Transitory In The Big Scheme Of Things -- December 4, 2023

Locator: 46232TRANSITORY.

For the archives. This data does not affect my investment strategy one iota. 

Disclaimer: in a long note like this, there will be typographic and content errors. Facts and opinions will be interspersed. I have no formal education or training in macro- or micro-economics. Read at your own risk. Or best yet, don't read at all.

As an aside, a couple of years ago, a dozen eggs was costing me $5.29; today, I can find a dozen eggs < $1.29. 

Link here. 

So, year-over-year, the benchmark, BRK, has appreciated 15%. Meanwhile prices year-over-year for major purchases have declined and groceries have only increased 2.5%. Gasoline is also less expensive today than it was a year ago.

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Disinflation and Deflation

Mohamed A. El-Erian is perhaps the most credible guest Joe Kernen, CNBC Squawk Box, interviews on a regular basis. 

In the tweet above, Mohamed A. El-Erian makes this comment:

These two WSJ charts ffor US inflation serve as a reminder of the need for strong disinflation in services before deflation comes to an end in the goods sector.

I missed Joe Kernen's interview with El-Erian this morning and I do not know what he means by this. He posts his tweet as if this is well-known by all investors and / or it's a "law" just like the "law of gravity." So, forgive me if I tell you that I don't understand the relationshhip between disinflation in services and deflation in goods.

In the process of trying to find the answer, I found this gem from the White House blog, back in July 2023, just a few months ago. Link here. It didn't give me the answer to my question but I found the note very helpful.

So, if I were a freshman in college, taking "Econ 101," and the professor asked me to explain  how disinflation in services is / was related to deflation in the goods sector, I might ramble on in this vein of thought.

Currently, goods -- things one buys, like a refrigerator -- are selling at a lower price than they were selling for a year ago. Assuming that the refrigerator was bought and paid for awhile ago by the retailer, the retailer is making less money on a refrigerator sale today -- maybe even taking a loss.

That's exactly what happened to Hormel this past quarter. The price for a turkey sold by the retailer, let's say Walmart, dropped so fast that Hormel had to "eat" the loss -- pun intended. It had nothing to do with folks desiring less turkey this past Thanksgiving. I can guarantee you that Walmart was not taking the loss except possible as a "loss leader."

So, back to the refrigerator. This is where it gets mushy. 

One possibility. Let's assume wages are static or have been static over the past year for the average consumer or wages have not kept up with "core" inflation."

The average consumer has only so much money to spend. The price of that turkey at Walmart is a combination of the cost to produce that turkey plus the cost of getting that turkey from the farm to the Walmart cooler. Much of that cost is services (and some transportation costs, which by the way have come down, year-over-year). 

The consumer can't directly affect the cost of services to get that turkey from the farm to Walmart, but the consumer can directly affect the price of that turkey at the checkout lane at Walmart in at least two ways: a) buy less turkey; and / or b) go elsewhere, looking for a less expensive alternate (a different turkey retailer or a different protein).

Regardless, unless Walmart wants to take less profit or a bigger loss on the turkeys in the store, Walmart needs to lower the price of the goods (the turkey).

If the retailer can buy a less expensive turkey (goods) wholesale and it is less expensive to be delivered (services) then the overall price of the turkey will be lower. 

My understanding, then, at least one way, for M.A.E-E's argument is that we need to see a further drop in the cost of services (either the rate in the drop [disinflation] or an absolute cut in price of wages and energy [deflation] which is very unlikely to happen. 

With a drop in the rate of the increase in the cost of services (disinflation) then, all things being equal, we should see Walmart having the "ability" to increase the retail cost of the turkey it is selling.

And that's exactly what M.A.E-E said:

These two WSJ charts ffor US inflation serve as a reminder of the need for strong disinflation in services before deflation comes to an end in the goods sector.

Having said that, if Walmart is making a profit on the turkey in the current economy, Walmart might even be able to decrease the price of a turkey further, though that's unlikely and leads to another discussion for another time.

Now, back to what M.A.E-E said.

The next question: what is driving the price of services? Why is disinflation in services so stubborn? Why is disinflation in services not stronger? There are some easy answers there but I've rambled long enough. But the answers to this question -- what is driving the cost of services -- is so obvious it hardly needs discussing. The huge increases won by the UAW and workers elsewhere  is the easy answer but it's the wrong answer. Exhibit A: the price for "motor vehicles and parts" dropped almost 2% year-over-year despite wage increases.

Right, wrong, indifferent with regard my answer (an A, C, or F from my professor) matters not. At least for now, for me, I have a better understanding of the point M.A. E-E was trying to make.

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For Investors

Investors want to see a bit of inflation, let's say 2 percent. Inflation, to some extent, drives earnings. Disinflation can be good, slowing the rate of inflation but by definition, does not completely bring inflation to zero (or less --> deflation). 

Deflation is bad for the investor as investors in Hormel discovered a few weeks ago. Deflation, all else being equal, will drive earnings lower and share prices will follow.