other words, “Don’t worry. Be happy.” However, I am both wor- ried and of the strong belief that there is reason to be unhappy.
In the globalized world of today, soft patches can easily be- come quicksand far more rapidly than the traditionalists think, be- cause the global economic and financial environment is far more unpredictable, uncertain, and unknown than the traditionalists re- alize. Consider the comments by John Plender in the Financial Times on hedge funds and the banking system: “We have a para- dox. More risk is being priced in markets today than ever before, which should make for a more efficient financial system. Yet much of this market activity is untransparent, which is worrying for fi- nancial stability.”
From my experience in both moderating numerous events in- volving economists of all stripes and reading their research, I have found that, for the most part, your classically trained economist tends not to be an out-of-the-box thinker. As a result, he/she tends to frame the world in the classical industrial era sense, not in the more dynamic interdependent, technologically driven global sense.
And this old school approach to the twenty-first-century world tends to neglect or minimize the new and hard-to-quantify factors such as those that John Plender (and others) have written about.
Moreover, there is the question of speed and the importance of confidence and the role they play in our brave new world. In such a world, soft patches can become quicksand faster than you can say “old school economics doctorate.”
The Consumer Price Index is a measure of the price level of a fixed market basket of goods and services purchased by con- sumers. CPI is the most widely cited inflation indicator, and it is used to calculate cost of living adjustments for government pro- grams and is the basis of COLAs for many private labor agree- ments as well. It has been criticized for overstating inflation, because it does not adjust for substitution effects and because the fixed basket does not reflect price changes in new technology goods, which are often declining in price. Despite these criticisms, it remains the benchmark inflation index.
CPI can be greatly influenced in any given month by a move- ment in volatile food and energy prices. Therefore, it is important to look at CPI excluding food and energy, commonly called the “core rate” of inflation. Within the core rate, some of the more volatile and closely watched components are apparel, tobacco, airfares, and new cars. In addition to tracking the month/month changes in core CPI, the year/year change in core CPI is seen by most economists as the best measure of the underlying inflation rate.
This is Yahoo! Finance’s opinion of the importance of the report, its source, the time of its release, and where to go to get the raw data. Speaking of the raw data, familiarizing oneself with U.S. government reports is an art as much as it is a science. It is also a daunting task for a noneconomist to decipher the language and volume of information published. Nevertheless, it is a very useful exercise and one that an independently thinking investor should be capable of doing. Take, for example, the U.S. Labor Department’s Consumer Price Index report for September 2005. (See Table 5.9.)
Consumer Price Index: September 2005
The Consumer Price Index for All Urban Consumers (CPI-U) in- creased 1.2 percent in September, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The September level of 198.8 (1982–84 = 100) was 4.7 per- cent higher than in September 2004. The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) increased 1.5 percent in September, prior to seasonal adjustment. The September level of 195.0 was 5.2 percent higher than in September 2004.
The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) increased 0.8 percent in September on a not seasonally adjusted basis. The September level of 114.7 (December 1999 = 100) was 3.5 percent higher than in September 2004.
Expenditure Category March April May June July August September September ’05a September ’05b
All Items 0.6 0.5 –0.1 0.0 0.5 0.5 1.2 9.4 4.7
Food and Beverages 0.2 0.6 0.1 0.0 0.2 0.1 0.2 1.9 2.5
Housing 0.5 0.3 0.1 0.1 0.4 0.2 0.4 4.0 3.1
Apparel 0.8 –0.6 0.0 –0.7 –0.9 1.0 –0.1 0.0 –0.6
Transportation 1.9 1.8 –1.0 –0.1 1.5 2.2 5.1 41.5 14.5
Medical Care 0.5 0.2 0.3 0.2 0.4 0.0 0.3 2.8 3.9
Recreation 0.0 0.2 0.3 –0.3 0.1 0.3 0.4 3.0 1.0
Education and 0.2 0.4 0.0 0.1 0.2 –0.1 0.7 3.2 2.1
Communication
Other Goods and 0.1 0.0 0.4 0.0 0.6 0.2 0.1 3.5 2.8
Services Special Indexes
Energy 4.0 4.5 –2.0 –0.5 3.8 5.0 12.0 122.1 34.8
Food 0.2 0.7 0.1 0.1 0.2 0.0 0.3 1.9 2.5
All Items Less Food 0.4 0.0 0.1 0.1 0.1 0.1 0.1 1.4 2.0
and Energy
All data: Changes from preceding month; seasonally adjusted.
