Systematic Relative Strength

If your firm’s economist is still worried about deflation, consider the following item from the New York Times:

The United Nations data measures commodity prices on the world export market. Those are generally far removed from supermarket prices in wealthy countries like the United States. In this country, food price inflation has been relatively tame, and prices are forecast to rise only 2 to 3 percent this year.

But the situation is often different in poor countries that rely more heavily on imports. The food price index of the United Nations Food and Agriculture Organization rose 32 percent from June to December, according to the report published Wednesday.

I highlighted the fun parts. We already know that the reason the prices aren’t rising in the U.S. is because manufacturers are stealthily shrinking the size of the packages. The United Nations tracks food commodity prices directly and they are going through the roof. Maybe it is theoretically possible for food prices to rise all over the globe except for the United States, but I wouldn’t bet on it. Frankly, unless you need to eat or travel, core inflation is not a problem since it excludes those pesky, volatile food and energy prices.

It seems the deflationary scenario may be the least of our worries. Unfortunately, inflation from package downsizing may not be captured in some of the newer, innovative attempts to track inflation, such as the Billion Prices Project at MIT. Their methodology just scrapes the web for prices on the items being sold:

Daily Online Price Index Computation: The daily online index is an average of individual price changes across multiple categories and retailers. The index uses a basket of goods that changes over time as products appear and disappear from a retailer’s webpage. It is updated on a daily basis and leveraged to estimate annual and monthly inflation. This index is not designed to forecast official inflation announcements, but to provide real-time information on major inflation trends.

I’ve underlined the problem. As the 16-ounce package disappears and the 14.5 ounce package is substituted in its place at the same price, inflation is temporarily hidden. Inflation is suddenly going to show up when manufacturers find it embarrassing to shrink the package any smaller. The only directly comparable way to track inflation is to use a fixed basket of goods, which the government gave up quite some time ago-1980 to be exact.

Shadow Government Statistics publishes inflation data using the original 1980 basket of goods and it looks substantially different from reported CPI.

Click to enlarge. Source: www.shadowstats.com

Financial markets have an uncanny way to adjusting to the underlying reality, sometimes in surprising ways. For example, during the wage and price controls in the Nixon era, the price of lumber was capped. However, the administration neglected to cap lumber futures and the futures price was soon massively higher than the official spot price. It’s basic beanbag economics. If you mush down one part of the beanbag, it poofs out somewhere else. With food commodity prices rising globally, there is sure to be some impact somewhere. Watching the relative strength of various securities and asset classes is perhaps the most fruitful way of discerning where the beanbag is going to poof out next.

According to a survey discussed in the WSJ Wealth Report, your clients want international stocks:

According to a new survey, 64% of wealthy investors plan to add money to long-only global stocks this year, making overseas stocks the biggest likely winner in the race for rich people’s cash.

Such a large move toward a more global portfolio was surprising, even to the study’s authors. Wealthy investors, even in the U.S., are now thinking globally.

“To me, the 64% was a stunning number,” said Charlotte Beyer, founder and CEO of IPI. “I think it marks a turning point for the wealthy.”

And they don’t want anything complicated or fancy. Simple is the fashion this year:

Ms. Beyer said that by investing in “long only” stocks overseas, the wealthy not only are shifting out of the U.S., but also doing so in a way that may avoid the fees and complexities of international hedge-funds and other complex alternative investing products.

“They’re saying, why do I need all that complexity, the tax implications and the fee structure?”

I would like to modestly suggest that our Systematic RS International account fits the bill perfectly. You can request information here.

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). Members of ICI manage total assets of $11.82 trillion and serve nearly 90 million shareholders. Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

Taxable bond funds attracted the most new money in the final week of 2010, while municipal bond funds had the biggest redemptions. For the year, taxable bond funds pulled in a whopping $249 billion, dwarfing the flows into foreign equity, hybrid, and municipal bond funds. Domestic equity funds had redemptions of $86 billion in 2010, despite the fact that the U.S. equity markets enjoyed their second straight year of double-digit gains.