Why Monitor Inflation?
“Don’t fight the central bank.” This is a lesson I had to learn the hard way in my life. The central bank is the most powerful financial institution known to the world. Only the Central Bank’s opinion is enough to move markets; Central bank policy moves the economy.
Some of the smartest people I’ve met in my life are avid “Fed Watchers,” and that, without a doubt, is why I respect them. Most investors use major indices (SPX) (SP500) (DIA) (QQQ) (NTX) are now “in Fed hands” and will “step down” once Fed policy returns to a less aggressive stance.
That is, once inflation cools down. As most readers here understand, the Fed is raising (or “hiking”) interest rates to slow the economy, with the goal of controlling inflation. The central bank uses a variety of economic data to guide its policies, carefully monitoring the relationship between rates and growth. The Fed continues to raise rates to 4%+, where it will pause and wait for inflation to return to its 2% target rate.
Because stocks are intrinsically valued based on the present value of future cash flows, they are sensitive to changes in interest rates. Higher interest rates mean higher discount rates on these future cash flows. The types of companies I’m most interested in — technology companies — are particularly sensitive because their present value depends on their future cash flows. Development.
There’s another, more intuitive way to think about it. If the central bank raises rates to slow economic growth, companies that derive significant portions of their value from future growth will suffer the most. This is why there is a “big cycle” in low-growth companies that will have less impact.
However, you cannot completely wash away the risks of inflation by going for a more defensive portfolio. In a market driven largely by passive investment flows, all stocks exhibit significant levels of correlation. Hence, tracking inflation is important even for a purely passive investor who only buys index funds.
Problems in monitoring inflation
Institutional investors can understand where inflation is headed by using futures to predict returns to implied Fed funds rates. These futures reflect market expectations, which of course are driven by inflation expectations.
This is useful, but the necessary data is not available to most people. Most people will have to wait for the CPI (Consumer Price Index) reports from the US Bureau of Labor Statistics, which detail the official inflation numbers. The latest report will be released today (December 13). The next report for December 2022 is due on January 12.
Besides waiting an entire month to get a snapshot of the data, there’s also the fact that this method changes frequently. This has come with significant criticism, as it has led to widespread distortions over time:
In the conventional economic world, you would think of inflation as the rate of increase in the price of a market basket of consumer goods defined by a government agency…
… they define a synthetic metric, right? I’m going to say you have to have a 1,000 square foot apartment, you have to own a used car, and you have to eat three hamburgers a week.
10 years from now, apartments are more expensive; I can adjust the market basket—they call them hedonic adjustments. I can conclude that in 1970 you needed 1,000 square feet. But in 2020, you only need 700 square feet because we’ve miniaturized televisions, and we’ve got more efficient electrical appliances, and you don’t need as much space because things have collapsed from the iPhone.
So now the apartment may be 50% more expensive, but after the hedonic adjustment, there is no inflation. Because I lowered my expectations of what a normal person should have.
-Michael Saylor (CEO of MicroStrategy and Bitcoin Advocate)
What is a chainlink?
In response to my cryptocurrency-related articles, the comments I receive are often filled with the old stereotypes of crypto as “meaningless”, “useless”, “a scam”.
So I wanted to write this article as a rebuttal to those kinds of comments. Not another philosophical piece about monetary theory, but a practical example of a cryptocurrency mechanism that people want to use – one that I use myself.
I won’t get into all the issues here, only a brief summary is necessary: Chainlink is a type of cryptocurrency designed to validate high-quality data for use in smart contracts (a type of contract written in code and stored/executed on the blockchain).
The validators of the ChainLink blockchain/network effectively operate a highly secure data base that the wider crypto ecosystem can use to engineer more sophisticated decentralized applications. Chainlink falls into the category of cryptocurrency projects I follow, but we’re heading into another “crypto winter” and don’t consider what that means for smaller projects.
Truflation is an application that calculates inflation in real-time using this decentralized and independent network infrastructure. This gives any investor an up-to-the-minute view of the inflation rate between official CPI releases. (https://app.truflation.com/) can be accessed directly from a normal web browser.
From these data, it can be seen that inflation is at the lowest point of the year. The inflation rate has not only fallen from its high of 12% annually to near 50%. If you drill down into the different categories, you’ll see that this has been driven by a dramatic drop in transportation costs.
Interestingly, Tribulation also offers a look at inflation rates in the UK. Looking at an eye-popping 18.3% annual inflation rate! This was largely a result of the war in Eastern Europe, which drove utility/energy costs sky high. Additionally, rising housing costs.
Conclusion: Is it compatible with CBI?
So, this begs the question: How close will the inflation data be to the official numbers released this morning? We’ll find out in a few hours, but I doubt that inflation correctly predicts the pace at which the rate of inflation has fallen meaningfully.