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The “I’s” Have It Series – Inflation

The last in “The ‘I’s’ Have It Series” is perhaps the most influential to investors…inflation. The rising trend that has been in place for some time but suddenly “got lit.” More importantly, it was ignored for some time even though the signals were flashing an increasing challenge to the Federal Reserve and the markets in general.

The primary shift has been in place since 2008 and was a trend that began in earnest in 1980. The globalization of the economy is pronounced and is not dead; however, it is in the incremental stages of hitting the top of the S curve where only marginal gains occur. In 1980 the amount of total trade to global GDP stood at 40% and rose consistently until 2008 when it topped out at 60%. Since then it has oscillated and is down slightly. As a byproduct, protectionism has appeared more pronounced through increases in net tariffs and restrictive trade policies as countries begin to protect their sovereign country from outside economic forces. Though this is a more complex subject, the simple point is globalization is disinflationary as materials and labor are exploited to assist in margins. Protectionist environments are more inflationary as there are fewer buffers to offset natural increase in prices. As a relative basis, globalization will slow its long-term ascent and stay at its level for some time which will give the feeling of an increased protectionist environment.

Consider what has occurred in just the last 14 months, and perhaps even more poignant is the move just since the end of 2016.


December 2015



U.S. Consumer Price Index YOY




U.S. Consumer Core Price Index YOY




U.S. Producer Price Index YOY




U.S. Import Price YOY




Case Shiller 20 City Composite




China Producer Price Index




China Consumer Price Index








Citigroup Emerging Market Inflation surprise




Source: Bloomberg, Citigroup, National Bureau of Statistics, Bureau of Labor Statistics, Eurostat
Past performance is not indicative of future results. | YOY = year over year; MUICP = Monetary Union Index of Consumer Prices

One area that points to a future increase of inflationary pressures is the output gap, or the difference of what the current state of the economy is and what it could produce. When the output gap was above its long-term average, the point it just crossed, the unemployment rate averaged 5.00% versus its 30-year average of 6.00%. Currently we are at 4.6%, which spells to a fairly large amount of wage pressure building should the current state of the economy keep its recent trajectory.

The consumer price index averaged 3.05% when the output gap was above its long-term average. The CPI (Consumer Price Index) averaged 2.70% over 30 years and currently is at 1.60%. That difference is significant should this gain 1.45% to get to its average; however, if one looks at the core rate that removes food and energy, the difference in pick-up is only 0.65% from its average. Clearly, the difference looks to be made up in increased costs of energy and food over the next year which only confirms recent movements in energy and helps explain the record yields of crops that has seen the Agricultural commodity index decline 43% off its high in the last four years.

OECD = Organization for Economic Co-operation and Development

One of the more revealing charts we present is the following showing the amount of liquidity in the market as measured by the M1 money supply as a percentage of Nominal GDP. With the strong over allocation of the U.S. dollar, the correction in this measure is not only counterintutitive, but also presents a potentially large opportunity to investors. What we see is this number may drop by an increse in the nominal GDP number and sets forth a trend we’ve seen when there were two peaks set.

During two significant periods of decline – while above the long-term average – average GDP growth of three years of declines from 1986-1989 and 1994-1997 was 3.77% while the long-term average was 2.56%. Nominal GDP growth was almost 9% higher than the average when liquidity, as measured above, was above the long-term average of 13.1%.

What those periods have in common with where we are potentially at now is a combination of excess GDP growth relative to M1 money supply growth, therefore bringing down the liquidity levels and that the dollar is still overvalued.

As Fed Chair Janet Yellen testified yesterday (2/14/2017), the inflation environment is becoming a bigger challenge and the hawkish tones are becoming more pronounced. For fixed income investors, we believe it is important to consider some inflationary protection via Treasury inflation-protected securities (TIPS) or floating-rate instruments such as CPI floaters, step-up coupons or prime rate floaters issued by the Small Business Administration.

CRN: 2017-0201-5782 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit



Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.