With the deluge of inflation-related media coverage last week I was reminded of a joke my Mom used to tell me when I was kid.
“What did the Momma tomato say to the baby tomato?
“Catch up” (while she slammed one foot to the ground).”
To bring this joke to present day, The Whaley Report is the Momma tomato and the markets are the baby tomato. I’ve been discussing inflationary concerns and the potential impact of inflation on US economic growth since February 3.
No, not the inflation calculations that the government releases, but the inflation that actually exists in the real world and taxes the consumer on a daily basis from corn and wheat, to coffee and orange juice. Those inflationary taxes have been increasing week-over-week all year long.
The US released price and inflation data for April last week and all of the data, unsurprisingly, accelerated from March. Producer prices had their biggest monthly gain since January 2010 gaining 0.6% month-over-month and 2.1% year-over-year.
Both of these growth rates accelerated from March’s readings. Food prices in April produced a 2.7% year-over-year growth rate. Year-over-year growth in food prices have been accelerating every month since last November, which had a year-over-year growth rate of -0.2%.
The Economic Data At The Margins
Looking at the margin of this data series shows us that most of the growth in food prices have occurred in the last two months. Febrauary’s year over year growth rate in food prices reported at 0.6%, followed by March’s 1.1% and finally April’s 2.7%.
Food prices increased 4-fold on a year over year basis in just two months, now that’s what I call acceleration! Even CPI accelerated higher in April from March’s 0.2% to a 0.3% rate in April. It was the biggest monthly gain for CPI in almost a year.
And the year over year rate for CPI also accelerated in April to 2.0% from March’s 1.5%. I wasn’t surprised by these numbers and regular readers of TWR shouldn’t have been either. But it didn’t take long for the media to run away with these numbers.
The headlines were comical: “Food Prices Soar,” “The Meat Crisis is Here,””Your Chipotle Burrito is getting pricier for one simple reason.”
I don’t think I’ve seen a single headline related specifically to the increasing cost of food in this country all year until last week. As usual, if you wait for the media and the rest of the market to start talking about something, you are generally too late to the party. Coming into last week, here are the year-to-date moves of a few commodities that consumers purchase every day: milk 16%, coffee 61%, sugar 9%, corn 10%, wheat 19%.
The year over year gain in some other “everyday” commodities also has been staggering: bacon 13%, chicken breast 12%, ground chuck 6%. Not to mention that Bubba Gump must be dying right now, the price of shrimp has increased 61% in the last 12 months.
So what does this mean? Consumers only have a certain amount of dollars to spread around. They have earnings and they have savings. If they're spending more on everyday items than they were 1,2 or 6 months ago, then they have less money to plow into the economy.
This truism was born out last week with April retail sales, which after climbing 1.5% in March, increased just 0.1% in April. It's important to point out that March’s increase was the largest since 2010 and that from a yearly perspective, April’s growth rate of 4.0% was just shy of March’s 4.1%.
It takes time for inflationary taxes on consumers to work their way through the system. Consumers, for a period of time, can offset higher food prices by dipping into savings. But this is obviously a finite resource. Unless wage growth can keep up with higher rates of real inflation then at some point the economy slows. Keep in mind that retail sales represent 24% of the domestic economy. So it's an important number to pay attention to and especially when you know what's happening at the margin.
The Market's Message
Now that we know what the numbers are saying and we know what the media is saying, let’s look at what the markets are telling us. The most glaring statement about future US growth from last week came from Treasury yields. While the entire complex declined lower, I’ll focus on the 10-year yield.
10-year yields broke down below the 2014 floor of 2.578%, bounced off the ABYSS line of 2.471% and closed the week just above 2.5%. Any market that breaks out of a 4 month trading range, either to the upside or downside, is a significant development.
That this trading range breakout occurred in 10-year yields is extremely significant. It tells us that the markets are expecting even weaker US growth ahead. This breakdown in yields was accompanied by a breakout by TLT, our proxy for long-dated US Treasuries.
TLT broke out and closed above a down trend line that began when TLT peaked by in July 2012. Breaking out and closing above a 22-month trendline is an extremely significant event. It will be that much more meaningful if TLT can hold that line in the week ahead.
When US growth is expected to be strong, Treasuries are being bid like they have been this year. TLT is already up over 12% for the year and looks poised for further upside. While the SPY is up 2.27% for the year, the divergence between Slow US Growth Assets and High US Growth Assets is widening, in continued favor of slow US growth.
My US Slow Growth Index made a new year to date high last week, gained an additional 85 basis points and now has climbed 11.3% so far this year. On the other hand, my US High Growth Index, declined 16 basis points last week, put in yet another lower high and is now down 3.0% for 2014.
That is 1430 basis points of outperformance this year by assets that favor a slowing US economy. At the margin, that cannot be ignored.
Slow growth assets have also outperformed the S&P 500 by 900 basis points so far. This type of analysis isn’t just good for adding pure alpha to an investment portfolio.
My daughter’s team won their stock market competition, out of 17 teams, with a portfolio that consisted of REITS, utilities, and Treasuries. Not sexy but in this environment it got the job done.
Markets and data are both confirming that the US is slowing and will continue to do so. Most of the markets you want to be in have already had meaningful moves. I believe those markets will continue higher but are probably do for a breather before the next leg up.
Be patient, let markets pullback to you before buying and always keep a cash reserve for those unexpected opportunities.