Commodities And Stocks Telling Two Different Stories

Whether it is that the passage of the U.S. election released Europe to begin fighting amongst themselves again about Greece, or instead that they’ve been fighting the whole time and we just didn’t notice because we were so introspective, it’s certainly happening and heating up again. The Eurozone finance ministers are bickering, publicly, over whether Greece should be given two more years to hit its financial targets. (See articles as Milton Friedman proposed many years ago.

As I’ve written frequently (and borderline obsessively), clarifying the exact path that the Federal Reserve will take in the future reduces the uncertainty that investors face. This is good in the absence of leverage, but if the opportunity to leverage exists then the decrease of apparent uncertainty causes an increase in the leverage desired by investors. The problem is that a margin of safety doesn’t only protect an investor from known uncertainties, which would decrease in this instance, but also from unknown uncertainties, which would not be affected and for which a margin of safety is absolutely crucial if we desire to avoid another financial market meltdown. But no one is listening to me.

Commodities rose yesterday, despite the continued decline in equities. This is not unreasonable. I think that commodities and stocks are telling two different stories. If there’s a recession, it should hurt stocks and commodities (but more directly should hurt stocks) while further QE3 ought to help them (but more directly help commodities). Right now stocks are going up on QE3 while commodities are going down on the recession … exactly the opposite of what ought to be happening. To my mind that just means the ‘value gulf’ is getting wider and wider.

The chart below (Source: Bloomberg) shows the ratio of the S&P total return index to the DJ-UBS index.

Right now there is an enormous loathing for commodities that I don’t really understand – it seems to me to be the bipolar nature of commodities investors that they either love or hate the stuff. It probably comes from the fact that there are no “value” investors in commodities since the theory on what constitutes “value” is so light. Right now it looks to me like stocks are relatively expensive, although they’ve been that way for a while.

For today’s CPI figures, the consensus forecast calls for an 0.1% rise month/month for both the headline and core indices (seasonally adjusted), maintaining the y/y core increase at 2.0%. Last month, core rose to 1.98%, and we’re ‘dropping off’ a +0.17% on the y/y comparison. If economists are right, and 0.1% is the rounded change in core inflation on the month, then the y/y rise in core inflation will more likely decline to +1.9% than stay at +2.0% (of the possible prints that would lead to +0.1% on the monthly, from +0.05% to +0.149%, anything from +0.05% to +0.129% would cause a downtick in the y/y figure while only monthly changes in the range of +0.130% to +0.149% would keep the number stable.

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However, I don’t see what will cause core to droop like that. I think economists are paying too much attention to the last several monthly changes and ignoring the fact that the weak prints were caused by outlier points (as evidenced by the fact that the Median CPI of the Cleveland Fed and the Sticky CPI of the Atlanta Fed, both different measures of central tendency, remain at +2.3% and +2.2% respectively).

Moreover, housing CPI – the main driver of core inflation – is accelerating with both primary rents and owner’s equivalent rent rising last month, and all indicators of housing tightness from housing inventories to apartment tightness continue to suggest that higher price increases are more likely than lower price increases ahead. Moreover, we’re seeing upside surprises in other countries, such as in Greece that I mentioned Tuesday, in the UK where core inflation rose to +2.6% y/y versus 2.2% expected (see Chart, Source Bloomberg), befuddling most economists there.

That doesn’t mean the y/y core figure in the U.S. will definitely rise back to +2.1% this month; to do that, core would need to print +0.23% for the month, meaning the main body of the economist profession was off by half.

Come to think of it, that’s not so far-fetched. If the last three months of core prints (+0.090%, +0.052%, and +0.146%) are quirky-low, then there should be a payback at some point. It’s hard to call for that in any given month, though.

Written By: Michael Ashton