Bob’s Journal for 7/29

Today’s Great Inflation Debate

Are the recent high inflation rates transitory, as the Federal Reserve says, or are we at the beginning of a long inflationary period, perhaps one like the 1960s and 1970s?

That’s a major debate among economists and market watchers. Regular readers of Retirement Watch know that, over the last few years, I’ve been expecting inflation to increase. I don’t believe we’re at the end of the period of elevated inflation levels.

The best arguments on the other side come from Lacey Hunt of Hoisington Investment Management, whose Wasatch-Hoisington U.S. Treasury Fund (WHOSX) I recommend for the Retirement Watch portfolios at times.

Hunt believes five key factors mean that the recent surge in inflation will last only a few months before declining.

The high debt levels in the United States and other developed nations exert continuing deflationary or disinflationary pressures. High debt levels tend to lead to austerity, which reduces economic growth and inflation.

These debt levels are rising, especially in the United States, and this pressure isn’t ending.

Also, sharp increases in economic growth after sharp declines in growth are unusual and historically are deflationary instead of inflationary. The pattern occurred in the U.S. in the periods 1957-1959, 1981-1983 and 2009-2011.

In 2020, the U.S. economy had its sharpest, deepest decline, and that was followed by the most rapid period of growth. Hunt says history indicates that this isn’t likely to result in sustained inflation.

The demographics in the United States are also deflationary. The population is getting older, and the percentage of the population in the workforce is falling. This is true throughout the developed world.

These demographic trends restrain investment and economic growth. They also keep a lid on inflation.

Hunt says the Fed’s extraordinary policies aren’t inflationary. We’ve seen that since 2009, with inflation falling, even though the Fed was expanding its balance sheet and printing a lot of money.

There hasn’t been high inflation because the velocity of money is low and has been declining. The velocity of money is the rate at which each dollar turns over in the economy.

Velocity is high only when debt is productive and pays off with high returns. Most of the current debt isn’t productive, and most of the money the Fed is printing hasn’t made its way into the real economy. One way to measure that is the relatively low level of lending by commercial banks.

The money has been helping the markets but not the economy. The debt that the Fed is financing is a drag on the economy and keeps a lid on inflation.

Hunt also says that heavily indebted economies usually end up with deflation. It is possible that the high debt will end with high inflation, but only with an extreme policy change, such as making the Fed’s liabilities legal tender.

The higher inflation we’ve seen recently is the result of supply and demand imbalances that will soon be corrected. After a few months of elevated inflation reports, Hunt forecasts, inflation will decline.

You can read Hunt’s thoughtful, scholarly quarterly reports for more details.

Declining Life Expectancy and Your Retirement Plans

You probably saw last week’s announcement that the average life expectancy in the United States declined by 1.5 years in 2020.

That is believed to be the largest one-year decline in life expectancy since at least World War II. Life expectancy was 77.3 years in 2020, according to the Centers for Disease Control and Prevention, about the same level as in 2003.

Life expectancy should be a major factor in retirement planning. Many features of a plan are likely to be different when the plan assumes a 15-year-long retirement instead of one that’s 30 years or longer.

Despite the importance of life expectancy in a plan, I don’t recommend changing a retirement plan in response to this change in average life expectancy.

Most of the decline in life expectancy in 2020 was attributed to the COVID-19 pandemic, drug overdoses (especially from opioids), homicides and some chronic diseases.

Most of those factors aren’t likely to affect those who currently are retired or near retirement. Most older Americans today are vaccinated from COVID-19 and engage in low-risk activities.

The increase in homicides tends to be concentrated in particular localities and among certain age groups, instead of being widespread.

If you didn’t die from COVID-19 in 2020 and don’t have a substance abuse problem, you didn’t contribute to the decline in average life expectancy in 2020 and aren’t more likely to in the coming years. Your retirement plan still needs to protect you from the effects of living a long life.

The Recession Ended Soon After It Began

The pandemic recession lasted only through April 2020.

That’s the word from the National Bureau of Economic Research, whose Business Cycle Dating Committee is the accepted arbiter of recessions and recoveries.

Contrary to popular belief, a recession isn’t two consecutive quarters of negative gross domestic product (GDP) growth. In April 2020, the committee declared we were in a recession, though the downturn had begun only in late February 2020.

A recession depends on the depth of the contraction, its duration and how broadly activity declined across the economy.

