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7/29/2019 Lighthouse Macro Report - 2013 - August
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Lighthouse Investment Management
Macro Report - US economic indicators - August 2013 Page 1
Macro Report
Economic Indicators - USA - August 2013
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Contents
Summary ....................................................................................................................................................... 3
Lighthouse Recession Probability Index........................................................................................................ 4Introduction .................................................................................................................................................. 5
Fed Funds Rate ............................................................................................................................................ 10
Crude Oil ..................................................................................................................................................... 11
Construction: Building permits ................................................................................................................... 12
Employment: Non-Farm Payrolls ................................................................................................................ 13
Employment: Jobs Gained / Lost ................................................................................................................ 14
Employment: Jobs Gained/Lost (zoomed-in) .............................................................................................. 15
Employment: Hire and Fire ......................................................................................................................... 16
Employment: Initial and Revised Non-Farm Payrolls .................................................................................. 17
Employment: Full Time ............................................................................................................................... 18
Employment: Part Time .............................................................................................................................. 19
Employment: Full-Time to Part-Time Ratio ................................................................................................ 20
Employment: Labor Force Participation Rate ............................................................................................. 21
Consumer Sentiment: University of Michigan Survey ................................................................................ 22
Consumer Confidence: Conference Board Survey ...................................................................................... 23
Credit: Total Outstanding ............................................................................................................................ 24
Credit: Bank Loans and Leases .................................................................................................................... 25
Retail Sales: Nominal .................................................................................................................................. 26
Retail Sales: Real ......................................................................................................................................... 27
Retail Sales: Real per-capita ........................................................................................................................ 28
Retail Sales Excluding Autos ........................................................................................................................ 29
Manufacturing: Hours Worked ................................................................................................................... 30
Manufacturing: Orders ............................................................................................................................... 31
Orders: Capital Goods ................................................................................................................................. 32
Manufacturing: Supplier Deliveries ............................................................................................................ 33
Electricity Usage .......................................................................................................................................... 34
Output: Electricity and Gas ......................................................................................................................... 35
Transportation: Miles Traveled ................................................................................................................... 36
Transportation: Gasoline Consumption ...................................................................................................... 37
Inflation: Implicit Price Deflator .................................................................................................................. 38
Income: Real Disposable Income per Capita .............................................................................................. 39Inflation: Consumer & Producer Prices....................................................................................................... 40
Inflation Expectations ................................................................................................................................. 41
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Summary
The "Good":
Retail sales growth accelerated Growth in capital goods orders ex defense/aircraft accelerated
The "Bad":
First major downward revision in employment growth since April 2010 Further decline in men's LFPR (Labor Force Participation Rate) September University of Michigan Consumer Confidence lowest since April July growth of bank loans and leases slowed to 0.9% (past 3 months annualized) Electricity usage and production is slowing down further Zero growth in real disposable income per capita
CONCLUSION: The probability for recession remains low. However, economic growth remains very
weak. The recent rise in 10-year yields (1.6% to 2.9%) and emerging market troubles (Brazil, China,
Indonesia, India) could have negative consequences going forward.
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Lighthouse Recession Probability Index
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Introduction
Recessions are bad for company profits and hence stock prices. Knowing when an economic slow-down
looms can give important clues about asset class selection.
In the US, the beginning and the end points of recessions are declared by the NBER (National Bureau of
Economic Research). The NBER defines recessions as a "significant decline in economic activity spread
across the economy" (not, as often believed, as two consecutive quarters of negative GDP growth).
The NBER takes it's time to date the beginning and the end of a down-turn; it announced the beginning
of the last recession (December 2007) only on December 1, 2008 - one year later. By that time, the S&P
500 Index had fallen from 1,575 points to 741. Similarly, the end of the recession in June 2009 was
announced on September 20, 2010 - more than one year later. By that time, the S&P 500 had already
soared from 940 points to 1,142.
Waiting for the NBER to declare beginning and end of recessions would have led to inferior investment
results (the NBER is correct in taking it's time, since many economic indicators are being revised multiple
times as preliminary data gets updated).
