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Bob’s Journal (12/20/2018)

Last update on: Nov 22 2019

Recent inflation data are sending a warning to the Federal Reserve, but the Fed doesn’t seem to be heeding it.

About a year after the financial crisis hit bottom, I presented a workshop to a group of individual investors. One of the group members gave me a hard time.

I had said inflation would stay low for a while and deflation was a bigger threat than inflation. He was convinced that the Fed’s quantitative easing would flood the economy with so much money that inflation would be at 4% to 5% within a year or so.

We know how that turned out. Inflation was below 2% for years until recently. The inflation data spiked higher the last couple of years, and that’s when the Fed became more committed to tighter money.

But the data indicate the inflation spike was short term. The forces behind it are fading. Long-term deflationary pressures still are present and soon could be the dominant forces.

You can see this by taking a deep dive into the inflation data. I did this research to spare you from needing to do it.

The economy was in the late growth phase of the economic cycle until recently, and that tends to put upward pressure on prices. Growth causes shortages of goods and labor, so the prices are bid up.

Cyclical services, in particular, contributed to higher inflation. These include restaurants, hotels, entertainment and other recreational activities. We’re now past the late growth phase, so those pressures should start to wane.

Energy prices also were a major cause of the higher inflation numbers. Those prices have fallen considerably since summer. The dollar was weak for a while, and that increased the inflation numbers. But the dollar has bounced higher, reducing inflation.

Housing contributed to the higher inflation numbers, and that also seems to be fading. When we look at the data, goods and the services that aren’t cyclical have had either flat or declining prices the last couple of years. Now that we’re past the growth phase, the growth-sensitive prices should stabilize or decline.

While the short-term pressure on higher prices is fading, the long-term forces that put downward pressure on prices still are present. These include high debt levels, technology and automation, as well as aging populations in the United States and most developed economies.

Globalization has helped keep inflation low. We’ve seen some reduction in globalization due to the trade conflicts and tariffs. But we’re a long way from reversing globalization, and efforts are underway to resolve the conflicts.

The Fed shouldn’t see much need or feel pressure to tighten money much more than it already has. The efforts so far are slowing the economy and reducing many asset prices. Inflation seems to have peaked.

That’s why yesterday’s Fed announcement disappointed many investors. The investors believed the Fed should take a break from its tightening policy instead of raising rates this month and planning two more increases in 2019.

It takes a while for policy changes to work their way through the economy. But if the Fed looks only at current data, it runs the risk of raising rates too much and causing a sharp decline in the economy and the markets.

The Data

Industrial Production jumped by 0.6% for the month, but the headline number doesn’t reflect the overall economy. Most of the increase was in utilities and mining and reflected recoveries from drops in previous months. Manufacturing was unchanged, and last month’s 0.3% increase was revised down to a 0.1% decline.

Retail sales for November increased only 0.2%, but the low number was partly due to a decline in gasoline prices. Last month’s number was revised from a 0.8% jump to a 1.1% increase. Excluding autos and gas, sales rose 0.5% for the month. Major gains were scored by non-store retailers (online shopping).

The economy slowed a bit, according to the PMI Composite mid-month flash report. The composite declined to 53.6 from 54.4. Manufacturing declined the most to 53.9 from 55.4. Services also declined to 53.4 from 54.4.

The Empire State Manufacturing Survey also reported a decline in manufacturing. The survey came in well below expectations at 10.9, down from 23.3. The components of the survey were weak across the board.

The Philadelphia Fed Business Outlook Survey also declined to 9.4 from 12.9. Even so, key parts of the survey improved, including new orders, unfilled orders and employment.

New home builders are losing optimism. The Housing Market Index from National Association of Home Builders (NAHB) was 68 only two months ago in October. It declined eight points in November to 60 and another four points this month to 56. Both sales and traffic are declining.

The housing starts report explains the declining optimism. Starts were nominally higher, coming in at the highest level in four months, and permits issued reached an eight-month high. But that activity was concentrated in multi-family homes. Single-family home starts declined sharply. Permits for single-family homes increased slightly. Over 12 months, starts are down 3.6% and permits increased 0.4%.

But existing home sales increased 1.9% for November. That’s its best number in three months. But the three-month average, which dampens short-term noise in the data, is down for the seventh consecutive month. Over 12 months, existing home sales are down 7.0%.

There was mixed news from the Leading Economic Indicators Index. It increased 0.2%, but last month’s 0.1% increase was revised to a 0.3% decline. The results indicate the economy will grow just under 3.0% in the first quarter of 2019 and increase at a slower rate after that.

New unemployment claims increased by 8,000 to 214,000. That’s still near historic lows.

The Markets

The S&P 500 slumped 5.35% for the week ended with Wednesday’s close. The Dow Jones Industrial Average fell 5.07%. The Russell 2000 declined 7.15%. The All-Country World Index lost 4.58%. Emerging market equities gave up 3.33%.

Long-term treasuries returned 2.63% for the week. Investment-grade bonds rose 0.54%. Treasury Inflation-Protected Securities (TIPS) gained 0.70%. High-yield bonds lost 1.90%.

On the currency front, the dollar rose 0.12%.

Energy-based commodities lost 4.43% for the week. Broader-based commodities fell 3.76%, while gold declined 0.25%.

Bob’s News & Updates

Recently, I was interviewed by Heather Wagenhals of Unlock Your Wealth Today. You can hear the interview by clicking here. We cover estate planning, trusts and some IRA strategies.

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Seriesclick here.

A recent five-star review of my book on amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

I’m now a regular contributor to the Forbes.com blog. You can view my contributor page here.

Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.

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