What Is The Bond Market Telling Us ??

[JEast]

The chorus is nearly unanimous that the dollar will continue to fall, that gold will continue to rise, that inflation is in the not too distant future, and that foreign investors (especially China) will start selling U.S. Bonds. However, the Bond Market appears to be ignoring these apparent facts, as the masses know them, now that the 30-year is on the verge to cross below the 4% mark again (3.99% as I write).

 

What does the Bond Market know that the chorus does not know?

 

http://www.bloomberg.com/markets/rates/index.html

 

 

Cheers

JEast

[ERICOPOLY]

The bond market looked similar in the 1940s, but I don't think it was a good time to buy long term bonds.

[dowfin1]

Comparing the spreads on 10 and 30 yr treasuries with the corresponding TIPS,

Mr. Market says we will have very moderate inflation.  The real fear is if the spread drops way futher like in December.

[uncommonprofits]

The real yield on bonds in the 40's was horrible.  Spikes of inflation took place -- but interest yields remained low.  Real Rates of yield as taken from Valueline for the LT AAA Corporate Bond (Moody's) were as follows (first figure Gross, second figure Real):

 

1940 = 2.8%, 2.1%

1941 = 2.8, -2.3

1942 = 2.8, -8.1

1943 = 2.7, -3.3

1944 = 2.7,  1.1

1945 = 2.6, 0.3

1946 = 2.5, -6.0

1947 = 2.6, -11.8

1948 = 2.8, -4.9

1949 = 2.7, 3.7

 

Simple average for the decade = 2.7% (gross), -2.9% (Real) [inflation of course making up the difference - ie. 5.6% SIMPLE average]

 

Over the last 8 decades in the valueline record -- the 40's was by far the most dismal decade in terms of real yields for bonds.  Will be interesting to see if the 2010's is shaping up to be something simililar to the 1940's, OR late 70's/early 80's, something in between, OR something entirely else.  Who knows, but the point is bond markets can suffer difficult stretches just as the stock market can - the 40's was really, really bad for bonds.   It's interesting to note also that the 40's was preceded by a similar era as we have now: a previous long term stretch of very good times for bonds (in real yield terms).  Of course the other common theme with the 40's was the real Pearl Harbour back then and as Buffett puts it the 'economic'  Pearl Harbour we face today that spread fear across the country in a similar fashion .... along with corresponding Government Spending.

 

UCP/DD

 

Ref: http://www.valueline.com/pdf/valueline_2006.pdf

[ERICOPOLY]

The real yield on bonds in the 40's was horrible.  Spikes of inflation took place -- but interest yields remained low.  Real Rates of yield as taken from Valueline for the LT AAA Corporate Bond (Moody's) were as follows (first figure Gross, second figure Real):

 

1940 = 2.8%, 2.1%

1941 = 2.8, -2.3

1942 = 2.8, -8.1

1943 = 2.7, -3.3

1944 = 2.7,  1.1

1945 = 2.6, 0.3

1946 = 2.5, -6.0

1947 = 2.6, -11.8

1948 = 2.8, -4.9

1949 = 2.7, 3.7

 

Simple average for the decade = 2.7% (gross), -2.9% (Real) [inflation of course making up the difference - ie. 5.6% SIMPLE average]

 

Over the last 8 decades in the valueline record -- the 40's was by far the most dismal decade in terms of real yields for bonds.  Will be interesting to see if the 2010's is shaping up to be something simililar to the 1940's, OR late 70's/early 80's, something in between, OR something entirely else.  Who knows, but the point is bond markets can suffer difficult stretches just as the stock market can - the 40's was really, really bad for bonds.   It's interesting to note also that the 40's was preceded by a similar era as we have now: a previous long term stretch of very good times for bonds (in real yield terms).  Of course the other common theme with the 40's was the real Pearl Harbour back then and as Buffett puts it the 'economic'  Pearl Harbour we face today that spread fear across the country in a similar fashion .... along with corresponding Government Spending.

 

UCP/DD

 

Ref: http://www.valueline.com/pdf/valueline_2006.pdf

 

 

Those returns don't look cheery, and can you imagine how bad it looks on an after tax basis? 