Traditional leading indicators include values such as the stock market and the slope of the yield curve.
However, the stock market does not seem very good at anticipating recessions, as the S&P 500 index
marked an all-time high in mid-October 2007, a mere six weeks before the most severe recession of the
last 8 decades began.
The yield curve has historically been a very good warning sign of recessions, as the Federal Reserve Bankwas forced to increase short-term rates in order to cool an overheating economy (thereby triggering a
recession). However, with short-term interest rates near zero for the foreseeable future, the yield curve
could only invert if long-term yields dipped into negative territory. While not entirely impossible
(negative yields for up to 2 year maturities have been observed in German, Swiss, Danish and other
government bond markets) it is very unlikely to happen in US Treasuries. Therefore, the slope of the US
yield curve is unlikely to give any hints about a recession occurring under ZIRP (zero-interest-rate-
policy).
Indicators published by other institutions, such as ECRI (Economic Cycle Research Institute), are
proprietary and not transparent, giving investors only the choice to "believe-it-or-leave-it".
The Conference Board Leading Indicator includes questionable values such as the S&P 500 Index, the
slope of the US yield curve and M2 money supply (which we have found to have little correlation with
economic cycles).
As most recessions last rarely longer than a year, the economy usually had already exited a recession by
the time the NBER declared it to be in one.
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Revisions to GDP growth render it useless for investment purposes; On August 28, 2008 (already 8
months into the "great recession"), Q2 2008 GDP growth was revised upwards from an initial +1.9% to
+3.3%, triggering a 2% stock market rally. Later, growth was revised down to 1.3%, with the following
quarters delivering -3.7%, -9.2% and -5.4% (quarter-on-quarter, annualized). The S&P 500 Index didn't
regain the level attained that day for another 2 1/2 years.
Finding a reliable indicator for identifying recessions "real-time" would already be a great improvement
over waiting for the NBER.
Over the past 50 years, every recession was easily explained by two factors: oil and the Fed.
Unfortunately, this does not have to be the case going forward. Due to impotence of monetary policy at
the lower zero bound and rapidly increasing government debt the Fed might not be able to raise rates in
the foreseeable future. A recession might hence happen without prior tightening by the Fed.
We looked at many indicators from every angle; most had to be smoothed to cancel out short-term
"noise" in order to prevent false signals (we use 3-months moving averages).
Some indicators do not reveal useful signals unless you look at decline from recent peaks. Other data
needs to be trend adjusted (number of miles driven, for example, benefits from rising number of cars
and population).
The table on the following page shows indicators we have tested. Our criteria:
false positives (calling for a recession when there was none) false negatives (missed a recession) confidence it will work in the future and lead / lag time
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No two recessions are the same. Trigger levels can be too strict (missing some recessions) or too lose
(giving too many false positives). We therefore created a range. The lower ("strict") boundary is the level
necessary to avoid false positives; the upper ("lenient") boundary is the level necessary to catch all
recessions. A high-quality indicator will have a narrow range, and recessions will be called with high
confidence. An indicator at the upper boundary will be awarded a 50% probability, increasing towards
100% at the lower boundary.
The overall "Lighthouse Recession Probability Indicator" (LRPI) is a weighted mean of individual
indicators. High confidence and timeliness of signal have been awarded higher weights (maximum: 3)
then those with low confidence or tardiness (minimum: 1). On the following page you see the LRPI since
1971, predicting every recession (assumed once 40%-50% probability is exceeded).
The Federal Reserve Bank of St. Louis publishes a recession probability indicator by Chauvet / Piger
(black line). It is based on four inputs (non-farm payrolls, industrial production, real personal income and
real manufacturing and trade sales). However, the most recent data point for Chauvet/Piger is usually
three months old, while LRPI is constantly updated (1 months old data).
You can see that LRPI shows first warnings signs much earlier than Chauvet/Piger.
In a recent response to a blog post, Chauvet clarified their indicator calls for a recession only "after
exceeding 80% for a couple of months". Additionally, their indicator is "smoothed" as the raw data canreach 70% (2003/4) without being followed by a recession. Their indicator initially showed a recession
probability of 20% for August 2012, only to be revised down to 1.7% six months later.
