All Aboard the Reality Express!

Shameless plug: Last October, "The Unpleasant Truth About Inflation"
noted all the reasons why inflation was actually much higher than most
people (including the Economists on Wall Street) believed.

It took market participants an astonishing 8 months to figure this out.

Nothing much has changed except perception. Growth is still
slowing, and is as Real Estate dependent as ever. Prices continue to
increase, regardless of the idiotic focus on the Core rate (don’t sugar coat it, tell us how you really feel). 

What has changed from last week, when the dominant meme was Pause!
to today, when the newfound fear is a Half-Point hike? Psychology.
Groupthink. Emotions and sentiment.

The only thing truly different is the Goldilocks fantasists have
changed trains, and are now on the Reality Express.  Next stop: 2%
GDP, 5% inflation. ALL ABOARD!

Of course, the markets haven’t liked this. Goldilocks is a fairy tale, while Reality has warts. These are consequences for decades of easy money and years of bad policy.  Like the twin deficits. Growing disparities in wealth, which will ultimately lead to spasmodic anti-capitalist legislation. Deficit producing tax cuts. Post crash damage still unresolved from 2000. A ruinous war costing treasure and lives and despoiling the United State’s reputation globally. Is it any surprise the greenback has gotten kicked around like a junkyard dog? All the while these markets have been as  utterly dependent as a babe at its mother’s breast on massive government stimulus for ongoing growth. My name is Mr. Market, and I am stimulus-aholic (Hi Mr. Market!)

Keep repeating after me: Except for everything going up in price, there is no inflation . . . 

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What's been said:

Discussions found on the web:
  1. Snooky Chase commented on May 19

    I hate it when they give ‘big chem.’ more excuses to raise end product pricing while they’re out buying cheap gas. Watching the $USD to see when it returns to it’s down trend.

  2. Marc Mayor commented on May 19

    Excellent post Barry.

    I would only challenge your final remark “Except for everything going up in price, there is no inflation”.

    How about the inflation concerning our waistlines ?

    Aside from that, I’m with you 100%

    BR: Marc, if you go to the link, you will see that last line is very tongue in cheek . . .

  3. Ricardo commented on May 19

    Well, put! It’s amazing how long the market was in denial mode … now it’s a very rude awakening. Hello DOW 10,000!

  4. DJ commented on May 19

    If inflation is such a problem then why are Treasuries rallying? The last CPI report was a result of the housing market decline (less demand for buying drives up demand for renting which causes long-overdue appreciation in housing CPI). The market is not saying inflation. It is saying recession.

  5. John commented on May 19

    Yes – Agree with your maco observations and the fact only one monster will be in focus – inflation – as it is real and has been real. This leads me to the conclusion that the guy running the printing press will need to take a smoke break and let the ink dry on the bills a little in addition to more rate hikes for the FFR.

    To quote American Beauty “Denial is a powerful weapon” and bread and cicus games are about to be over with the executive branch and economy.

  6. Ned commented on May 19

    DJ- remember stagflation? think Barry is says worst of both in the new perception. slowing growth and higher inflation. but maybe inflation is peaking here now that everyone sees it and is scared…Boo.

  7. Ned commented on May 19

    meant saying not says. sorry.

  8. CrispE commented on May 19


    I know this sounds contrarian, but who exactly do you think it is that now “gets it”? Traders may get it, fund managers may get it, but until Main Street “gets it” the market will continue to act irrationally, thinking Kudlow and Cramer are prophets at the Church of the Always Profitable and those who preach caution are albino monks the church keeps in the back rectory.

  9. Uncle Jack commented on May 19

    Everybody break out your W.I.N. buttons, they’ll be just as effective as last time.

  10. JoshK commented on May 19

    I’m don’t think this is the best analysis. When you have high inflation, you don’t want to be in bonds, even though they just rallied. You do want to be in equities that will have earnings growing with inflation.

    Even though we are not getting to far w/Iraq, we are not really affected economically that much. Paying for Iraq is dwarfed by paying for entitlements, and that is an issue that no one has really dealt with yet.

  11. John commented on May 19

    Its not about inflation, its about what happens in a game of musical chairs when the music stops. Everyone in the market has a two minute investment horizon (how many are planning on buying into the rise only to go aggressively short at or near the next top?). Not everyone can get through the door at the same time. There is still much more fear of losing out on the next run than fear of losing capital. That takes time.

