Phantom Inflations

October 2017

“Pay no attention to the man behind the curtain!”
- The Wizard of Oz

Over the past few months, we’ve been wondering why the U.S. stock market continues to go up when it seems like it might have better reason to go down or at least sidewards. Please don’t misunderstand, we are enjoying the ride as much as anyone, but we also believe this market is relatively overvalued on a fundamental basis; as we stated before, we’d simply like to see a healthy correction to bring valuations in line and set us up for a better future. Coincidentally, we have also been wondering why reported inflation is apparently static while it seems like it should be going up. The answers may lie in looking behind the curtain to figure out not only who may be orchestrating events, but also by pondering the short and long term consequences of any possible manipulation.
For instance, I think we can all agree that the Federal Reserve has been working behind the scenes to manipulate inflation lower in order to stoke a recovery from the Great Recession. But what are and will be the consequences of flooding the U.S., if not the world, with cheap money? And when, not if, the Fed takes away the punchbowl (which it is starting to do), how will the economy and the markets react?

As for the economy and inflation, it’s really a mixed bag of reporting and opinion. At the end of September the core consumer price index, which excludes food and energy, increased only 1.7% over the past year, and the personal consumption deflator, which the Fed apparently prefers to watch, rose only 1.3%. On the flip side of the coin, however, the Labor Department also said that in August core prices rose .2% in that month alone, the largest monthly increase since 2016. Even more important, prices including food and energy rose by .4% in August. And in my humble opinion, since we all need food and energy to live, that latter is much more pertinent. Thus, we think inflation is ticking up quicker than most realize, or are told by the government. And don’t even get me started on the “yogurt phenomenon”, where we are paying the same amount of money for less product over time (remember getting eight ounces of yogurt for a dollar and now we only get three ounces for that same dollar if we’re lucky!).

As for the stock market, the U.S. market in particular, we think it could be inflating for reasons other than fundamentals. Sure, earnings are pretty strong, and we are optimistic for continued earnings strength, but at what price? In other words, will people continue to pay higher and higher prices for the same amount of earnings? Actually, talking it out, we can speculate that since stock purchasers are essentially the same people who pay more for less, as discussed above, then the answer may be “yes, people may pay higher and higher prices”. And, although this bull may be in need of a breather or correction, we see a few other reasons why it could continue for a bit longer. First, we believe markets tend to move to extremes; or as Newton told us, things in motion tend to stay in motion. Second, there seems to be a growing chorus of naysayers when it comes to this aged bull. And if I’ve learned anything over the past twenty years, contrarian bets against the crowd tend to be decent wagers. Last, but not least, we are watchful if not downright hopeful that we may actually see some sort of tax reform in twelve months or so.

You see, right now we have a dizzying array of loopholes and deductions that mostly serve the special interest groups that spend billions of dollars to lobby their congressional leaders for that preferential treatment. But we sense the politicians may actually be starting to (finally!) understand that Americans want a simpler tax code that could encourage growth. And if we do get some real tax reform, in contrast to just tax cuts that we can ill afford right now, the economy could be pushed from anemic to robust growth, possibly pulling the stock markets along to further historic highs; i.e., the markets may be more likely to melt up rather than melt down in the near term.

But there are a couple of caveats, of course. Remember, the S&P 500 (our preferred gauge of the United States stock market) has not had a 5% correction in almost eighteen months, which is neither healthy nor normal. Further, a beneficial near-term market does not necessarily make for a long-term success. So even if the economy is stimulated by tax reform or other inflationary (in the good sense) events, such as a continued synchronized global recovery, we still need to eventually pull our heads out of the sand and address an imploding Social Security, Medicare, and Medicaid system (not to mention over $1.4 trillion in student debt). This is why we, as your financial planners, are always looking at what could go right as well as what could go wrong, and try to plan accordingly regardless of what the people behind the curtain are trying to make us think or do.

Speaking of planning, we can’t believe it’s already getting close to the end of 2017. Although the holidays can be a time for fun and relaxation (especially if you don’t have to travel!), we hope you also have time to reflect on what the holidays mean. You see, we are just as guilty as anyone else at forgetting that the holidays are a celebration of life and love, and we try to remind ourselves that sometimes the best gift you can give is thanks. So, as always, we want to thank you for your friendship, your trust, and your referrals! Take care!

R. Timothy Curran, JD, CFP®

tcurran@lpl.com Direct 704.499-9703

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.


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