The Bull That Will Not Die
Ross M. Miller
Miller Risk Advisors
April 12, 2004
The world's economy is like the philosopher's ever-changing
river. Every time is different—models that once worked, stopped working long
ago. And not only does the game change, so does the method for keeping score.
Government numbers, from GDP growth to the unemployment rates to consumer and
producer inflation—all rough approximations to begin with—are continually
being "tweaked." Still, despite the complexities and conundrums of our
post-modern economy, there are occasionally moments of clarity. One such moment
is now at hand.
After having been lost and presumed dead, inflation in the
United States is coming back in a big way, bigger than the U.S. Labor Department
numbers would have it appear. Although I am not one to attribute impure motives
to anyone, it could be more than coincidence that about the time that the U.S.
Treasury started to issue bonds indexed to the Labor Department's published CPI
(Consumer Price Index) numbers, the Department made fundamental changes in the
way its numbers were computed. After historically understating the rate of
inflation by a full percentage point or more, current CPI numbers appear to
underestimate of the actual rate of inflation by a significant margin.
Furthermore, they contain so many "adjustments" that they may not only
get the total amount of inflation wrong, but also how it changes from month to
month. And the PPI (Producer Price Index) is not doing any better. Indeed, it is
undergoing such a major overhaul that its timely publication has been suspended
It doesn't take a government economist to tell you that
inflation is turning the corner from a creep to a gallop. Regardless of what is
responsible for that shift—monetary laxity, fiscal irresponsibility, OPEC, you
name it—it is reaching the point where it can no longer be ignored.
We are beginning to see inflationary psychology reappear.
The perception of inflation by humans influences their
behavior in a very simple way—it shifts purchases from the future to the
present. With borrowing costs at historic lows and credit plentiful, why wait to
buy something if the price is going up. Many producers have already figured this
out and that is why inventories are swelling. Savvy consumers have caught on,
So, what happens as inflationary psychology takes hold? One
word—boom. Just in time for the presidential election as luck would have it. A
self-sustaining, self-fulfilling boom so powerful that virtually no one or
nothing can stop it. At least not this year and probably not until well into
next year. Such a boom would carry many stocks with it, especially growth
companies involved in emerging technologies. It would also carry interest rates
higher—back to their historical averages and possibly beyond.
The conventional wisdom says that it is no big deal that
inflation is coming back. Once Alan Greenspan and his trusty band of Fed
governors get even the faintest whiff of inflation, they will smite it with not
just one rate hike, but an entire series of them. Not only will that nip
inflation in the bud, it will send the stock market for a mighty tumble. And, of
course, Chairman Greenspan is a good Republican and he would not want to do
anything to spook the financial markets until after the November election.
Indeed, virtually everyone that I have surveyed believes that "the fix is
in" until the election. The stock market may indeed plummet after the
election, but then it will no longer matter with the next election four years
away. Of course, if "everyone knows" the jig is up on November 3,
everyone will bail out before then. Another October crash, perhaps? That is the
last thing the current administration wants.
Fortunately, there does not have to be a crash. If economic
growth is sufficiently strong, as it would be in the case of an inflation-driven
boom, both the stock market and the economy can absorb several rate hikes with
minimal damage. With Alan Greenspan in the habit of telegraphing his moves in
advance, these hikes will be even easier for the markets to swallow.
Historically, increases in interest rates from the extremely low levels that
currently prevail in the market tend not to hurt stocks the way they would. The
tendency for higher interest rates to hurt the stock market only clicks in when
rates are already on the high side.
How fast would the Fed have to move to spoil the party?
Without boring you with the math, for the Fed to get back to a
"neutral" monetary policy would require a fed funds rate of at least
five and probably six percent, especially when one considers that the current
CPI of two percent corresponds to what in the past would have been easily three
percent inflation. Even the most rabid economist on the Street only has the rate
getting to three percent by the end of 2004.
The bottom line is that the present situation is very bullish
for stocks, especially those that are relatively insensitive to interest rates
and short-term rates in particular. This is not to say that the anticipation of
increases in rate hikes will not provide speed bumps for the market, they will
initially. Even the stock market will require time to adjust to the new mindset.
Still, it will be hard for the Street to ignore the surge in corporate earnings
that will vastly exceed all expectations through a combination of a relative
increase in prices (technology prices will not fall as fast and other prices
will rise faster) and an absolute increase in output. Both geopolitics and
presidential politics may provide the stock market with additional turbulence
along the way, but once inflationary psychology takes hold, it is almost
impossible to shake.
Is an inflationary boom a certainty? Of course not. Nothing
is. Even a minor rumbling that the Fed is considering another rate cut is a sure
sign that something is terribly wrong. Likewise, any consistent failure of the
stock market to respond positively to good news, especially news concerning
corporate earnings, should be taken as a major warning sign.
Confirmation that the inflationary boom is underway should
manifest itself in several forms. Announcements of price increases by
manufacturers should become a common event. New car incentives should begin to
disappear on many models. Business inventories should continue to rise. Retail
sales should barrel along. Newspaper stories about inflation should start
broadening from gasoline and commodity prices to prices of consumer goods.
Of course, inflation is only a positive for the stock market
up to a point. Indeed, the risk going forward is not that the Fed will apply the
breaks too fast or too hard, but that inflation ultimately degenerates into
Once Time or Newsweek runs a cover story on inflation, you
know it is time to look for your coat and start saying your goodbyes. When the
Wall Street Journal and CNBC start to use the words "overheating" and
"bottleneck," the host will be locking up the liquor cabinet. By the
time "credit crunch" appears, your key should be in the ignition.
And what comes after the party is over? Just about anything.
It may be some time before the signs are as clear as they are now.
Copyright 2004 by Miller Risk Advisors. Permission
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No representations or warranties are made as to the accuracy or completeness of
any information contained in this report. The economic opinions contained on
this site are not to be construed as recommendations to buy or sell specific
securities or as other financial, accounting, or legal advice. You should
consult with a professional where appropriate. And if this is not enough to
scare you, the author has a Ph.D. in economics from Harvard.