CPI Inflation November Report Produces Two Alternate Investment Trends

This morning’s November CPI report adds another notable inflation improvement. The All Items monthly rates fell from October’s low, 0.4% rates to: A nominal (actual) decline of -0.1% (-1.2% annualized), and a seasonally-adjusted rise of only 0.1% (1.2% annualized). So, now, which investment trend is the better choice?

The choice is ours to make, but it’s not a straightforward decision. What makes the situation complicated is that choice #2 (short-term, Wall Street trend) appears to be replacing #1 (long-term, Federal Reserve trend), but it’s not. Instead, it’s picking the winner we’re comfortable with: The first – an older and well-known, albeit plodding, train. Or the second – a newer and faster train racing down a parallel track.

Stalwart Engine Number One is grinding up the mountain as Engineer Powell and his team stare at the storm that hides the summit. The passengers’ refrain is, “How soon?” “Not yet – be patient,” is the reply. Meanwhile, the team busies itself with alternate progress measures such as counting ties, studying the changing vegetation, measuring the altitude, estimating the grade, and evaluating the passengers’ health.

Shiny Engine Number Two, meanwhile, is charging up the second track. With Wall Street at the controls and the baggage car forgotten on a siding, it looks ready to assume the lead. All that’s needed is that promised “Summit” sign ahead. It will propel #2 into the lead, thereby relieving #1 of its struggles.

And, so, here we are…

The November Consumer Price Index inflation report just proclaimed to Wall Street, “You’re the winner!” Now, onto to the big investment show, with the Federal Reserve bankers giving themselves high fives. Hooray!

But wait…

Those nearly immediate media commentaries and market movements have to be based on presumptive simplicity: The conclusion that if the top line inflation number is lower, all is right with the world. Nobody even cracked the binding of the report and reflected on what all those other numbers mean. Moreover, as is common when the goal is to make money, contrary information (like last week’s “too high” Producer Price Index inflation number) is just forgotten. The new number must be more relevant, right?

(For more on the missing analysis, see “The Coming CPI Inflation Report Will Be Sketchy – So, View Media And Market Reactions Skeptically”)

So, now the big question…

Do we jump aboard train #2, or do we stick to #1, waiting for more proof? (We all know that “waiting for the dust to settle” is a loser’s strategy – right?) Deciding isn’t easy at such junctures because the in-your-face, right-now, money-making action is happening. Clearly, Wall Street has full membership in that party, but should we?

Think of the decision as a choice of two different trends.

First (train #1) is the longer-term trend of wrestling with inflation while avoiding a recession (AKA, a soft landing)

Second (train #2) is the shorter-term trend of identifying and acting on signposts quickly

Viewed this way, we see that using the shorter-term trend to alter our view of the longer-term trend is a recipe for disaster. It’s one or the other.

But then there is the Federal Reserve…

Now comes the big wrinkle. Most Federal Reserve bankers are economists and/or lawyers and/or academics – not investment experts. However, they are influenced by Wall Street’s views. That means Wall Street’s optimism could spill over into the Federal Reserve’s deliberations (actually, they are now calling them, “debates,” with implications of real disagreement).

The reason this influence is so important is because it has led the Fed astray in times past.

Note: The first time I witnessed such an effect was in 1966. (I was 21, working on my bachelor’s degree in finance and in my third year of trading stocks.)

The Federal Reserve, interpreting the price increases that accompanied 1965’s exceptional, blue-chip company growth as inflation, tightened money in early 1966. It was an effective effort, cutting the GNP growth rate (the primary economy measure at the time) significantly and knocking the stock market down sharply. But in the fall, Wall Street worries about too-much, too-fast emerged, so the Fed reversed before the GNP hit negative real growth (recession) territory and before the inflation rate returned to its 1% to 2% level.

Swinging the pendulum to easy money, the Fed’s new policy immediately gripped Wall Street, and the 1967-68 “go-go” stock market and investment banking activities began in earnest. So, too, unfortunately, did inflation. That was its first roller-coaster undulation that would repeat through the 1970s and finally peak (and trough) in the 1980s. Here’s the chart of those early days…

The bottom line: Choose wisely

Passing up easy-looking gains may seem foolhardy. However, going against a contrary, longer-term trend can have terrible results.

But then there is the Federal Reserve Open Market Committee (FOMC). If a less-tight money policy is in their heads and they confirm it tomorrow (Wednesday, Dec. 14), we could witness a recharging of economy growth and stock gains. And, as in virtually all past cycles, that growth and those gains will be in different areas than in the past.

Happy investing!