Is Inflation Around The Corner?
The Dynamic Wealth Report
October 14, 2010
by Jay Chernoff, Editor
I have a quick question for you. Are you more concerned about inflation
or deflation? Off the top of your head, which do you think is the bigger
issue?
If you’re having trouble answering that question, you’re not alone. Even
the experts can’t figure it out. There are a lot of moving parts. And
the situation is becoming more and more complex by the day.
I’ll tackle the topic of inflation and the economy in more depth next
week. But for now let’s focus on what’s coming next.
So how do we know if inflation or deflation is coming?
We can start by looking at the Consumer Price Index (CPI). The CPI
number for September comes out tomorrow. It should provide a strong clue
about where the economy’s headed.
Let’s take a look at what CPI is and how to understand tomorrow’s
number.
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Basically, the CPI is a cost of living measure. It’s an index calculated
each month from the prices of about 200 different goods and services.
These 200 items are divided into eight different categories.
The eight categories are then weighted based on spending importance. For
example, spending on housing is going to be weighted higher than
spending on recreation. Housing is clearly a more important expense than
recreation.
In fact, housing is the largest component of the index, making up around
42% of the CPI’s value. Transportation is next at 17%. Food is third at
15%. Other categories include medical care, apparel, recreation,
education, communication, and a miscellaneous catch all.
So what does the CPI number actually mean?
The CPI number shows the change in total cost of the 200 items from
month to month. You compare it to previous months to see if prices are
rising or falling.
It can also show longer-term trends in inflation.
You see, the CPI was set at 100 for a base period between 1982 and 1984. The most recent CPI (for August) shows the index at around 218.
That
means overall prices of goods and services in the U.S. have more than
doubled in just over 25 years. (How’s that for a kick in the gut?)
The long-term data can be an interesting conversation piece… but let’s
get to the bottom line.
The markets aren’t really concerned with the longer-term trends.
Investors are more focused on the short-term implications. They want to
know if the economy is improving and if inflation or deflation is the
greater concern.
Here’s a great example…
This year’s June CPI came out at 217.97… a drop from the previous
month’s 218.18. While it was only a 0.1% drop, it was the first time the
CPI dropped after five straight months of inflation. It immediately
brought back fears of deflation.
What’s more, it really spooked the markets.
Get this… on July 16th, when the June CPI was released, the S&P 500
dropped nearly 3% in one day. Make no mistake, the CPI can move the
markets up or down dramatically.
So what should we expect tomorrow?
When the CPI is reported, the first number you’ll likely see is the
change from the previous month. So expect a small percentage change,
positive or negative, most likely 0.5% or under.
I’m going to go out on a limb here and make a prediction for you. Just
remember I’m not an economist. (Although that means I’ll probably be
right.)
Drum roll please…
The CPI is going to go up tomorrow. Commodities had a big month in
September and food is a pretty sizeable component of the index. Also
pending home sales increased more than expected and should mean the
housing component increased as well.
All in all I expect to see an increase in the CPI. And… we just might
start hearing concerns over inflation. Next week, I’m going to discuss
what inflation concerns mean for Fed policy and the economy. But for
now, let’s get ready for an interesting Friday.
One of the most active ETFs this week is the United States
Natural Gas Fund ETF (UNG). UNG is down an eye popping 50% over
the last 52 weeks. It’s been a tough year for natural gas. Huge
inventories and lack of demand are pushing down prices of UNG.
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