aCompound annual rate three months ended.
bUnadjusted 12 months ended.
Source:Bureau of Labor Statistics.
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Please note that the indexes for the post-2003 period are sub- ject to revision.
CPI for All Urban Consumers (CPI-U)
On a seasonally adjusted basis, the CPI-U increased 1.2 percent in September. Energy costs increased sharply for the third consecu- tive month—up 12.0 percent in September—and accounted for more than 90 percent of the advance in the September CPI-U.
Within energy, the index for energy commodities (petroleum- based energy) increased 17.4 percent and the index for energy ser- vices rose 4.6 percent. The index for food, which was unchanged in August, rose 0.3 percent in September, largely reflecting an up- turn in the index for fruits and vegetables. The index for all items less food and energy registered a 0.1 percent increase for the fifth consecutive month. Shelter costs, which were virtually unchanged in August, declined 0.1 percent in September, largely as a result of a 2.5 percent decrease in the index for lodging away from home.
The index for apparel, which increased 1.0 percent in August, de- clined 0.1 percent in September. These declines were more than offset by upturns in the indexes for new vehicles, for medical care services, and for communication.
Consumer prices increased at a seasonally adjusted annual rate (SAAR) of 9.4 percent in the third quarter of 2005, following increases in the first and second quarters at annual rates of 4.3 and 1.9 percent, respectively. This brings the year-to-date annual rate to 5.1 percent and compares with an increase of 3.3 percent in all of 2004. The index for energy, which advanced at annual rates of 21.1 and 7.5 percent in the first two quarters, increased at a 122.1 percent rate in the third quarter of 2005. Thus far this year, energy costs have risen at a 42.5 percent SAAR after increasing 16.6 per- cent in all of 2004. In the first nine months of 2005, petroleum- based energy costs increased at a 67.9 percent rate and charges for energy services increased at a 14.6 percent rate. The food index rose at a 2.2 percent SAAR in the first nine months of 2005.
The index for grocery store food prices increased at a 1.3 per- cent rate. Among the six major grocery store food groups, the in- dex for nonalcoholic beverages registered the largest increase during this span—up at a 4.3 percent rate—while the index for fruits and vegetables recorded the only decline—down at a 1.7 percent annual rate.
The CPI-U excluding food and energy advanced at a 1.4 per- cent SAAR in the third quarter, following increases at rates of 3.3
and 1.2 percent in the first two quarters of 2005. The advance at a 2.0 percent SAAR for the first nine months of 2005 compares with a 2.2 percent rise in all of 2004. Each of the major groups—in- cluding alcoholic beverages and the non-energy portion of the housing and transportation groups—registered a rate of change in the first nine months of 2005 within 1 percent of that for all of 2004. The annual rates for selected groups for the past seven and three-quarters years are shown [see Table 5.10].
The importance of understanding the consumer price index and the value in reading and understanding government reports such as those from the U.S. Department of Labor lies in two areas: an investor’s ability to do original research and the link between inflation and interest rates.
If one is to attempt to incorporate a macroeconomic element into his/her investment strategy, that investor should not rely solely on the comments and opinions of economists, no matter how well respected or impressive they are. To think for yourself is a precious commodity. Being capable of reading and interpreting government and private organizations’ reports requires a commitment to learning. It is not easy but it is well worth the effort.