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Verification of LRPI:
We set 40% as threshold for the LRPI to indicate a buy (recession probability 40%) signal.
Transactions have been done at the monthly closing price of the S&P 500 following the month for which
the signal occurred (in order to accommodate time lag):
An investor using the LRPI as a trading tool would have suffered only one loss of 7% (August 1980) while
avoiding the dot-com crash (2001) and the 'great recession' (2008-2009). The system creates no
unnecessary churn. While the control group ('buy-and-hold') would have created a higher return (with
higher volatility) this might be due to the test period coinciding with one of the longest bull markets in
history (1982-2000).
Annex: LRPI Components
Please find charts for all contributors to the LRPI on the following pages.
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Fed Funds Rate
The US central bank ("Fed") increased interest rates ahead of each of the last 9 recessions. The black line
shows the absolute level of the Fed Funds rate; the blue line the increase from the prior post-recession
low. An increase between 2 and 4.5 percentage points from the previous low preceded every recession
since 1954.
Recessions are shaded in gray. Yellow dots indicate the beginning of a recession; green dots the end.
The absolute level (black line) is usually on the right-hand scale, while percentage changes (blue line) are
on the left-hand scale. Negative absolute numbers should be ignored as they are merely needed for
better formatting.
This indicator has a double weighting in the Lighthouse Recession Probability Indicator.
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Crude Oil
An increase in the price of crude oil of 75% to 100% preceded five out of the last six recessions. Close call in March 2011 and February 2012. Currently not a red flag. Crude oil would have to rise above $113/barrel in order to trigger an early warning. This indicator has a triple weighting in the LRPI
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Construction: Building permits
Want to build a house? Need a permit! Any decline in permits of 25%+ from prior peak and you can bet
on a recession. Missed the one in 2001 though. 2011 was a close call. Absolute level still below 1990/91
recession lows (despite US population growth from 250m then to 316m in 2013).
Due to housing overhang unlikely to give a boost to the economy. Due to low level unlikely to do much
damage to GDP either (should permits decline again). Currently no red flag. However, it needs to be
seen how rising mortgage rates will impact the housing market going forward.
This indicator has a triple weighting in the LRPI.
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Employment: Non-Farm Payrolls
The number of people on "payroll", or employed, is a good proxy for the health of the economy. You can
see the long "valleys" of lost payrolls after recent recessions compared to earlier ones. A decline of more
than 1% from previous peak payroll level indicates a recession. There have been no misses and no false
positives; even the "tricky" back-to-back recessions in 1980 and 1982 have been called correctly by this
indicator. The payroll report, also known as "Establishment Survey", is based on a sample of a third of
US payrolls (>40 million). The "Household Survey" (not shown), on the other hand, consists of a sample
of only 60,000 households, leads to similar results, but more volatile.
Does counting jobs reflect the actual picture of the economy? Only 47% of all working-age Americanshave full-time jobs. Since 2007, six million full-time jobs have been lost, but 2.5 million part-time jobs
gained. Part-time jobs often come without "benefits" such as health insurance. From peak employment
(Q1 2008) to Q1 2010 1.2 million "higher-" wage jobs (median hourly wage $21-54) have been lost; in
the subsequent 2 years only 0.8 million have been recreated. While almost 4 million mid-wage jobs
($14-21) have been lost, only 0.9m have reappeared. Among lower wage jobs ($7-$14), 1.3 million have
been lost, but 2 million gained. This indicator has a triple weighting in the LRPI.
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Employment: Jobs Gained / Lost
Current monthly payroll growth of 184,000 (12 months average) indicates zero probability of recession.
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Employment: Jobs Gained/Lost (zoomed-in)
August non-farm payrolls (+169,000) slightly missed expectations (+175,000) July has been revised downwards by 58,000 (from 162k to 104k) This is the first major downwards revision since April 2010 However, it should be noted that the margin of error is around 100,000, and revisions can be up
to 300,000
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Employment: Hire and Fire
Each month, more than 4 million people are newly employed and more than 4 million peoplequit their job or are fired.