    If it was really about inflation, bonds would not be rallying. The consensus seems to be that we are in real trouble on the inflation front, but its nothing that Gentle Ben can’t handle at the next meeting. Remember, the biggest component of the CPI increase (other than energy, which we all know by now doesn’t matter) is housing, which for many people is not a factor. I fully expect to see some “respectable” pundit on bubblevision talking about “core inflation ex housing” and how it is still remarkably low.

  12. D. commented on May 19

    When inflation is accelerating BOTH equities and bonds do badly. For bonds the reason is obvious. As for equities, they begin to do better only when inflation expectation catch up to reality. I don’t think this is the case yet!

    With inflation, input costs and interest expense start to rise faster than the top line thus compressing earnings.

    I wouldn’t be plunging into the equity market just yet. Firstly, higher rates imply a multiple contraction. Secondly, earnings should contract.

    Companies are still reporting good numbers because consumers were still spending. It takes 6 months for homeowners to spend their cash from refi or HELOC. Since real estate is stalling and has been slowing since the end of 2005, by this summer we should see a drop in consumer spending. So companies’ top line will suffer.

    As for expoenses, they’re on their way up. Input costs are finally coming through the system. Shipping is probably hurting too. Interest expense will aslo make a dent. DD&A should pick up from its historical low base (in 2002, companies probably wrote off everything but the kitchen sink). Net margins have peaked and are on their way down. The market is looking in the rearview mirror and expecting more of the same.

  13. D. commented on May 19

    We all know that a huge amount of mortgages will reset. Maybe not all homeowners will crack under the weight of debt but I’m sure a few will have to sell their investment portfolios (which they built thanks to cash from a refi) to pay off some mortgage debt.

    That could push equities lower.

  14. Blissex commented on May 19

    «With inflation, input costs and interest expense start to rise faster than the top line thus compressing earnings.»

    That is not so automatic — depends entirely on who has more pricing power: suppliers, companies or employees?

    So far it is employee wages that have been compressed: they have grown slower than inflation, and even gone down in nominal terms if one includes rapidly shrinking benefits.

    Part of the reason is that thanks to a policy of zero or negative real interest rates for a long time the cost of capital is/has been very low (which has enabled a lot of outsourcing: USA companies have been investing immense amounts of capital abroad to create cheaper manufacturing and service bases).

    If Barry is right when he writes: «Next stop: 2% GDP, 5% inflation.» then currently real interest are zero. Bad news for wages still.

  15. C commented on May 19

    No, gold is a metal.

  16. Eddie commented on May 19

    Inflation vs. Increase cost of oil.

    Everyone is talking about this inflation thing, but that implies that something can be done about it on the rate front. Sure, raise the rates to 7%, kill the market again, whatever. But that’s not going to change the fact that oil is $70 and THAT is what is happening to prices. EVERYTHING is affected by energy prices, so of course EVERYTHING is gonig to cost more. But that does not mean we are in a typical inflation cycle, where raising rates is going to accomplish anything.

    I am of the opinion that the new economic order will just have to include higher oil prices, and that this ‘inflation’ thing is a one-time adjustment to bring everything level with that fact.

  17. dark1p commented on May 19

    Bonds aren’t going up, they’re bouncing. Big difference, I think. The basic trend is down, but it may take a couple weeks or even months to get back to it in earnest.

    Besides that, however, looking at the bond market to discern what the real inflation rate is, is very questionable at best. Looking at any market for any real info is a total crap shoot. The main driver is psychology, and humans can be very, very strange.

  18. Sestina commented on May 19

    Bond investors clearly don’t believe that inflation is going to 5%. Why are they so confident that inflation is under control? On a related note, I keep on expecting MBS hedging activity to start taking treasury prices down. As mortgage rates go up, prepayment models should tell MBS holders to lighten up on treasuries. That should have started to affect treasury bond prices by now.

  19. me commented on May 19

    So much for the “higher oil prices don’t matter” crowd. How do they say it? Oil is cheap compared to 1973, almost as if no one has to pay for it.

  20. B commented on May 19

    Ok, saw the new web site. Nice Site. I like the fact that you are a philosopher. lol.