 

Especially if you were in the top marginal tax rate (as high as 94%):

http://www.truthandpolitics.org/top-rates.php

 

It's hard to belive that in my lifetime, tax rates were as high as 70%.

 

Everyone should convert their IRAs to RothIRAs next year when there are no income limits.  Get out while you can.  (that's my fear mongering for the day)

[JEast]

Are the Hoisington folks correct? Maybe the Bond market has it right for the next year.

 

Executives at Kroger Co., the largest U.S. supermarket chain, blamed deflation for a 7 percent drop in earnings in the second quarter.

 

http://www.bloomberg.com/apps/news?pid=20601087&sid=ame31IjWda6w

 

 

Cheers

JEast

[Guest Broxburnboy]

That's a curious article, as the title implies that we have a deflation THREAT. In the body of the article, they introduce the word "disinflation" which means apparently, the slowing of the rate of inflation. These are two very different conditions, slowing of the rate of price inflation does not mean that we are in a deflationary phase, quite the contrary... prices are still inflating. Next month, the rate of inflation may speed up again, or it may decline, or it may stay stable.. I don't think we can logically conclude from the facts presented in this article that deflation is imminent.

 

This is the same kind of faulty reasoning that we have been fed for years... spinning news to support a previous prediction. Every month for the last year we have seen the headlines "home prices stabilizing in sign of housing bottom" and "slowing rate of unemployment signals end of recession in sight" (and others). For the real, unspun numbers on inflation see shadowstats.com. and other 3rd party sites.

[ERICOPOLY]

For the real, unspun numbers on inflation see shadowstats.com. and other 3rd party sites.

 

Shadowstats.com has an inflation calculator that give us the "real" rate of inflation (although their data is secret unless you pay them a fee).

 

So I plugged in $17,000 for the median priced home in 1970 to see what it is "really" worth today:

http://www.shadowstats.com/inflation_calculator?amount1=17000&y1=1970&m1=1&y2=2009&m2=8&calc=Find+Out

 

It turns out that the official BLS data suggests it is worth $113,258, and (while they won't give out the exact number for free), the ShadowStats data suggests that home is worth nearly $300,000 today.  The height of their block 2.5x to 3x the height of the CPI-U block (suggesting at least 2.5x to 3x the price of $113,258).

 

Hmmm....  is that really the inflation adjusted price?

 

It feels to me like the BLS number is closer, but that's because I doubt the real price of the median 1970 house is anywhere close to $300k.

[Guest Broxburnboy]

For the real, unspun numbers on inflation see shadowstats.com. and other 3rd party sites.

 

Shadowstats.com has an inflation calculator that give us the "real" rate of inflation (although their data is secret unless you pay them a fee).

 

So I plugged in $17,000 for the median priced home in 1970 to see what it is "really" worth today:

http://www.shadowstats.com/inflation_calculator?amount1=17000&y1=1970&m1=1&y2=2009&m2=8&calc=Find+Out

 

 

 

CPI is a measure of the cost of a basket of consumer goods and services... and originally used to indicate the impact of price inflation on an "average" consumer. During the Clinton era, the basket of goods and services was changed , like substituting hamburger for steak,

which had the effect of understating the rate of CPI inflation. Shadowstat's calculation of CPI uses the prices of the original basket components in order to track the inflation of an unchanged basket, and hence gives a different, higher number.

For rates of inflation in USD of housing assets you should refer to the Case Schiller index and for rates of inflation of stocks or other assets, check the appropriate industry price index.

[Guest Broxburnboy]

Amongst the free data on the Shadowstats site is an explanation of CPI and what it measures:

 

http://www.shadowstats.com/article/consumer_price_index

 

[ERICOPOLY]

For the real, unspun numbers on inflation see shadowstats.com. and other 3rd party sites.

 

Shadowstats.com has an inflation calculator that give us the "real" rate of inflation (although their data is secret unless you pay them a fee).