These are big numbers compared to the balance between those two (the monthly change innon-farm payrolls).
The difference between those two lines are the net changes in employment (lower chart). You will notice less separations (fewer employees resign) during the 'great recession';
unemployment rose simply because new hires fell even faster.
The US labor market is very dynamic, as more than 1/3 of total employees (4.2m x 12 = 50m)change jobs each year.
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Employment: Initial and Revised Non-Farm Payrolls
This chart shows monthly changes in employment as initially reported (black dotted line), therevised number (thick black line) and the difference between the two (green/red chart, right-hand
scale).
During the last recession (we didnt know we were in one yet), monthly employment numbers wererevised downwards by up to 273,000.
In Q3 2008, revisions were -159k, -190k and -273k (thats before Lehman happened).
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Employment: Full Time
The overall employment picture may be misleading, as higher paying full-time jobs are usuallybeing replaced with part-time jobs during a recession.
Full-time employment growth (year-over-year) stands at 1.5% (previous: +1.4%). Part-time jobs usually come without healthcare benefits, forcing employees to cover their own
medical expenses (leaving less money for consumption).
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Employment: Part Time
During each recession, the number of part-time employees spikes up Companies, uncertain regarding the economic outlook, prefer not to enter longer-term
commitments
A part-time job may be better than no job, but usually does not sustain the costs of living of afamily.
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Employment: Full-Time to Part-Time Ratio
The number of full-time employees used to be more than five times the number of part-timeemployees
In each recession, full-time employees are replaced by part-timers The ratio has not recovered in a meaningful way since the 'great recession'
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Employment: Labor Force Participation Rate
The US unemployment rate is declining thanks to a decline in the 'labor force participation rate'(people with jobs relative to people who could potentially work).
Many have exhausted their unemployment benefits, have left the workforce and are notcounted as unemployed.
Large numbers have applied for disability insurance, removing those folks permanently from thelabor market (as opposed to unemployment, which usually is temporary).
Economic growth depends on decent increases in employment and real incomes - none of whichis occurring.
Given low savings, increased consumption is possible only through credit expansion, leading torising indebtedness. This trend is unsustainable, but encouraged thanks to very low interest
rates.
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Consumer Sentiment: University of Michigan Survey
The University of Michigan, together with Thompson-Reuters, conducts more than 500telephone interviews twice a month to gauge consumer sentiment, with a reference point from
1964 set to 100. A preliminary mid-month survey is followed up by a final one towards the end
of the month.
The indicator had one false positive (2005) and one miss (1981; the 1980-1981 recessions wereback-to-back, so let's not be too harsh about that).
A decline of 25%+ from previous peak indicates a recession.
2011 was a close call. The September reading (76.8) was the lowest since April 2013 (76.4) This indicator has a triple weighting in the LRPI and does currently not deliver any warning signs.
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Consumer Confidence: Conference Board Survey
The Conference Board, an independent business membership and research association,conducts a survey of consumer confidence by mailing out surveys to more than 3,000 randomly
selected households. The cut-off date for a preliminary number is the 18th of the months. The
final number includes all surveys returned after that date.
The indicator had two false positives (1992, 2003), but it did catch all recessions including theones in 1981/2 and 2001 (difficult for a lot of other indicators).
2011 was a "close call". Consumer Confidence in August increased to 81.5 (from 81 in the prior month), the second-
highest since January 2008.
This indicator has a double weighting in the LRPI and currently does not raise any red flags.
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Credit: Total Outstanding
Most recessions have been accompanied by a reduction in the growth of debt. But, for the first time in
60 years, debt has actually shrunk in 2009. A meager 2% reduction caused a massive recession. The
classic question of chicken and egg comes to mind: did the recession cause debt to shrink or did
shrinking debt induce a recession?
I have included the 1987 stock market crash (red triangle). A dramatic revelation dawns: economic
growth is dependent on credit (debt) growth; without additional debt, growth is impossible.