As for this specific report and the link to interest rates, it is well known that interest rates are driven primarily by Federal Reserve policy at the short end of the maturity spectrum and by fixed income investors (often called “bond market vigilantes”) at the medium and long end of the matu- rity spectrum. And their behavior is driven by inflation today and expecta- tions of future inflation rates, for the Federal Reserve’s mandate is to provide price stability (along with growth in the economy), and the bond investors’ mission is to make correct interest rate bets. As a result, both are very interested in what inflationary pressures there are and might be in the months and years ahead that will impact interest rates today. By studying the government report on inflation, an investor goes a long way toward gaining a valuable insight into this very important area of the economy.
As to the specifics of this report, the key item to note is the last line in the chart: all items less food and energy. It is that figure that excludes the very volatile food and energy factors as they are subject to greater monthly fluctuations and thereby tend to present a distorted picture of the true un- derlying inflation. It is interesting to note the price action of the benchmark 10-year U.S. Treasury, which was trading around the 41/4percent level at the time of the report. The price action for the next few months in the fall of 2005 is illustrated in Figure 5.2.
It’s interesting to note that the rather benign core inflation rate (all items less food and energy) over the past several years did not produce a decline in the 10-year rate, even after the subsequent report on consumer
Expenditure Category 1998 1999 2000 2001 2002 2003 2004 2005a
All Items 1.6 2.7 3.4 1.6 2.4 1.9 3.3 5.1
Food and Beverages 2.3 2.0 2.8 2.8 1.5 3.5 2.6 2.1
Housing 2.3 2.2 4.3 2.9 2.4 2.2 3.0 3.2
Apparel –0.7 –0.5 –1.8 –3.2 –1.8 –2.1 –0.2 –0.7
Transportation –1.7 5.4 4.1 –3.8 3.8 0.3 6.5 17.1
Medical Care 3.4 3.7 4.2 4.7 5.0 3.7 4.2 4.0
Recreation 1.2 0.8 1.7 1.5 1.1 1.1 0.7 1.1
Education and Communication 0.7 1.6 1.3 3.2 2.2 1.6 1.5 2.5
Other Goods and Services 8.8 5.1 4.2 4.5 3.3 1.5 2.5 2.8
Special Indexes
Energy –8.8 13.4 14.2 –13.0 10.7 6.9 16.6 42.5
Energy Commodities –15.1 29.5 15.7 –24.5 23.7 6.9 26.7 67.9
Energy Services –3.3 1.2 12.7 –1.5 0.4 6.9 6.8 14.6
All Items Less Energy 2.4 2.0 2.6 2.8 1.8 1.5 2.2 2.0
Food 2.3 1.9 2.8 2.8 1.5 3.6 2.7 2.2
All Items Less Food and Energy 2.4 1.9 2.6 2.7 1.9 1.1 2.2 2.0
aSeasonally adjusted annual rate nine months ended September.
Source:Bureau of Labor Statistics.
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prices was unchanged from the September 2005 report. This strongly sug- gests that forces other than the rate and trend in inflation are at work. Per- haps the next chapter on the markets might shed some light on the subject.
SUMMARY
Shakespeare wrote, “All the world’s a stage.” When it comes to twenty- first-century economic matters, it is truly a global stage that businesses and governments are performing on and consumers are affected by—for good or ill.
So, how does an investor digest the scale and scope of so vast a subject as the global macroeconomy? In a word, judgment. Given the scale and scope of the global task at hand, judgment must play a central role in an investor’s ability to determine the critical variables at work. Moreover, given the dynamic nature of a globalized world, the shifting areas of in- vestor emphasis are relentless. One day it is the U.S. dollar and its move- ments, the next it is interest rates, and then the investment emphasis shifts to the trade issues with China, and on and on. If you accept the premise that it is the global economy, stupid, then an investor has little choice but to embrace the task and adhere to the principles of hard work, good sources, critical variables, and judgment to gain the necessary insight that FIGURE 5.2 Ten-Year U.S. Treasury Note
Source:BigCharts.com.
an investment strategy based on incorporating economic matters demands.
It is what it is.