 

So I plugged in $17,000 for the median priced home in 1970 to see what it is "really" worth today:

http://www.shadowstats.com/inflation_calculator?amount1=17000&y1=1970&m1=1&y2=2009&m2=8&calc=Find+Out

 

 

 

CPI is a measure of the cost of a basket of consumer goods and services... and originally used to indicate the impact of price inflation on an "average" consumer. During the Clinton era, the basket of goods and services was changed , like substituting hamburger for steak,

which had the effect of understating the rate of CPI inflation. Shadowstat's calculation of CPI uses the prices of the original basket components in order to track the inflation of an unchanged basket, and hence gives a different, higher number.

For rates of inflation in USD of housing assets you should refer to the Case Schiller index and for rates of inflation of stocks or other assets, check the appropriate industry price index.

 

Robert J. Shiller is the author of a book titled Irrational Exuberance Second Edition.  I have a copy of this book sitting here next to me.  He makes a case that house price outpaced their "real" values, as measured by the CPI (as measured by the BLS).

 

Now, if Shiller had instead used the data provided by ShadowStats.com then he would have been forced to conclude that housing was getting cheaper in real terms, as opposed to more expensive.  Perhaps then the title would have been Rational Exuberance.

 

Yes, the CPI has been altered.  But why do you feel that steak a more reliable measure of inflation than hamburger?  Supposing for a minute that there is a real conspiracy by the government to underreport CPI, how would they know ahead of time that hamburger would rise in price at a slower pace than steak?  Once the CPI adjustment is made, on a going forward basis the price of hamburger should still increase with inflation right?  So shouldn't the price of hamburger be perfectly reasonable to use as a price measure for say, 2005 vs 2004 CPI calculations?  Hamburger is consumed in much greater quantity, and steak is really a luxury item.  I would say steak is to hamburger as first class seating is to economy seating, and if they CPI were based on first class seating I would think it reasonable to correct the mistake and base it on economy pricing given that it's what's purchased most broadly.

 

[Guest Broxburnboy]

When hamburger is substituted for steak in the index, the index is corrupted. If steak is selling for 2.00 lb on the day of the conversion, and hamburger is substituted at 1.00/lb, the CPI calculation will thereby reflect the inflation of a basket of commodities, whose intrinsic worth is declining. Far more accurate to trace the price of a stable basket over time. One pound of steak in 1970 vs. 1 pound of steak in 2009, not the price difference of 1 pound of steak in 1970 vs. 1 pound of hamburger in 2009.

If a consumer consumes 1 pound of steak in 1970 at 2.00/lb then 1 pound of hamburger in 2000 at 2.00.lb and later (say 2015) one pound of dog food at 2.00lb, I don't think anyone can reasonably conclude that inflation in red meat prices over the years is stable.

 

Comparing trends in asset prices like homes and stocks to the CPI, is a problematic exercise because they are not components of the basket. It is probably a useless exercise.

It may be less problematic to compare total monthly rental costs (a consumer cost), and use the CPI as measure to compare their relative inflation.

 

 

[ERICOPOLY]

When hamburger is substituted for steak in the index, the index is corrupted. If steak is selling for 2.00 lb on the day of the conversion, and hamburger is substituted at 1.00/lb, the CPI calculation will thereby reflect the inflation of a basket of commodities, whose intrinsic worth is declining. Far more accurate to trace the price of a stable basket over time. One pound of steak in 1970 vs. 1 pound of steak in 2009, not the price difference of 1 pound of steak in 1970 vs. 1 pound of hamburger in 2009.

If a consumer consumes 1 pound of steak in 1970 at 2.00/lb then 1 pound of hamburger in 2000 at 2.00.lb and later (say 2015) one pound of dog food at 2.00lb, I don't think anyone can reasonably conclude that inflation in red meat prices over the years is stable.

 

Comparing trends in asset prices like homes and stocks to the CPI, is a problematic exercise because they are not components of the basket. It is probably a useless exercise.

It may be less problematic to compare total monthly rental costs (a consumer cost), and use the CPI as measure to compare their relative inflation.

