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US Inflation - be afraid?
Freefall Junkie
Posted: 15 February 2018 07:14:36(UTC)

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Anyone else find the market reaction to yesterdays US inflation figures a bit odd? It was rising wages fuelling fears of inflation which seems to have triggered last week's selloff, then yesterday when the keenly anticipated hard data on inflation was announced and the figures were worse than expected the markets actually rose strongly. 3 ways you can look at this:

1) The markets have regained some common sense and realised that rising inflation is a sign of strong economic fundamentals and not impending Armageddon.

2) There are now renewed signs of complacency and late-bull euphoria: 'hey guys, we've had our correction, what could possibly go wrong now?'.

3) Who cares, its all just short term noise.

Normally I'd be firmly in the 3) camp but I do wonder if 2) is near the mark and it might be time to consider taking a bit of risk off the table.

Posted: 15 February 2018 08:06:15(UTC)

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My view (expressed already) is that this has been more about the bond market than the equity market, although when bond yields adjust, that has a knock-on effect on equities.

That said, we were due a correction which has now happened - falls are always steeper than rises, prices are marked down more than current transactions warrant because when there are few if any buyers, nobody in the middle wants to be long on stock.

I note that yesterday the 10y Treasury yield rose further towards the upper indicator of 3% while equities rose instead of falling. This suggests to me that investors are returning some of the cash to the equity market.

Five years ago all the talk was of an expected ''great rotation" from bonds to equities. That did not happen. But we may be seeing the beginnings of a rotation now - IF interest rates are now on a modest but sustained upturn. As I've said in other posts, a rise in interest rates/bond yields will have a knock-on effect on equities, primarily those with low growth and high yields, bought primarily for yield, and also those with high debt that will eventually have to be rolled over at higher interest rates. Companies with growing revenues and strong balance sheets will be preferred.

All this is set against a backdrop of modestly rising world growth and the inflation/deflation question together with the gathering withdrawal of excess stimulation by central banks (which will adversely affect all asset prices). There are some interesting comments on inflation/deflation by Patullo on Trustnet:

As to whether that's it - I doubt it. The US equity indices are still rather high when seen against their moving average envelopes, and further wobbles can be expected.
6 users thanked Micawber for this post.
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Keith Cobby
Posted: 15 February 2018 09:10:29(UTC)

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My view is that markets are now driven by central bank policy and large money flows through ETFs and the ridiculous VIX gamblers. If you expect interest rates to be low for the long term (as I do) due to huge debts everywhere, then active funds are the place to be. Therefore it is 3 for me!
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Posted: 15 February 2018 09:13:42(UTC)

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I can quite see the effect that rising bond yields will have on equities as described by Micawber. What I find more difficult is understanding the impact on bond funds: I assume that managers of said funds will gradually sell off their poorer yielding holdings as better prospects become available and they buy those? They obviously won't get a great price for the stuff they sell, so the NAV of the fund will fall. Is that how it works?
But then the income from the fund will rise, attracting more investment, so premiums may rise?
Sorry to ask such a simple question! I have never really understood how this works. But as a contrarian, wondering at what stage it may be worth thinking about buying bonds.......
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Posted: 15 February 2018 09:45:23(UTC)

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The bond market is far too complicated for me and belongs with good mathematicians. It is also distorted in that
- liquidity at the level of institutional holdings is a factor (and by all accounts has worsened over the past five years)
- some very substantial institutions (pension funds, insurance) are required, or deem it necessary, to hold a high proportion of bonds
- the safety factor (getting face value back) also favours bonds at times of instability or worry

There is the usual jagged progress rather than a comforting gradual line chart. But in the smoothed-out long term view, the time to buy bonds for capital appreciation and income is when the interest rate cycle is thought to have just about peaked and also when inflation is low. At present, the interest rate cycle has passed its bottom and inflation is ticking up very modestly. Moreover, the Fed is into reducing its bond balance sheet by not rolling over bonds bought during QE. So unless you want bonds for diversification or safety (and are prepared to lose a little money), or if you are so contrarian as to think that deflation is still a bigger pressure than growth and inflation, now does not seem to be a good time.

