I'm Just a Force that Prices Up Goods - Oh Lord, Please Don't Let Me Be Misunderstood

As the week comes to a close, we find markets at all time highs and investors unsure if the next move is another high or another step back (as we experienced just six weeks ago). What propelled markets higher this week was a softer than expected inflation reading. Inflation is still the number one concern on people’s minds; the annual Harvard Youth Poll had close to two-thirds of respondents name inflation as the most important issue facing the country (of note healthcare came in at 59%, protecting democracy at 50% and Israel-Palestine at 34%). This week, we take stock of all the narratives and how they impact pricing and people’s perception of pricing.

This week’s data was a small win for everyone. April CPI inflation moderated to 0.3% from 0.4% in March and February. Core inflation also came in at 0.3% and is now running at 3.4% year over year. While the six month averages for core and super core inflation are running high (4% and 6% respectively), there are signs that the economy is slowing and that pricing is following suit. This most recent data release prompted market makers to reprice one rate cut (September) while just a week ago the consensus was no rate cuts for 2024. Naturally, the thought of lower interest rates is a boost for equities, as the values we see on stocks is based on the present value of future expected cash flows. How does one ‘present value’ future cashflows? By discounting them using a multiplier. What is the multiplier derived from? The investment rate of return which is directly impacted by the level of interest rates. While people’s expectations of future cashflows and discount rates can vary, they average themselves out to the stock values we see today. For those interested, the present value formula is as follows: PV=FV/(1+i)n.

Pivoting away from Finance 101, the topic of inflation is hotly debated at the moment. Several prominent economists have warned that the Fed’s data dependency will likely leave them in a reactionary mode as opposed to a proactive one. ?As a reminder, every recession that we have dealt with in the last 50 years has started with a central bank that was late to react to a slowing economy. So, it is natural to want the central bank to get it right. This morning, for example, economists Mohamed El-Erian (Allianz) and Seth Carpenter (Morgan Stanley) were discussing the topic on Bloomberg. Mr. Carpenter, sees three rate decreases this year (September, November, December) while Mr. El-Erian has published countless opinion pieces warning that data dependency is a flawed approach, as data is lagged (an indicator of the past) and may not accurately capture underlying weakness.

There is some data that exists that will challenge the current perspective on inflation; if we use harmonized core PCE inflation (which excludes owner’s equivalent rent), we are currently below the Fed’s 2% target. There’s a debate over the inclusion of owner’s equivalent rent in the calculation; it is difficult to accurately capture this figure at any point in time which is why some countries do not use the figure in their inflation calculations. Furthermore, higher interest rates are always going to have an undesired impact on housing costs; it is a sector that relies heavily on leverage as most buyers only put 20% down payments. In the case of the United States, where 30 year mortgages exist and homeowners are less likely to want to sell in this environment, it has led to a boom in new home sales. It is worth noting, that these home builders are also subject to higher rates which are then passed on to the prospective home buyer, so again,?higher rates are doing the damage here.

While housing and services remain expensive, goods inflation is close to flat. After consumers went on a post-covid shopping binge, consumption of goods has slumped while demand for services remains strong. In another form of irony, China is helping keep pricing down in the consumer goods category. While President Biden has announced increases in tariffs across several categories, it may have been a self defeating initiative. While it is true that the President should be concerned about protecting American jobs, polling today suggests that voters are more sensitive towards inflation as opposed to the job market. Is there a better balance to strike? Perhaps, as several respected publications have suggested that the tariffs could have been dealt with differently. Another sensitive political issue in America is immigration. It has been suggested that the influx of legal and illegal immigrants has alleviated some of the consequences of the tight labour markets. While it is certainly important to create order at the border, Americans have been able to collectively benefit from the current crisis.?

If there is even a smidgen of hope that inflation has indeed abated, why do consumers continue to feel pricing pressures? Are the measures that we use flawed or manipulated for political reasons? The truth here is that when we pay for goods, we are not necessarily comparing prices to their year over year comparables; our minds do not work that way. We’re often comparing prices to where they were X years ago and from that perspective, yes, prices have gone up dramatically. Unfortunately, without experiencing a deflationary passage of time, prices are not going to return to where they were. Cumulative inflation is high; prices have increased an estimated 20% since the pandemic and that’s what we see when we pay for goods and services today. That being said, even if inflation hovers at 2% per year, it would take more than 10 years at this pace, in order for pricing to feel more normal. Without a recession, which is an undesirable outcome for most people, it would be wishful thinking to hope for prices to come down, which means that we will likely be paying $8.00 for a Big Mac for the foreseeable future (although McDonald’s is looking to bring back value meals!).

In summary, inflation continues to be to most important factor affecting markets, economies, consumers and politics. Something I’ve been told my entire life is that I need to be more patient, especially throughout my youth. I do not want to lecture anybody, but I also feel like I have no choice but to remind everyone that we need to be patient. Though we are dealing with pricing at this level, it is still more desirable than a recession where a large proportion of the population would lose their jobs, their businesses and/or their homes. We cannot spend our way out of this, we can only let time pass while maintaining this pace. For the members of the Fed, they should not be so binary; lowering rates does not mean returning to a low rate regime. A small decrease would provide some reprieve from those most sensitive to the higher rates but, with the right messaging, would not encourage over consumption. If they choose to react too late, it will run counter to their dual mandate, specifically the part about maximizing employment.

Healthy Distraction

We lost another great Canadian this week with the passing of Darren Dutchyshen. ‘Dutchy’, as he was often referred by, was born in Saskatchewan and began his career at TSN in 1995 and eventually became an anchor for SportsCenter. He took a leave of absence as he?battled prostate cancer in 2021 and?triumphantly returned to co-host SportsCenter in September 2022, until again taking a break at the end of 2023.

The best way to describe him is to quote those closest to him:

“His sharp wit remained until his final moments, classically delivering plenty of jokes – most of them good and all of them inappropriate” his family said.

“A larger-than-life personality, Darren’s incredible sense of humor and magnetic energy made him a natural broadcaster who connected easily with viewers” said Stewart Johnson, senior vice president for sales and sports at Bell Media.

“Giant of a man. In stature, personality, humor, heart. Especially heart” wrote James Duthie, a TSN colleague.

For myself, Leon and many others, it will not feel the same listening to sports highlights without his distinctive voice calling the plays. The best way to assess someone’s life is not by what they accomplish but how they impact other people for the better. By that measure, even at 57, Dutchy had a fulfilling life.

Our sincerest condolences to his family and friends.

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