Cross-eyed Mary

By David B. Armstrong, CFA | Nov 24, 2014 | Weekly Market Commentary

While the classic song found on the epic 1971 Jethro Tull Aqualung album is more about a wayward schoolgirl than an actual cross-eyed girl, it can evoke an image of someone or something not seeing straight.  Like inflation.

So What’s Up With Inflation?

It may seem cross-eyed.

Casual mention of the word “inflation” can elicit many different responses.  For example, what goes through your mind when you see a story on the low rate of inflation in the U.S.? Any way you slice it, it can probably be agreed upon that the official measures point to inflation that’s running below 2% per year.

Oh yeah, I know you… if you are a guy, you are probably eyeing that smoking hot deal on a 60-inch LED TV just in time for Rivalry Saturday in College Football.  These days that thing is probably gonna run you a lot less than you’d spend on a new set of bed linen from Pottery Barn.

But on the other hand you may be saying, yeah but what about the rising food costs, higher health insurance premiums, the cost of an airline ticket or the most recent hike in your cable bill.  Really, I’m 12-18 months away from a day where I’m not watching anything that is not streaming off the internet… but that’s another thought for another day.

Without a doubt, it’s easy to point to anecdotal examples of outsized price increases. In the case of food, rising prices have outstripped the broader measures like the Consumer Price Index (CPI).

While food costs as measured by the CPI rose just 0.1% in October (BLS), price hikes at your local restaurant and in the grocery aisle have accelerated this year. See the chart below.

Since the start of the year, the rate of increase in all food (it’s the black line) has nearly tripled. Also, shelter costs (not in the chart but make up nearly one-third of the CPI), have been increasing at roughly 3% per year.

So yes, modest inflation is being reflected in parts of the economy.

But, the broader measure of inflation remains benign. For example, last month, the CPI (generally referred to as Headline CPI by smarty pants finance peeps) was unchanged as energy fell 1.9% including a 3.0% decline in gasoline prices. (You’ve been to the gas station lately, right?)  If you strip out oil and food (known as Core CPI), inflation rose 0.2%.

That leaves the year-over-year Headline CPI up 1.7% and the Core CPI up 1.8%. Historically, that’s pretty mild.  Kicker – it’s also BELOW the 2.0% target established by the Federal Reserve. Check out this sweet chart.

Check out the part of the chart starting with January, 2013.  For the most part, Core CPI (blue line) has held within a narrow range. AND, based on what’s happening to wholesale prices (measured by what’s called the Producer Price Index), there is little in the way of inflation building in the pipeline.

Now, given the recent drop in oil and most commodity prices, some inflation watchers are checking to see whether falling input costs will bleed into Core CPI.  We’ll see.

Based on the minutes released from the Fed’s late October meeting, most Fed officials believe inflation is “likely to edge lower in the near term, reflecting the decline in oil and other commodity prices and lower import prices.” But they also continue “to expect inflation to move back to the (Fed’s) 2% target over the medium term.”

If the Fed is wrong and the rate of price hikes begins to slip, it may delay an interest rate increase, which most analysts believe will probably occur in middle of next year…IF it happens.

1. I capitalized it because it’s a “BIG” if. Did you see what I did there?  Creative huh?

Markets

Here’s how the markets ended up last week.

Earnings

I missed blogging last week when earnings came to a close, so this news is about a week stale.  The 3^rd quarter finished up relatively strong.  Here’s how it wrapped up:

The percentage of companies beating their revenue estimates for the 3Q ended up at 57.2%. This was below the average of 60% that we’ve seen since 2001 and also below the 60.7% that finished up the 2Q of 2014.  However, it was above the 56% final reading we saw in the 1Q.  Since the revenue readings bottomed out in the 4Q of 2011, quarter-over-quarter readings have ping pong’ed but the trend has been steady UP for revenues.

The percentage of companies beating their earnings estimates finished at 62.1%.  This is above the 58.6% final reading from the 2Q of 2014 and well above the 56.7% reading from the 1Q.  We were at 66% at one point but once the small-cap stocks started reporting, this came down.  But it’s still good.

Thanksgiving

The stock and bond markets will be closed on Thursday and will close early on Friday. We will be open but lightly staffed.  Please have a safe and joyous holiday with family and friends!

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