Posts filed under “Inflation”
I wanted to take a moment out this morning to briefly discuss the differences between real, nominal, after tax, and total returns:
Why is it that nearly any chart that gets posted — be it index, stock, bond or commodity — invariably results in a knee jerk demand for an inflation adjusted version? I half expect to see those comments on even intra-day stock charts.*
Different return measures (and the corresponding charts that go with them) provide information about different things. It is not, as some suggest, that one is inherently superior to another. Rather, they measure different things, provide a different context, and are appropriate in different circumstances.
Perhaps a few definitions are in order:
Nominal Returns: Are what an investment generates before taxes, fees and inflation. It is simply the net change in price over time.
Real Returns: Are the actual value of your returns, typically after adjusting for inflation and fees. During a period of high inflation (i.e., 2001-07), Real Returns inform the gains minus inflation by keeping purchasing power of capital constant over time.
Net Returns: Usually referenced in the context of high fee investment vehicles like VCs or Hedge Funds. Net returns informs the investor exactly what they have left after managers take their pound of flesh. Can reference net of fees and/or taxes and other expenses. (Related definition: Net Return Shock!)
Total Returns: Is the combination of both capital appreciation (change in market price) plus all interest, income, dividends and distributions.
After-Tax Returns: Usually used in reference to tax-advantaged securities (i.e., municipal bonds, TIPS), it is the actual financial benefit which accrues to an investor on an after tax basis. The after-tax return often differs significantly from the nominal rate of return. It is dependent upon the investor’s city and state of resident, Federal tax bracket.
All of these return measures are valid ways of depicting slightly different measures of investing results. They seek to gauge returns in slightly different forms relative to each other. They actually measure different things, and each are more (and often less) appropriate in specific settings.
While the numbers used to depict these varied forms of returns are neutral and objective measures, how they are employed often is not. I see an awful lot of biases revealed in some quarters always selecting one type of return or another. Always showing inflation adjusted returns is an attempt to reduce the returns of a rally, typically one missed by the speaker. Never showing inflation adjusted or Total returns reveals a similar if opposite bias.
Which brings us to the chart shown up top. If you want to get a true picture of returns, inflation adjusting alone is misleading. Consider the typical investor saving for retirement in an IRA or 401k. For these investors, the real inflation adjusted return is important, but so is their total return. Their real total return informs them both of the dollar amount of their investments’ worth plus any change in its purchasing power.
This leads investors to the most important questions about their long-term investing in the first place. It is a fair question to ask: How much money will you have when you retire, and what will that sum of money be worth?
* Yet another reason to look askance at comments.
DJIA – Dow Jones Industrial Average (index) pre- and post- Gold Click for full chart Source: Peter Williams, Advisor Perspectives Interesting look at long term Dow but using the Gold Standard as a dividing line. To be blunt, I am really not sure what to make of it. Was going off of the Gold Standard inevitable, and therefore unimportant? Or was…Read More
I cringe each time I hear some inflationista — you may have met that guy who insisted there was no inflation during the 2000s as the dollar plunged 41% but now sees inflation everywhere — brings today up the Weimar Republic every chance he gets. Here is a look at long term Inflation we spoke…Read More
Happy anniversary Helicopter Ben! It was 10 years ago today that Mr. Bernanke gave his speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here” as at the time some “expressed concern that we may soon face a new problem, the danger of deflation or falling prices” as reported inflation rates were low at the time…Read More
Bloomberg Brief points to this report from Carl J. Riccadonna, senior U.S. Economist at Deutsche Bank, looking at the misery index — Inflation + Unemployment. Riccadonna took the usual analysis one step further, applying it to the swing states in the Presidential contest. What did he find: “The following states are “worse-off” based on…Read More
A Little Chronic Deflation
October 13, 2012
One of the questions I (and other analysts) get asked most frequently is whether I think there is deflation or inflation in store for the US. My quick answer is “Yes.” A brief answer is that we are in a deflationary period and have been for over 30 years, but like all cycles it will come to an end. A great deal of the “when” depends on how the US deals with its deficit following the election. If we put the US on a realistic glide path to a balanced budget (over time) then that deflationary impulse will last longer than most observers think, even given QE3+++. If we do not deal with the issue, and try once again to kick the can to the next election, inflation could be a very real problem.
But one of the definitive experts on the question, and someone who has taught me a great deal over the years, is Dr. Gary Shilling, who has literally written the book (several, actually) on deflation. This week he summarizes a recent client letter for our Outside the Box, and I think you’ll will find stimulating. His is not the consensus view, but it’s one we need to understand.
You can subscribe to Gary Shilling’s Insight for the special introductory rate of $275 for Outside the Box readers (email delivery) and get a copy of the full Insight report excerpted here plus a copy of Gary’s latest book, Letting Off Steam, a collection of his commentaries on matters great and small, complex and mundane, serious and frivolous.
Gary will be writing about the details of who will be winners and losers in the Fed’s QE3 program, how overseas economies are faring, and what it all means for US stocks and the American economy. To subscribe to Insight call them at 888-346-7444 or 973-467-0070 and be sure to mention you read about the offer here.
This has been an interesting week. I was supposed to speak at a client meeting for Common Sense Investments at noon on Wednesday in Portland. Kyle Bass of Hayman Advisors was also speaking, so he graciously offered to let me fly with him in his plane rather than catching a redeye the night before. I got up early and made it to the hangar, but the plane had a mechanical problem. A quick call to American Airlines and a mad dash to the airport got me on a scheduled flight that would have gotten me in on time. Except that flight too had issues and the other flights were booked solid. An extremely helpful staff member at American somehow sorted it out and got me onto a full flight (with wifi!) and into Portland in time to let me give a speech as the “closer” for the day. Meanwhile, Kyle was in Chicago and found another way to get to Portland. The other speaker had a personal tragedy to deal with and couldn’t make it; so I called my old friend Ed Easterling, who lives not far from Portland, and he kicked the meeting off with his usual dynamic presentation while the rest of us figured out how to get there.
