This article walks you through – quickly, I promise – the increasing number of data points showing sharply declining inflation. I suggest that you take two actions with my conclusion:
- If you know a member of the Federal Reserve’s Board of Governors, please pass this article along to him or her. I don’t know what these Governors do all day, but looking at real-time economic data doesn’t appear to be on their list.
- Sharply slowing inflation has a lot of investment implications. I’m far from qualified to pontificate on all of them, but in my area of expertise – housing and consumer finance – my favorite ideas are mortgage REIT, AGNC, and private mortgage insurers like MGIC (MTG), Radian (RDN), and National Mortgage (NMIH). I summarize my investment themes on them at the article’s end.
Slowing inflation signal #1: Jobs
Consumers have three main sources of cash they can spend: (1) wages, (2) savings, and (3) borrowing. All three will be weaker next year.
First up is salaries, which of course in turn is driven by employment. And business’ employment plans are slowing rapidly. I calculate “business payroll plans”, which is the sum of the actual number of jobs plus job openings from the “JOLT” survey. Averaging the changes over 6 months (monthly data is volatile) produces this chart:
It couldn’t be clearer – job growth is slowing rapidly and appears ready to turn negative. The media adds news of another major company planning layoffs almost every day.
Slowing inflation signal #2: Savings
COVID threw household savings patterns completely out of whack, as this chart shows:
First, the federal government handed households and businesses $5 trillion during the year following COVID’s February start. As the chart shows, households at first saved most of it. But over the past 1½ years, they have been pulling those savings out of the bank and spending it. Using the pre-COVID savings rate of 8-9% as a norm, I estimate that within 6 months, the COVID money will have been effectively fully spent, which will put a drag on consumer spending.
Slowing inflation signal #3: Net worth
Another influence on spending is the wealth effect. When our stocks go up, we feel like we can afford to save less and spend more. And vice versa. This chart highlights that we are in the “vice versa” stage. After years of wealth-induced spending, it seems likely that we will be saving more for the foreseeable future.
Slowing inflation signal #4: Housing
At the margin, home prices are falling, and should through ’23:
Further, the cost of building homes, which was soaring, is now abating:
“We, like other builders, have been receiving inbound calls [from contractors]. Most are not new to this rodeo and have been through housing downturns before. They know they enjoyed the price appreciation during the upturn. And I believe most are fully expecting to have lower pricing on new communities going forward.” (Hovnanian earnings call transcript, December 8, 2022)
For example, lumber costs are well off peak prices:
And apartment rents are falling:
“Today, rents remain much higher than they were a year ago in all but 10 U.S. cities, according to Zumper’s October National Rent Report, which examined the 100 largest U.S. cities…But in looking at recent month-over-month changes in median rent, a new trend has emerged: After peaking in April, the national median rent for both one- and two-bedroom units has been falling…” (New York Times, November 3, 2022)
Slowing inflation signal #5: Energy
Oil prices are off about a third from their peak earlier this year:
With oil prices caught up in the Russia/Ukraine war and China’s recession, I am not as confident that oil prices will stay down next year, but clearly higher prices are not inevitable.
Slowing inflation signal #6: Car prices
Car prices surged during 2021 because of supply chain-induced shortages. But used car prices are clearly falling, and new car price increases appear to be leveling off as production increases:
Better times seem ahead for car production:
“The chip shortage has pummeled the global auto industry for years…But experts from AutoForecast Solutions say that by the end of 2022, the semiconductor shortage won’t be nearly as bad as it was last year. Better yet, 2023 could look even rosier.” (Insider, December 5, 2022)
Slowing inflation signal #7: Ocean shipping
A dramatic price decline in this former logistics bottleneck:
“A 90% year over year drop in ocean freight rates for cargo from China bound to the U.S. West Coast exceeded the expectation among logistics firms for just how fast trade demand would fall.” (CNBC, December 7, 2022)
Slowing inflation signal #8: China goods production should improve
“China announced on Wednesday that frequent coronavirus tests and digital health codes…would no longer be required — a significant relaxation of previously unyielding restrictions…The relaxation measures were an extension of a 20-step ‘optimization’ plan released in early November aimed at reducing the economic and social costs of arbitrary and excessive restrictions.” (Washington Post, December 7, 2022)
Slowing inflation signal #9: Computer chips
“The chip industry has pivoted hard from a clamor for higher output to cost cutting as it adjusts to a slump for semiconductors. Chip companies in recent weeks have instituted hiring freezes and layoffs, slashed capital spending plans, reduced factory output and warned investors of a stark reversal in their customers’ buying habits. Qualcomm joined the chorus, saying it was curtailing spending in some areas and pausing hiring.” (Wall Street Journal, November 4, 2022)
Result: A rapidly declining PPI is pushing down the CPI
The Producer Price Index, or PPI, measures the costs of goods that businesses buy to make their products. The chart below shows that:
- The year-over-year change in the PPI is rapidly declining. In fact, since July, the monthly PPI changes were negative.
- The PPI is a leading indicator of the CPI, so consumer inflation should slow materially in ’23.
OK, what to do. One is to buy AGNC…
AGNC is a REIT that specializes in investing in mortgage-backed securities (MBS). Here is my most recent article on it. It currently has a $1.44 dividend, for a 13.5% yield. It will maintain that dividend – or even raise it! – if my inflation outlook causes the bond market to stabilize. AGNC’s big opportunity is a narrowing of the spread between mortgage rates and Treasury rates. The spread set records a few months ago but narrowed by 50 bp recently and is still 75 bp above normal.
…And buy mortgage insurers MGIC (MTG), National Mortgage (NMIH), and/or Radian (RDN).
A mortgage insurer protects Fannie Mae and Freddie Mac if a low-down payment mortgage (less than 20%) defaults. Here is my most recent article on MGIC. Yes, home prices will decline for perhaps 12-18 months. But lower mortgage rates will limit the decline. And the odds of material mortgage defaults are slim because of:
- Today’s serious housing shortage
- A decade of conservative mortgage lending standards
- Sub-4% mortgage rates from late 2019 to early this year, which allowed most U.S. homeowners to lock in very affordable mortgage payments.
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