Housing, CPI And Why I Only Have A Nickel Left
In the daily download of economic data points two in particular jumped out at me - the NAHB/Wells Fargo Housing Market Index and CPI. While both reports were a positive for the economy in the short term - it was the broader aspect which sparked my curiosity.
Home Builder Sentiment Ahead Of Fundamentals
The release of the NAHB/Wells Fargo HMI showed the housing market stalling slightly after eight prior months of dramatic improvement. The housing market index is unchanged this month at 47, still three points short of the 50 level above which would indicate that more builders describe conditions as good than bad. The index is also up sharply from its early 2009 lows of 8 as shown in the chart below which also smoothed with a six-month average.
From the lows sentiment has surged by over 450% which, if you could trade it, would have been one "helluva" good investment. However, as with all things in the financial markets, it is common place for sentiment to run well ahead of fundamentals. Unfortunately, that is the very issue that leads to large reversions when expectations collide with reality.
While the media is has been replete with stories about the return of housing, and the economic driver that it will be, I caution that such enthusiasm should be somewhat tempered with reality. The housing market is indeed recovering which is a good thing. However, we are still a long way from just getting back to normal levels of activity. David Rosenberg had an excellent note in his daily commentary recently stating:
When I look at recoveries, I always make sure I assess them not only based on the bounce off of the bottom but also in terms of how much of the prior corrective backdrop has been reversed during the rebound. That is needed for perspective.
So where I come from on the housing situation is this:
1) The Case-Shiller 20-city home price index has recouped 11% of the recession plunge
2) New Home Sales have recouped 9% of the recession plunge
3) Singly family starts have recouped 14% of the recession plunge
Note that I am not disputing the recovery. I'm only disputing its vitality (all the more so given how much attention this sector receives, even though it is a 2% share of GDP and a 0.14% fraction of the S&P 500 market cap.)
Meanwhile, the homebuilding stocks have reversed about 40% of its bear market loss in this recovery phase. And the NAHB survey has recouped 60% of its peak-to-trough slide during this recovery so far.
In other words, the 'sentiment' is running far faster than the actual improvement in 'real activity.' For sure, the market is a forward-looking barometer, but that said, a lot of future expansion seems to be "built in" judging from the relative reversals.
The chart below shows our Total Housing Activity Index (which is a composite index of New & Existing Home Sales, Permits and Starts) relative to home building sentiment. You can clearly see David's point.
Furthermore, while housing activity has improved, somewhat, since the recessionary lows let us not confuse this recovery which has been driven by a multitude of interventions from bond buying programs, mortgage write downs, write offs, short sells, tax credits, inducements, forgiveness and bailouts from a normal organic housing recovery. For the trillions of dollars that have been thrown at the mortgage, and housing market, since the crisis we should really be disappointed in the lackluster recovery that has occurred so far.
However, what this does tell us, is just how bad the housing market really was and, most likely, still is.
Inflation Is Dead - Long Live Inflation
The latest release of the Consumer Price Index (CPI) showed virtually no change in inflation in the last month. Still lower energy costs in December kept the headline CPI soft. The consumer price index in December was unchanged after declining 0.3% in November. The December figure matched market expectations for no change. Excluding food and energy, the CPI edged up 0.1 percent, following a modest 0.1 percent rise in November. This was much of the same story we saw in yesterday's report on the Producer Price Index (PPI).
The chart below shows the year-over-year change in the composite inflation index (both headline and core).
No real surprise here. Since 1980, inflationary pressures have been on the decline as gains in productivity, technology and communications have pushed costs, and wages, lower. The reality is that despite the fears of "hyperinflationists" there are still more deflationary pressures on the market than inflationary ones - this is particularly the case with wages. This is clearly shown in the chart below which shows the ratio of corporate profits to wages which is at the lowest level in history - $3.95 in wages for every $1 in profits.
It is very difficult to have a large inflationary push when wages are being suppressed and the deflationary demand for lower product prices reigns supreme. This is why "Made In Some Other Country" adorns everything from clothes to gadgets.
Why Do I Only Have A Nickel?
It certainly seems to me that my dollar doesn't go as far as it used to. My four children and I will sneak out for an occasional trip to our favorite hamburger joint for some bonding time. However, that trip used to be accomplished with help of just Andrew Jackson. Today, it is starting to require Mr. Jackson and a couple of Abraham Lincoln's to buy the same amount of food. This is not a uncommon scenario for many American families which is why reported inflation always gets a good bit of push back from consumers.
The constriction of wages, when combined with the rising costs of living, have reduced the purchasing power parity of the dollar over time. The chart below shows the purchasing power of the consumer dollar as compared to reported headline CPI.
Clearly, between rising inflationary pressures and stagnant wage growth, the realized purchasing power of dollar has fallen from $1 in 1913 to less than $0.05 today. This is why subject of inflation, reported versus real, remains a very hotly contested topic.
As I wrote recently:
"The sole purpose in measuring inflation is to help businesses, individuals and governments adjust their financial planning for the impact of inflation. Inflation erodes future purchasing power, and decreases economic prosperity, if not accurately accounted for. The accuracy of measuring inflation, and accounting for it properly, is essential to long term economic prosperity."
While reported CPI is showing virtually no inflation over the last year the reality is that for the average American the gap between incomes coming in, which have now decreased further due to higher taxes, and their standard of living has to be filled by credit. With savings rates already low the drag on incomes from debt service requirements erodes future prosperity.
As stated above the question that really must be answered is whether, or not, we are really accounting for inflation correctly? If the next trip with the kids requires the company of more than one Andrew Jackson - we may have our answer.