I must say I have been one of those viewing vast and growing debt as hugely deflationary, but there are also those who point out that central banks would be much more comfortable with 'normalised' base rates of 3 - 4% and inflation at a steady 2% and also that stronger inflation would tend to reduce the accumulated debt's real value. If world growth continues modestly upwards we're more likely to get the latter.

Were base rates in the US to reach 4% we'd be facing a headwind of up to roughly -20% for equities to overcome by growing earnings and that's the potential downside for bonds in such a cycle. But of course the other factors need to be superimposed.

All in all, most large investment institutions are forecasting much lower compound annual returns from equities over the next few years, on the average, than we've been used to. It's hard to argue with that.
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Posted: 15 February 2018 10:33:51(UTC)

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The thing is, the trade-weighted US dollar index, DXY, fell again yesterday. It's been falling since Trump was elected. Inflation in the US isn't so sensitive to the value of the dollar but exports and profits of big US companies rise as the dollar falls.

From the chart, it looks as though the fall is only half way complete. So long as the dollar keeps falling it won't matter (to the US stock market) so much if interest rates rise. Many, large US companies have heaps of cash and will not need to borrow at higher rates.

I suspect the likes of Fundsmith have been hedged against the dollar to take full advantage of the US stock market rise.

bigcharts and St Louis Fed.

Edited to add:
Will Higher Bond Yields Derail the Stock Market?
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Mike L on 15/02/2018(UTC), Keith Hilton on 15/02/2018(UTC), Micawber on 15/02/2018(UTC)
Posted: 16 February 2018 03:38:06(UTC)

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An explanation of the falling DXY: it's the deficit.
Westpac explains why the US dollar is getting beaten up
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Micawber on 16/02/2018(UTC)
Tyrion Lannister
Posted: 16 February 2018 06:36:15(UTC)

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When people talk about bonds, it's seldom obvious to me whether they mean government bonds (gilts in the UK) or corporate bonds. These are not the same thing, especially in todays climate.

I think in this thread the discussion is primarily about government bonds?

I hold two corporate bond funds but decided a while ago to look at individual bonds. However, using simple maths, I couldn't find any that would give me a positive return in the short term, long term or on maturity. Maybe buying on launch is the only answer?

Have I got this right, and if so why bother buying from the market!?
Fell Walker
Posted: 16 February 2018 09:09:15(UTC)

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Micawber;57196 wrote:
......but there are also those who point out that central banks would be much more comfortable with 'normalised' base rates of 3 - 4% and inflation at a steady 2% and also that stronger inflation would tend to reduce the accumulated debt's real value. If world growth continues modestly upwards we're more likely to get the latter.

If I could get higher interest rate on a savings account than inflation of 1% or even 2% I'd probably drain my trading account and stick it in cash savings, I'd leave my ISA fully invested in equities.

That's probably one of the reason that when rates go up bonds and equities fall, people don't need the uncertainty to get a return.
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Law Man
Posted: 18 February 2018 11:17:44(UTC)

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Probably the true answer is that no-one knows what will happen next.

For the majority, who have a long future investment period and hold diversified assets, the response is - do nothing.

If you are near the end of your investment journey, consider selling a few (few) mainstream equities.
Tug Boat
Posted: 18 February 2018 16:52:59(UTC)

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Every Friday I used to buy a curly-wurley on the way to school.

At the end of the autumn term I distinctly remember four price labels stuck to the confection's wrapper. This means four price increases in three months, or about one every three weeks.

Two years later, I was at work. We all received a 33% pay rise and at the end of the year a 25% pay rise.

Now that was inflation.

This piss-pot panic about rates going up to 0.75% makes me giggle.

Guess the curly-wurley buying year.
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dyfed on 18/02/2018(UTC), Hank Elvis Dobbs (texan) on 18/02/2018(UTC)
Captain Slugwash
Posted: 18 February 2018 16:59:02(UTC)

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Has to be the good old 70's, soon to be revisited with Corbyn?

The Curly Wurly has definitely shrunk or have I reached the age when we say that about everything?
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