The Rent is Too Damn... Part 3

Did you REALLY think that CPI report was "hawt"?

Summary

• Inflation Trends in Core Services: Excluding Core Services, inflation appears normalized, but within this category, significant dynamics are unfolding. Core Services, excluding shelter (34% of CPI), have shown a substantial rise, nearly 2.5 times pre-pandemic levels, primarily driven by increased costs in transportation services like motor vehicle maintenance and insurance.

• Impact of Owner's Equivalent Rent (Shelter): Shelter costs, a major component of Core Services, have been retreating towards pre-Covid averages. Despite a recent methodological adjustment by the BLS increasing the weight of single-family homes, the retreat in shelter prices continues robustly.

• Automotive Services and Insurance Dynamics: Maintenance and repair costs (M&R) for vehicles are closely aligned with vehicle prices, experiencing peaks and troughs with an 11-month lag relative to vehicle price changes. Meanwhile, auto insurance costs are rising due to factors like increased vehicle values and repair costs but are subject to regulatory oversight which could temper rate hikes.

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Top Comment

Thomas offers a thought: “On the matter of buybacks, and dividends, for that matter. In the case of existing creditors, including bondholders, where are the covenants to restrict outflows of cash? In the absence of government regulation, the private solution would be for creditors (who are most at risk) to demand limits on cash outflows. Something like the protection a first trust/lein holder has when they extend credit on a property. I believe there is a case for Vanguard, for example, to have a fiduciary duty to bond fund holders, but which is in conflict with their fiduciary duty to equity fund holders.”

MWG: Thomas, Vanguard’s duty to fund holders stops at the individual fund, so we can’t expect them to advocate for equity holders over bondholders or vice versa. Your first question, however, is more interesting. To my knowledge, there has never been an equivalent of a “clawback” on equity buybacks. Should we see an increase in distress as companies struggle to repay higher-interest loans, I think there’s a reasonable chance somebody will try, but my gut says they’ll fail miserably. The simple reality is that managements are well insulated from civil lawsuits.

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The Main Event

I’m back in Annapolis, MD, for the weekend, and the sun is starting to shine. Going for coffee this morning, I was treated to a Navy parade. I’m excited that I will begin calling this place home in the next few months. That’s right, the transient lifestyle is coming to a close (after a few more months of travel). I look forward to making lots of crab chowder.

The past week saw confusing data on inflation that suggests the “Team Transitory” narrative is in doubt. I have never seen such exultation from Harley.

First, a reality check:

Excluding Core Services, inflation has already more than “normalized” at 0.71% and shows no meaningful signs of moving higher. Can energy prices rally on war in the Middle East? Of course not… demographics.

That is obviously sarcasm, but I had to test you. If you found yourself nodding, then perhaps we all need to take a short pause and recognize that forecasts or expectations are ALWAYS conditional. Demographics are not magic. If there is an escalation of war in the Middle East, then yes, energy prices are at risk. Perhaps not so much as the oil bulls would like to believe, but they are entitled to facts in their narrative as well.

On the flip side, if you found yourself immediately shouting at the screen, “Demographics??? You fool! Don’t you know that war is inflationary?” then perhaps an early morning Irish coffee is in order. Let’s all try to de-escalate a touch. Iran/Israel, I’m talking to you, too.

For those who continue to embrace Charles Goodhart's “Aging is Inflationary” thesis, let me introduce you to my friend, China, where a far more rapidly aging population is once again in zero inflation. It’s NEVER been about aging; it has always been about population growth. Unfortunately, that growth continues to decelerate (and turn negative) everywhere, with the possible but unlikely exception of the United States. Regardless, even if we accept (as I do) that aging populations, or more accurately, increasing dependency ratios, have an inflationary bias once we control for population growth, the impact is both small AND almost behind us. Note the peak inflationary age for demographics under the latest models is 65-69. The modal year for Baby Boomers’ birth was 1957. Those Boomers are now at the peak of their inflationary effect. If you really believe this is the dominant driver, then you should be watching out for a collapse in inflation.

I acknowledge that “inflation minus everything is nothing.” Excluding Core Services, which make up 58% of the CPI basket, is obviously cheating. But it’s “Purpose dRiven Cheating” — PRC for short — because the ends justify the means. I’ll see myself out now.

But there is indeed a reason for the distinction because it’s within the “Core Services” that life starts to get interesting. First, the same picture for Core Services:

Oof… that does not look good for Team Transitory. While the standard of 2.0% for this series is clearly “wrong” as an expectation, given a 2.8% pre-Covid average, it does appear that forward progress on inflation has stopped. So what is going on?