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DEFLATION...DEFLATION...DEFLATION

Rich Walls - Tuesday, January 19, 2016

The year-to-date stock market declines are the worst start for equities in recorded history. Pundits and guests on financial news networks have done a disservice to viewers by not speaking truth to what is, and what will likely continue to occur in capital markets, and our country, for the foreseeable future. Has anyone dared to utter the word “deflation”? Global central banks have flooded their respective countries with cheap money, and have vowed to continue their devaluation… except for ours! Our Federal Reserve has raised short term rates while simultaneously lowering their GDP estimates for our country. Why? Good question. The only two logical answers are that they are either politically motivated, unlikely, or that they are basing their decisions solely on only one of their two mandates prescribed by congress... unemployment. Leaving their other, and much more significant mandate of price stability (inflation) not only ignored, but shunned. This could not be more of a mistake in our view. Basing Fed policy decisions on a headline 5.0 unemployment rate, which is not reflective of what our actual unemployment/underemployment rate is, is a dangerous route for determining macro-economic policy.  

The Federal Reserve has dramatically cut their Q4, 2015 GDP estimate from a 2.8% consensus in early November to their most recent estimate of 0.6% stated just this past Friday, January 15th.

Their objective for raising rates in mid-December was to show a signal of strength to the market(s). So, they slash their own GDP estimates for our country by nearly 80%, which is by definition weakness, while simultaneously attempting to signal strength by raising rates? We believe that this strategy of raising rates into an economic slowdown will continue to hurt our economy as well as haunt the voting members of the Fed until they decide to reverse course and CUT, yes, cut rates sometime this year in order to stem the pain of the very present deflationary tide.

As our Federal Reserve raises rates and increases the value of the U.S. dollar as a result, the value of the rest of the world’s currencies will fall, and fall even further should their respective central banks continue to do more quantitative easing and devaluing on their end. This is not a scenario in which the United States will benefit from in two ways:

1)      Goods that are produced here will become more expensive, leading to consumers buying fewer goods, forcing an oversupply, causing a reduction in prices to get the goods sold, equating to smaller cash flows and profits for companies, and follow the chart clockwise for the eventual spiral.

2)      As we are a major import country for our goods, mostly from China, Canada and Mexico, the cost of all these imported goods will continually be less and less as a result of the declining value of the producing country’s currency. Why buy it today, when it will be less expensive tomorrow? Resulting in an oversupply of goods, forcing a reduction in prices to get the goods sold, causing smaller cash flows and profits for companies, and follow the chart clockwise for the eventual spiral.

In the 12 months through December, 2015, the Producer Price Index (PPI), which measures the change over time in the selling prices received by domestic producers for their output, declined 1.0 percent. December marked the 11th straight 12-month decrease in the index. With the Fed raising rates, these prices for domestic producer’s goods will likely continue to decrease, which outlines scenario 1 above.

This is what is actually playing out behind the scenes of the market volatility year-to-date.


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