Deflation? Not so fast…

It was a pretty good month for the US markets in February. Each of the three major market indicators closed with nice monthly gains and now have positive year-to-date return numbers. Right now, with interest rates low and corporate earnings rising across sectors, I continue to believe the market still has room to move higher.

Part of my assumption is that we’ll be seeing inflation moving higher in response to our growing economy. However, there’s lately been a lot of talk about, and focus upon, deflation and all the ugly stuff that would come with it. Here’s some information on that for your consideration.

Definition

Economic Times says, “When the overall price level decreases so that the inflation rate becomes negative.” They add, “A reduction in money supply or credit availability is the reason for deflation in most cases. Reduced investment spending by government or individuals may also lead to this situation.”

Former Fed Chair Ben Bernanke provided this definition. He said, “Deflation, per se, occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.” Put another way, the dropping of the price of different kinds of “stuff” – like crude oil – by themselves don’t equal deflation.

On a big scale, deflation is not a good thing, to be sure. That’s because if a country’s economy experienced across the board lowering of prices and if that dragged on for too long, companies’ profits could begin to decline. This would likely cause the firms to reduce wages, or even lay off workers or close facilities. At this point, unemployment would go up, the economy can’t grow and people aren’t spending their money because their economic future seems uncertain. And, of course, stock markets would suffer as well.

So, why are we talking about this?

The rapid drop in crude prices has led some pundits to apparently assume that it’s just the beginning of deflationary pressures. They used as further proof the Labor Department (DOL) saying this past week that the Consumer Price Index (CPI) fell 0.7 percent in January. This was the largest monthly decline since December 2008. Yes, it was, but what’s the bigger picture?

The drop in the crude price was the main driver for this – period. Year over year, in order to give you more of a trend instead of just a snapshot, the same data show consumer prices, when energy isn’t included, are definitely non-deflationary, They’ve actually risen by 1.9%…just below the Fed’s current inflation target growth rate of 2%.

For those of you who buy gasoline, you’ve already seen some rise in your costs at the pump as the crude prices have pretty much stopped dropping. This will reduce any further drops from energy in the CPI. And, for those who visit grocery stores, the DOL’s report showed food prices have risen 3.2% in the past 12 months. Matter of fact, if you’re a fan of steak, you’ve been out of luck with this deflation stuff. Steak prices are up almost 15% from a year ago….not including tip.

A very good deflation effect

With the obvious exception of those involved with exploration and production of energy, the ripple effect of lower crude prices in our economy has been, in my opinion, mostly positive. I see proof of that coming from the section of the CPI report which reported that “real”, i.e., inflation-adjusted, average hourly earnings rose 1.2% in January.

This marked the fourth consecutive month of gains and was the largest monthly rise since 2008. Earnings are now up 2.4% from a year ago and up at a faster 4.9% annualized rate over the past six months. Translation…consumer purchasing power continues to grow as US workers got their biggest raise in years. And, in a services-based economy like ours, that’s significantly positive.

Summary

I believe this observation from Peter Boockvar, chief market analyst at The Lindsey Group, sums this deflation scare talk up very well. He said:

“Bottom line, talk of deflation is complete nonsense as this inflation gauge is being almost fully driven lower by energy prices. We are a services economy and services inflation ex-energy was up 0.3 percent month-over-month and 2.5 percent year-over-year and has been persistently above 2 percent for years.”

I think this deflation talk is all just another financial media blather du jour story, just focusing on a headline to sell a story.

As I suggested at the top of this piece, the (positive) trend remains your friend in the markets…

Please email or call me with your questions or comments.

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

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