In the unique pandemic recession, the decline in economic activity was quick and broad. The committee decided back in 2020 that the magnitude and broad reach of the decline warranted labeling it a recession soon after the decline began.

But activity also rebounded quickly and broadly, making it the shortest recession we’ve had. The previous shortest recession was six months in 1980. Some economists have argued the recovery from that recession was so weak that the committee should have categorized the 1980-1983 period as one long recession instead of two separate downturns.

Though it declared the recession to have ended, the committee said that’s not a declaration that the economy is operating at its previous capacity. Though some measures of the economy are at or above pre-pandemic levels, employment still is well below the peak.

The Data

New home sales declined by 6.6% in June from May’s level and 19.4% over 12 months. Also, sales for the three previous months were revised significantly lower from the initial reports.

The 12-month numbers are starting to look poor, because sales surged beginning in June 2020 after several months of no activity during the pandemic.

The S&P CoreLogic Case-Shiller U.S. National Home Price Index increased 2.1% in May. Over 12 months, the index increased 16.6%. That compares to the 14.5% 12-month increase reported in April.

The 12-month increase set a record for the second consecutive month. The index also marked its 12th consecutive month of accelerating prices.

The price increases are broad-based. All 20 cities in the index had price increases in May and higher 12-month increases in May than in April. In 18 of the 20 cities, prices are at all-time highs.

In this index, the May data actually are a three-month average of March, April and May data.

The Federal Housing Finance Agency (FHFA) House Price Index for May also was strong. It reported a 1.7% increase from April to May, following a 1.8% rise in April. Over 12 months, prices increased 18.0%.

Existing home sales increased 1.4% in June, the first month of advances following four months of decline. A low inventory of homes for sale continues to be a problem.

Over 12 months, sales increased 22.9%.

The median price of an existing home rose in June to an all-time high of $363,300. That’s a 23.4% increase over 12 months.

The median sale price can be misleading. Sales of lower-priced homes (those below $250,000) declined by 16% over 12 months, while sales of homes priced between $750,000 and $1 million increased 119%. That changing mixture of high-priced and low-priced homes distorts the median price.

New unemployment claims increased in the latest week by 51,000 to 419,000. After several weeks of new claims mostly declining, they are back to the levels of early June.

Most of the increase was attributable to the auto industry, which is reducing production because of parts shortages.

Continuing claims in the regular state programs decreased by 29,000 to 3,236,000.

The number of Americans receiving some form of unemployment compensation declined by 1.3 million to 12.6 million. That’s the lowest level since the pandemic began.

The Leading Economic Indicators Index reported by The Conference Board increased another 0.7% in June following a 1.2% increase in May.

The Kansas City Fed Manufacturing Index increased to 30 in July, following a reading of 27 in June. The report indicates manufacturing growth is strong in the region and the growth rate is increasing.

The Dallas Fed Manufacturing Survey also reported strong growth. The Production Index derived from the survey rose to 31.0 in July from 29.4 in June. The General Activity Index declined a bit to 27.3 in July from 31.1 in June.

The Richmond Fed Manufacturing Index increased to 27 in July. The June Index was revised higher to 26 from the 22 that was initially reported.

Durable Goods Orders increased 0.8% in June, while May’s increase was revised higher to 3.2%. Excluding transportation, orders increased 0.3% in June, compared to 0.5% in May.

Core capital goods orders, a measure of business investment, increased 0.5% in June, and May’s number was revised from a 0.1% decline to a 0.5% increase.

Growth in the services sector slowed in the first half of July, according to the PMI Composite Flash Index. The services component decreased to 59.8 from 64.8 at the end of June.

The manufacturing component increased to 63.1 from 62.6. The composite index declined to 59.7 in mid-July from 63.9 at the end of June.

The Consumer Confidence Index, as reported by The Conference Board, increased to 129.1 in July. June’s Index was revised higher from 127.3 to 128.9.

The Markets

The S&P 500 rose 1.84% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 1.61%. The Russell 2000 lost 0.31%. The All-Country World Index (excluding U.S. stocks) fell 0.02%. Emerging market equities are 4.52% lower.

Long-term treasuries lost 0.24% for the week. Investment-grade bonds increased 0.22%. Treasury Inflation-Protected Securities (TIPS) added 0.88%. High-yield bonds gained 0.21%.

In the currency arena, the U.S. dollar declined 0.56%.

Energy-based commodities increased 3.74%. Broader-based commodities rose 3.28%. Gold dipped 0.52%.

Bob’s News & Updates

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