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INFLATION COLLAPSE? Don't Overlook this Market Tailwind!

INFLATION COLLAPSE? Don't Overlook this Market Tailwind!

| November 30, 2023


Hello Wealth Builders, do you remember when reporters used to pay close attention to how thick Alan Greenspan's folder was when he entered Federal Reserve meetings? Well, the top financial authority in the US is trying to be more open and approachable nowadays. Recently, we got some news that the Federal Reserve is currently in what they call a "HAWKISH PAUSE."

The San Francisco Federal Reserve has issued a warning about the possibility of inflation going down. In the past year, there's been a lot of talk about inflation, especially because of how the pandemic has affected the economy and caused turbulence in the stock market.

Inflation might sound like a boring topic, but it became a big deal during the pandemic recovery. Its impact was evident in the stock market crash of 2022, and ever since then, people have been trying hard to predict what it will do next.

However, guessing where inflation is headed is complicated. Just looking at how it behaved in the past doesn't give us the full picture of what's coming.

In our client discussions, we've talked about the Federal Reserve's favorite way of measuring inflation, which is the "core personal consumption expenditures (PCE) price index." This is different from the inflation number you usually see in the news. This difference led the Federal Reserve to raise interest rates even though overall inflation was going down.

Today, we're going to dive deeper into this topic. There's something interesting happening beneath the surface, and research from the Federal Reserve itself suggests that inflation might drop significantly in the next year.

To understand this prediction, let's focus on one important thing: housing costs.

Housing costs are special because they're the only part of inflation where past data can really help predict the future. Housing inflation, which looks at how much it costs to have a place to live, is the biggest part of the Consumer Price Index (CPI). It's figured out using something called "owners' equivalent rent," which is basically what homeowners would pay if they were renting.

However, the way the government calculates housing inflation isn't perfect. Government data includes rental prices for everyone, not just people with new leases. So even if rents are going up a lot, your landlord can't raise your rent until your lease is up, and that creates a lag in the data.

In 2020 and 2021, rents shot up, but it took a year for that to show up in the data. So, even when rent increases slowed down a lot, the data still showed that housing costs were high because of that lag.

What's really interesting is that the San Francisco Federal Reserve published a paper in August that not only explains this but also predicts that housing inflation might go down in the future.

The paper used the core CPI (excluding food and energy) for its analysis, which is pretty close to the core PCE, the Federal Reserve's favorite measure of inflation. The authors used data on rents to make predictions about future housing inflation, testing their accuracy over time.

The result is pretty surprising: Housing inflation might actually turn negative by the middle of 2024. That means not only will housing inflation slow down a lot, but it might actually result in prices going down within a few months.

Since housing makes up over 40% of the core CPI and a big part of the core PCE, if housing inflation goes negative, it could pull down the overall inflation rate a lot. Even if other prices keep going up, we might still hit the Federal Reserve's target of 2% inflation in the next year.

Remember, though, this is just a prediction and doesn't account for unexpected events. But it's based on the data we have and what we know about how housing inflation will change in the near future.

Federal Reserve Chair Jerome Powell also talked about this trend in his recent speech at Jackson Hole. He mentioned that the slowdown in rents in the housing market is starting to show up in housing inflation, and that will affect how we measure housing costs in the coming year.

So, in short, the Federal Reserve thinks we're still dealing with inflation, but the expected drop in housing inflation could be a big help. While the Federal Reserve might still think about raising interest rates, we think the really aggressive actions have probably already been taken.

This is potentially good news for investors because the Federal Reserve's previous anti-inflation measures didn't do stocks any favors. If housing inflation really goes down, along with overall inflation, it could be a positive sign for the stock market. That's one more reason why investors might be feeling pretty optimistic right now.

To wrap things up, with early signs of some major worries about the market fading away, it looks like the bull market could be here to stay. But, some investors are still cautious about how long it will last, even with all the good signs we're seeing. 

At Maendel Wealth we often point out the historical data that Markets often Turn at Peaks in Sentiment. This is NOT information that most investors incorporate into their wealth building. Our article The Pearl Harbor Market Bottom digs into some of the more surprising examples of "rational and obvious" investor decisions being the EXACT wrong course of action for wealth building. Take a look!

Here's a synopsis of our thoughts:

  1. Inflation Hype: So, inflation has been all the rage lately. If you're not a '70s kid, you've probably never seen this much talk about it. It's a bit of a snooze-fest topic, but it's been grabbing headlines since the pandemic recovery. It even made the stock market take a tumble in 2022.

  2. Inflation is a Puzzle: Predicting where inflation is headed can be like trying to solve a Rubik's Cube blindfolded. Looking at the past isn't always enough to predict the future.

  3. Fed's Role: The big guns at the Federal Reserve have been making moves, like raising interest rates, even though inflation has chilled out a bit. They're trying to keep things in check.

  4. Shelter Inflation Spotlight: Here's the deal, a huge part of inflation is all about where you rest your head – shelter. It's the biggest part of what they call the Consumer Price Index (CPI), which measures the cost of living. They calculate it based on what homeowners would pay if they were renting.

  5. Flawed Numbers: But here's the hiccup. The way they crunch the numbers on shelter inflation isn't perfect. They count everyone's rent, not just new leases, which means there's a lag in the data. So, it takes a while for real changes in rent prices to show up.

  6. San Fran Fed's Findings: Now, the San Francisco Fed did some digging and found something fascinating. They used core CPI data and rent info to predict where shelter inflation is headed. Their big takeaway? Shelter inflation might actually turn negative by mid-2024!

  7. Inflation Impact: Since shelter inflation is such a big piece of the puzzle (like over 40%), if it goes negative, it could drag down the overall inflation rate. That could help the Fed hit its 2% inflation goal, even if other things are still getting pricey.

  8. Powell's Take: The head honcho at the Fed, Jerome Powell, talked about this too. He thinks that even though the Fed might still raise interest rates, they're not going to go all out against inflation. They see falling shelter inflation as a good thing.

  9. Investor Angle: Now, for all you investors out there, if shelter inflation takes a dive and overall inflation cools off, that could be music to your ears. It means the stock market might not face as many hurdles. So, stay optimistic!

  10. Bull Market Cheers: Bottom line, this article is saying that the bull market we're in could stick around. With inflation worries easing up, there's a lot to be excited about.

  11. Let's Talk!