Unfortunately, data becomes available only once every quarter, with the latest data often many months
old. To ensure timeliness for our LRPI we had to exclude this measure, however present it here forinformational purposes.
In Q1 2013, TCMDO was growing at a $3.1 trillion rate over the last 8 quarters (versus 2.8 trillion in Q4).
TCMDO-to-GDP has increased to 357% (Q4'12: 356%, Q3: 353%, Q2: 354%, previous peak was 385% in
Q1'09). Year-over-year growth accelerated slightly to 3.6% (from 3.4%) - still far below the past peak
(10.6% in Q3 2007, when the S&P 500 hit its previous all-time-high of 1,575).
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Credit: Bank Loans and Leases
Growth of total US bank loans and leases slowed further in July to +2.8% (previous month:+2.9%)
The growth of the past three months has slowed to 0.9% (previous month: +1.7%) Since 1971, growth of loans and leases below 2% has been associated with recessions Securitization and shadow banking might be able to mitigate the effects of slowing bank lending However, slowing lending is always a concern in a credit-based economy We have not yet incorporated this data into our recession indicator
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Retail Sales: Nominal
US retail sales growth accelerated in August to 5.4% (previously: +5.3%) July retail sales have been revised upwards by $1.2bn to $425.6bn For the LRPI, we have replaced this indicator with "real retail sales" (see next page). Nominal
retail sales include inflation, and hence say little about volume growth.
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Retail Sales: Real
Real retail sales (volumes) have finally surpassed their pre-recession level In July, real retail sales growth accelerated to 3.6% (+3.2% previous month) No recession signal currently This indicator has a triple weight in the LRPI
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Retail Sales: Real per-capita
Real per-capita retails sales are still 5% below their pre-recession peak In July, the rate of growth improved to 2.9% (previous: +2.5%) No recession signal
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Retail Sales Excluding Autos
Monthly auto sales, at $80 around 1/5th of total retail sales, continue to benefit from very lowinterest rates, abundant credit and deep-subprime used-car loans.
Over the past three months, auto sales grew at 17% annualized Excluding autos, retail sales grew by 4%. This level is dangerously close to recession territory. In Q4 2012, 45% of all car financings were subprime (FICO score
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Manufacturing: Hours Worked
Companies prefer to reduce employee's working hours rather than firing them straight away A drop in average weekly working hours in the manufacturing sector of 2% or more indicates a
recession (except for 1996)
According to "hours worked", the US economy is still sailing smoothly This indicator carries a double weighting in the LRPI
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Manufacturing: Orders
The Institute for Supply Management (ISM) regularly asks company executives about orders,sales, inventories etc.
A level of 50 indicates "unchanged" (economy stagnates). This indicator delivered one false positive (1989). The ISM new orders index has been hovering around 50 for a while. This indicator carries double weighting in the LRPI and currently does not give a warning sign.
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Orders: Capital Goods
Defense and aircraft orders are lumpy and distort trends, so we exclude them here. We have"medium" confidence in this indicator due to limited historic data. The "red zone" has been set
at -5% to 0%.
June orders came in at $69.7bn - the highest level ever recorded. However, defense and aircraft orders are more than twice as much as the rest. Any cuts in
defense spending or problems with Boeing's 787 model may affect total orders, with
repercussions for many suppliers. So I wouldn't get too excited about the non-defense ex-
aircraft data.
This indicator carries a single weighting in the LRPI and currently does not give a recessionwarning.
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Manufacturing: Supplier Deliveries
Multiple false positives (1985, 1989, 1995, 1998, 2005) muddy the water. Therefore, this indicator has been slapped with "low" confidence and a corresponding single
weighting.
Recent surveys hovered around the 50-point mark. The current reading suggests no growth in manufacturing supplier deliveries, but does not give a
recession warning.