    So, speaking of philosophy, I’m a big fan of the Socratic teaching methods. Or Socratic debating methods. Or Socratic whatever.

    Ok, I’m not going to argue there isn’t inflation. There is. And there is alot of it. But, I am going to argue that the Fed’s mandate of price stability also includes deflationary pressures as well as inflationary pressures. And, I dispute that it is a given that inflation is a long term or permanent problem. Therefore, continuing to raise rates has the possibility of having the opposite effect of what is desired. The Fed needs to look at coincident data and not what happened to commodities over the last few years.

    If one believes there is incipient inflation, then one could argue there is no housing bubble and housing prices cannot or will not drop appreciably. Because asset based investments will continue to rise during inflationary times and, historically, that includes housing. Partly because input costs into housing will keep prices high. ie, concrete, timber, metals, petroleum, blah, blah, blah, blah will keep the cost of replication high. We all know housing is an old-line industry that has very intensive inflationary input costs. And partly because wage inflation would allow assets to continue to rise in price as the consumer could continue to afford higher prices. So, without wage inflation, higher home prices would continue to affect affordability causing a slow down in demand. (Key point to sustainable inflation is that wage inflation is in the system. Yet, you have argued that wages are stagnant. Which I tend to agree with for the general population but not necessarily so for many skilled workers. Only time will tell but globalization does not mean we will not see wage inflation.)

    Ultimately, without wage inflation, asset inflation will choke off demand for the base materials and high input prices. This would cause a drop in input prices, ie commodities, and eventually housing prices and a drop in inflationary pressures. Therefore, without wage inflation, the long term problem is not inflation. It is likely not stagflation. It is most likely deflation or just a plain old fashioned recession.

    ie, This cycle is not sustainable nor is inflationary pressures. That is, unless one believes we will start to see significant wage inflation. Given the Misery Index oft quoted and the consumer survey results, you are likely right that there is no generalized wage inflation. That means we are likely in a recession or soon to be in one. That is a plausible scenario as to why the long bond has not played out higher rates. Now, that may yet come to pass but since the markets are discounting mechanisms, I tend to think we are headed for a recession. Earnings recession or economic recession is an unknown. But, if you believe the home builders, it is likely an economic recession. Oh, and those who are nibbling at home builders because their PE is 5, the last mess in home building took them down 90% around 1990. Not that we will get this play out but, it’s a consideration for value investors. All of the consumer indices are cratering. If there was wage inflation, homebuilders would likely not be making multi-year lows because assets, ie housing, would continue to be in great demand as consumer wages continued to increase. Retail, homebuilders, consumer cyclicals, even Big Bob Nardelli’s Home Depot are cratering. Bob says Home Depot does great regardless of the housing market. I want some of what he’s smoking. And he can afford to smoke alot of it, given the lack of governance at the Home Depot’s board.

    I just saw the top real estate developer in Hong Kong is very bullish on China. Very bullish. It just so happens he is doing alot of real estate development in China. But, he does have one concern. That concern is a real estate bubble coming to pass in China. HUH? Btw, without wage inflation, China will also follow the same fate.

    We need wage inflation for the Fed to continue to raise rates. And we need more than a month of data. Otherwise, the Fed is going to KILL(ED) the consumer and is fighting an inflationary ghost. JMHO.

  21. Mark commented on May 19

    Wasn’t this supposed to be another rally day? I had my rally hat on! Now I get to dig out my W.I.N. button! (Thanks for THAT memory)

    Barry, how do you look in a cardigan next to a fireplace? I think it should be the new Kudlow show set. When the camera pans back it will reveal your feet propped up on his head.

  22. alan commented on May 19

    Has anything changed in the Real world? I see that US
    long term bonds have rallied and are at their highest for the last 2 weeks. According to the USA today, Colorado posted the highest foreclosure rate in the nation for the second month in a row – a miniscule .2%. Is an avalanche coming when the house mortgages reset or what? Or have the bond market vigilantes lost power? Natural resources and metals are down big time. Are there noiseless whirlybirds dropping their packages at night? Will Bernanke please step out from behind the curtain and tell us the truth? I doubt it.

  23. KirkH commented on May 19

    Sestina, because we’re seeing a second industrial revolution (IT) and during the first there were years of deflation. The difference now is that the poor people owe a half $million on houses.