The next day, the founder of Common Sense Investments, Jim Bisenius, took us to his 36,000 acre ranch (and wildlife preserve) in Eastern Oregon to do a little hunting and fishing. It is a rather amazing place. He is such a gracious host and has a gift for getting people to tell their stories. Kyle brought along a young man who had been Special Operations in Iraq and who now carries around about four pounds of metal from a IED that can’t be gotten out of him. He’s in quite a lot of chronic pain but is rather cheerful and can tell some pretty amazing stories. It makes me humble to realize what sacrifices people make for our freedoms. The courage he and his brethren display on a regular basis is inspiring. I simply stand in awe and gratitude.
I was able to hitch a ride back to Dallas, got in late, got up the next morning, taped videos and read some emails, and then hopped another plane to Houston, where I am getting ready to go to my 40th Rice University class reunion. I am sure it will be another night of old friends and great stories, so I think I will hit the send button and go on to the party. Have a great week!
Your rather amazed at how much fun I get to have analyst,
(Even more amazing is that I get paid for this!)
John Mauldin, Editor
Outside the Box
Seven Varieties of Deflation
By Dr. A. Gary Shilling
Inflation in the U.S. has historically been a wartime phenomenon, including not only shooting wars but also the Cold War and the War on Poverty. That’s when the federal government vastly overspends its income on top of a robust private economy—obviously not the case today when government stimulus isn’t even offsetting private sector weakness. Deflation reigns in peacetime, and I think it is again, with the end of the Iraq engagement and as the unwinding of Afghanistan expenditures further reduce military spending.
Few agree with my forecast of chronic deflation. They’ve never seen anything but inflation in their business careers or lifetimes, so they think that’s the way God made the world. Few can remember much about the 1930s, the last time deflation reigned. Furthermore, we all tend to have inflation biases. When we pay higher prices, it’s because of the inflation devil himself, but lower prices are a result of our smart shopping and bargaining skills. Furthermore, we don’t calculate the quality-adjusted price declines that result from technological improvements in many big-ticket purchases. This is especially true since many of those items, like TVs, are bought so infrequently that we have no idea what we paid for the last one. But we sure remember the cost of gasoline on the last fill-up a week ago.
Furthermore, many believe widespread deflation is impossible and that rampant inflation is assured in future years because of continuing high federal deficits, regardless of any long-run budget reform. And annual deficits of over $1 trillion are likely to persist in the remaining five to seven years of deleveraging, as I explain in my recent book, The Age of Deleveraging. The 2% annual real GDP growth I see persisting is well below the 3.3% needed to keep the unemployment rate stable. So to prevent high and chronically rising unemployment, any Administration and Congress—left, right or center—will be forced to spend a lot of money to create a lot of jobs.
But big federal deficits are inflationary only when they come on top of fully-employed economies and create excess demand. That’s obviously not true at present when large deficits are reactions to private sector weakness that has slashed tax revenues and encouraged deficit spending. Indeed, the slack in the economy in the face of persistent trillion dollar-plus deficits measures the huge size and scope of the offsetting deleveraging in the private sector, as noted earlier.
The deleveraging, especially in the global financial sector and among U.S. consumers, will be completed in another five to seven years at the rate it is progressing. At that point, the federal deficit should fade quickly, assuming a war or other cause of oversized government spending doesn’t intervene. The resumption of meaningful economic growth will reduce the pressure for economic stimuli and rising incomes and corporate profits will spur revenues. Serious work on the postwar baby-related bulge in Social Security and Medicare costs will also depress the deficit.
A decade ago in my two Deflation books, I distinguished between two types of deflation—the Good Deflation of excess supply and the Bad Deflation of deficient demand. Good Deflation is the result of important new technologies that spike productivity and output even as the economy grows rapidly. Bad Deflation results from financial crises and deep recession, which hype unemployment and depress demand.
I’ve been forecasting chronic good deflation of excess supply because of today’s convergence of many significant productivity-soaked technologies such as semiconductors, computers, the Internet, telecom and biotech that should hype output. Ditto for the globalization of production and the other deflationary forces I’ve been discussing since I wrote the two Deflation books and The Age of Deleveraging. As a result of rapid productivity growth, fewer and fewer man-hours are needed to produce goods and services. The rapid productivity growth so far this decade is likely to persist (Chart 1).
While I’ve consistently predicted the good deflation of excess supply, I said clearly that the bad deflation of deficient demand could occur—due to severe and widespread financial crises or due to global protectionism. Both are now clear threats.
My forecast is that the unfolding global slump will initiate worldwide chronic deflation. A number of indicators point in that direction. Sure, much of the recent weakness in the PPI and CPI has been due to falling energy and food prices. Excluding these volatile items, prices are still rising but at slowing rates (Charts 2 and 3). Consumer price inflation is also falling abroad in the U.K. and the eurozone.
One measure of a successful monetary policy is its ability to anchor expectations about future inflation rates. Financial crises, such as that of 2008–09, can be considered natural experiments that test this anchoring. The effects of the crisis on inflation expectations were largely temporary in the United States, but longer-lasting in the United Kingdom. That…Read More
Click to enlarge: Source: Bloomberg Is Gold cheap? Pricey? Somewhere in between? I have a hard time answering that question because I have no frame of reference. With equities, I could look at earnings and/or dividends, sales, book value, etc. to determine relative valuation. With bonds, interest rate, credit rating (and whether its callable)…Read More