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Electricity Usage
If you run a business you need electricity Weather can have an impact as electricity use in the US peaks in summer due to air conditioning If electricity usage drops by 1% or more, it's a recession Limited historic data, but no misses and no false positives The drop of 1.5% in May puts the likelihood of recession at 100% "Electricity usage" carries a single weighting in the LRPI
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Output: Electricity and Gas
Electricity production should be linked to economic growth This indicator, unfortunately, had many false positives (1983, 1992, 1997, 2006), so confidence
is "medium"
Setting the trigger lower than -0.5% would eliminate false positives, but make you also misssome recessions
Recent data has seen quite some revisions of up to 2.5% magnitude Electricity production suggests we are in a recession with 100% likelihood The indicator carries a single weighting in the LRPI
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Transportation: Miles Traveled
The US population grows by 2.25m people (0.7%) per annum, so traffic increases constantly. If total
miles driven grow less than 0.1% versus its own trend, you are likely to be in a recession (the
unemployed drive less).
The 2001 recession was missed. This indicator says we had a recession in 2011 (which is theoretically
possible - we might not know it yet). The prolonged decline in miles traveled since 2007 is puzzling; the
decline being deeper than the back-to-back recession 1980/81. Online shopping, car pooling and work-
from-home jobs might have contributed to this trend. A recent poll indicated young Americans are less
keen on acquiring a driver's license than one or two decades ago.
Unfortunately, data is made available only with a time lag of three months. This, combined with lower
confidence, made us exclude this indicator from the LRPI. In March, historic data has been revised going
back for years, denting confidence in this indicator further.
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Transportation: Gasoline Consumption
Cars need gas, and gas needs to be delivered to gas stations Inventory effects are unlikely because of high turnover "Low" confidence because of false positive (1996) and limited historic data The harsh decline in 2012 is puzzling, but recovered since March 2012 Some US cities are upgrading their public bus fleet onto natural gas, potentially contributing to
the decline in gasoline consumption
This indicator is currently giving 0% likelihood of recessionThis indicator is related to "miles driven", confirming trends on one hand, but being redundant on the
other. It has therefore been excluded from LRPI.
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Inflation: Implicit Price Deflator
The implicit price deflator is derived from the quarterly GDP report by comparing the current-dollar value of personal consumption expenditures (PCE) to its chained-value series
The Federal Reserve prefers this variable over the official consumer price index (CPI) Increasing nominal yields combined with slowing inflation lead to higher real yields - a
nightmare for the Fed
Inflation expectations, too, are falling The Fed might have no choice but to reverse course and abolish its plans to 'taper off' bond
purchases ("quantitative easing") towards the end of 2013
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Income: Real Disposable Income per Capita
Real disposable income per capita is not growing Real consumption can therefore only grow if consumers dip into savings (difficult if no savings
present) or take on additional debt
The stagnation of real incomes is the main reason for slow economic growth in the US
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Inflation: Consumer & Producer Prices
Core consumer prices (excluding effects from food and energy prices) are currently rising at aseasonally adjusted rate of 1.7% (previously 1.6%) .
Producer prices (PPI) are currently rising at 0.8% (previously 2.2%). CONCLUSION: Barring a significant rise in the oil price there are no inflationary threats visible.
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Inflation Expectations
Real yield = nominal yield minus inflation. Resolving the equation for inflation you get:inflation = nominal yield minus real yield
We use Treasury bonds for nominal yields, and TIPS (Treasury Inflation Protected Securities) forreal yield. The break-even rate of inflation is the rate at which it does not matter if you bought
Treasury bonds or TIPS. The resulting implied inflation rates for over the next 5 (red), 10 (blue)
and 30 (black) years are printed in above chart.
If you know the average rate over 10 years, and for the first 5 years of those 10 years, you canderive the expected rate of inflation for years 6 to 10 (green).
The "expected" rate of inflation is nota forecast; it may or may not come true. Marketexpectations change.
Changes in the expected rate of inflation are of interest due to a high correlation with the stockmarket.
7/29/2019 Lighthouse Macro Report - 2013 - August
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endorsement to buy or sell any security or other financial instrument. You shouldn't be surprised that
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we might not necessarily disclose updated information should we discover a fault with our analysis. The
author has no obligation to update any information posted here. We reserve the right to make investment
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