  24. D. commented on May 19


    In the last few years, companies have been able to make gangbuster profits because:

    Top Line:

    1. Thanks to low rates, consumers have been spending like maniacs.

    I expect: Consumer spending to slow down

    2. There have been price increases which have been masked by low rates and a monthly payment mentality.

    I expect: price increases to become more evident with rising rates.


    1. Lower rates and a drastic decline in credit spreads
    have hugely shrank companies’ interest expense.

    I expect: interest expense to creep up as soon as rates and credit spreads rise. Companies financed short term will suffer most.

    2. With huge consumer spending has come economies of scale which has somewhat hid the impact of rising input costs.

    I expect: rising input costs to become more apparent as consumption slows.

    4. Low DD&A because companies took huge write-offs in 2001, 2002 and haven’t really invested too much since. Also unit sales are so large that fixed unit costs have dropped.

    I expect: DD&A to increase as sales taper off and investment picks up.

    5. Wages have been weak but the entire compensation package has been creeping up for corporations. Since there was overinvestment in the 90s as well as China competing, companies have had lots of room to cut.

    I expect: this to continue although a drop in the US dollar and inflation in imports could help. Due to overcapacity, I expect major consolidation in many sectors…. all the ones related to the last 5 years excesses.

    I also believe there is a huge amount of Boomers who are probably succession planning. Usually this is done 5-10 years before retiring. Within the next few year, many companies will be sold off ot just shut down and capacity will shrink.

    What we’ll have is the ones with the best business acumen retiring, the least efficient working and government supporting consumption. Inflation anyone?


    A rising tide lifts all boats. The tide is retreating. Of course some companies will do well, that’s why I probably won’t be indexing.

    Let’s face it. If rates go back to 6-8%, it solves a lot of problems. Healthier pensions is just one element.

  25. sonomaca commented on May 19

    Re: wars in Iraq/Afganistan: America’s anit-terrorist interventions around the world have neuralized an international security threat which, left unchecked, would certainly have undermined the global economy.

    Truman’s cold war actions made him as unpopular as Bush is now. Of course, we now know that he was courageous and correct.

  26. quints commented on May 19

    CORE inflation is benign. And besides, I don’t care because they’ve just made a great announcement – Choco rations going up by 10%!

  27. alex commented on May 19

    you speak my heart, Barry…I agree 100%.

  28. tjofpa commented on May 19

    Ok, what planet am I on…
    Market tanks 214 on inflation fears => rate hike more likely in june

    Tune in to Futures pit expecting to see an
    80 to 90 % chance now of Jun Hike => nope only 50%

    Expect to see Treas prices dropping => nope they’re surging.

    … all in conjunction with absolute PANIC selling spree in the Yen.

    I’m picturing Doug Floutie to Greg Phelan from the 50 yard line. Amazing turn about just as the Yen carry was about to blow itself into oblivion!

    …and oh yea, the gold bugs started to sell off a few days in advance even while bull still above 700.
    Could it be the same old Jap liquid gold coming to
    market. If it is then expect to see all asset classes rising again next week.

    Same old same old. Maybe we’re not just addicted to Oil.

  29. Sourdes Menées commented on May 19

    Sonomaca really had me goin there, regurgitating that predigested party line tailored for pig-ignorant crackers and snake-handlers with a straight face like he actually bought it. You card, you. And when Jesus drove off the dinosaurs he prevented global warming for all time, and foreign central bank reserve growth is due to America’s preeminent moral leadership and strong promise-keeping families. That’s what I call fundamental analysis.

  30. Dave commented on May 20

    A good part of all this is that the US is a country that is built on credit.

    The housing boom all starts with credit. The consumer spending is all about credit.

    I don’t know if anyone has a recent set of statistics on how much debt the average American is in. Credit cards, Mortgages, Student Loans, Car Loans, etc.

    Not only does our government continue to spend irresponsibly (and thus weakening the dollar), but we as Americans aren’t all that much better.

    This upcoming recession/correction/deflation might just put that all back into the spotlight again and make Americans really consider their financial ignorances.

  31. jkw commented on May 20

    The Federal Reserve tracks consumer debt. The information is somewhere on their website. As I recall, non-mortgage debt is fairly low right now.

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