Thursday, February 09, 2012

Inflation or Deflation? Which One Is It?

Inflation vs. Deflation: See the Chart That Settles the Debate

I once heard a legendary radio broadcaster and producer describe what he believed is the biggest sin a public speaker can commit.

It's not verbal stumbling, going overboard with warm-up jokes or speaking too long. The greatest sin a public speaker can commit is to be uninteresting. What's more, the failure is related much more to the speaker's lack of preparation than to the topic.

This broadcaster argued that even the history of the fork could become an interesting talk.

We believe our financial and economic analysis is made even more interesting and insightful by using handcrafted charts. They're different than what you find in other financial publications -- they reflect our uniquely independent analysis.

The chart below from the December Financial Forecast is a good example. It addresses the inflation vs. deflation debate. (Below the chart, you'll find the edited accompanying text):

. . . the annual rate of change in the Consumer Price Index shows how deflation is slowly assuming control over the economy...The stock market decline of 2000-2002, the first Cycle-degree decline since the 1970s low, failed to generate outright deflation, but it did produce a steady reduction in the rate of growth of inflation. As Cycle wave c down grabbed hold in 2008, [the Financial Forecast] warned of outright deflation, which would be the first year-over-year consumer price decline in 53 years. One key tip-off was a clear uptick in concern about inflation. In March 2008...the spike to the most recent high on the chart formed and a commodity blow-off “sparked economists’ talk of inflation.” [The Financial Forecast] held instead that a “powerful deflation will carry the day.” The chart [above] shows the result.

The arrow marks the CPI’s drop in 2008 as just the beginning of a new deflationary era. Importantly, the inflationary concerns cited in 2008 have yet to abate. The bottom line on the chart shows the median expectation for consumer prices over the next year. Despite the relentless decrease in the rate of inflation from 1980, and especially since 2008, rising consumer prices remain the chief worry...A “fighting the last war” mentality explains much about the persistence of inflationary expectations...the Cycle wave IV bear market (first grey area on the chart) from 1966 to 1982 (in inflation-adjusted terms) mostly featured intensifying inflation. As CPI growth surged to a peak of 14.8% in March 1980, inflation expectations also peaked, at 10.4% in January 1980. At this point, the relentless slowing of rising prices has yet to generate any aggregate fear of falling prices...Deflation will be the pre-eminent feature of the bear market; it won’t go away until it generates expectations that are at least commensurate, inversely, with the 1980 peak in inflation fear.

In the latest Financial Forecast, you'll find more charts and analysis. The topics include:

A Dow Jones Industrials' trendline stretching back to 1932, and the immediate relevance that trendline has today.

European financial developments and how they're dove-tailing with the market's "peaking process".

An extreme in investor sentiment and what that may mean for the market just ahead.

And much more!