, thus inflates S&P. When CPI has been high they have maintained higher rates, thus lower S&P's value.
went back over data.
Using lagging numbers. It also indicates that the Fed changes money supply based on the stock market.
When the market is down, they print. When the market is up, they stop printing.
preserve,
Thanks for the comments.
When CPI is low, the Fed cuts rates, thus inflates S&P. When CPI has been high they have maintained higher rates, thus lower S&P's value.
When the market is down, they print. When the market is up, they stop printing.
In addition to your points, I would add that when the market is up they also feel comfortable printing because they don't see the inflationary effects in the price of goods and services.
For example, just before the dotcom bubble burst we could earn a real 3 1/2% inflation adjusted annual return on 30-year tax deferred I-Bonds. They'll be printing money to pay for that for the next 23 years. Further, that inflation won't show any time soon because those who have those I-Bonds will be loathe to cash them in early.
This real return was offered to hold down inflation (keep our dollars tied up in government bonds instead of commmodities) but all it really did, at least in my opinion, was defer that inflation into the future.
I-Bonds purchased today only offer a 1.2% real yield (and much if not all of that will actually be paid in taxes). There isn't nearly as much incentive to hoard dollars these days. I think our dollar's decline, the price of oil, and the price of gold all reflect that.
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