 

 

I hear you, it sucks to say steak one day and hamburger the next.  But once the switch is made, it no longer upsets the differential in CPI for subsequent years.  For example, I will have a higher degree of confidence next year when I get the 2010 BLS numbers because I'll at least be satisfied that they are measuring the right thing.  If I pay this guy for his shadowstats.com numbers I will get a less useful view of consumer inflation because I will be seeing the price of steak which is a luxury, vs the price of a more widely consumed item.  I don't want to continue on the wrong path forever simply for consistency -- consistently inaccurate is not a good thing.  If we're supposed to be measuring the most broadly consumed items, then lets do it and quit fucking around with steak which doesn't allow us to arrive at what we're trying to measure in the first place which is the cost of living, not the cost of luxury.  The sin as I see it was that they didn't correct the index soon enough, not that they should never correct it at all.  I don't care if seniors can't afford steak with their Social Security income -- let them eat hamburger! (that was a joke).

 

Nevertheless, past (hamburger for steak) substitutions in the CPI do not explain why ShadowStats.com suggests that the rate of inflation was approximately 3% higher per annum every single year this decade.  You might get a distortion in the very year that a substitution is made (as you describe, $2 steak for $1 hamburger), but this is ridiculous.  Every single year!

 

True, homes are not components of the basket, and Shiller knows this.  However he argues that homes cannot increase faster than inflation, and he uses the CPI as his measure of inflation.  The price to rent ratio was adequate in 1970, rent is a component of CPI, and it's widely accepted that in the long run prices should rise in line with rents.  Therefore, although housing prices are not directly a component of the CPI it does actually make a good deal of sense to use rents as a proxy for house prices given that only a bubble should be responsible for a large distortion in the price/rent ratio.

 

 

 

 

 

 

 

[Guest Broxburnboy]

The steak/hamburger switch is only one of several adjustments used in BLS CPI calculations. There are components of the index, whose weighting has been changed to reflect "hedonism". These adjustments are ongoing and tend to diminish the intrinsic value of the basket. Shadowstats has simply continued to calculate CPI using the same components at the same weighting before the ongoing "devaluation" of the basket. They call this the pre-Clinton CPI.

The point is there is a danger in using BLS CPI as an indicator of general inflation... It is what it is.. an attempt to measure the impact of price inflation of a "typical" basket of consumer goods and services purchased by a "median" income consumer. It is skewed because it now measures prices of a basket whose intrinsic worth is also degrading. Over time the divergence between BLS CPI and pre-Clinton CPI will increase, not be a one time divergence.

 

A quote from the BBC comedy series "The Black Adder" may be in order:

 

Percy: You know, they do say that the Infanta's eyes are more beautiful than the famous Stone of Galveston.

Edmund: Mm! ... What?

Percy: The famous Stone of Galveston, My Lord.

Edmund: And what's that, exactly?

Percy: Well, it's a famous blue stone, and it comes ... from Galveston.

Edmund: I see. And what about it?

Percy: Well, My Lord, the Infanta's eyes are bluer than it, for a start.

Edmund: I see. And have you ever seen this stone?

Percy: (nods) No, not as such, My Lord, but I know a couple of people who have, and they say it's very very blue indeed.

Edmund: And have these people seen the Infanta's eyes?

Percy: No, I shouldn't think so, My Lord.

Edmund: And neither have you, presumably.

Percy: No, My Lord.

Edmund: So, what you're telling me, Percy, is that something you have never seen is slightly less blue than something else you have never seen.

Percy: (finally begins to grasp) Yes, My Lord....(Sound of hand slapping the back of the head)

 

Cheers

[ERICOPOLY]

I spent quite a while on ShadowStats.com today. 

 

I take it the feeling is that the government can hold down CPI calculations to fix budget issues by limiting payments to Social Security.  Why then have they rigged it so that FICA taxable income also is pegged to the CPI?  I mean, if they keep CPI down sure it limits payouts, but it also limits revenue at the same time.  Probably wasn't wise to link taxable income to CPI if they are rigging it.  I couldn't find anywhere on ShadowStats where he admits the government is also deliberately holding down their revenue -- not that he would say that given that he is selling his data.

 

My grandmother (Australia) doesn't trust the CPI either.  She too thinks the CPI numbers are bunk.  I think the CPI has understated inflation, but I think the real rate of inflation is somewhere in between the two.  For instance, I don't think a median house is going to be as low as the $112,000 or so that the CPI suggests it would be if houses followed the general trend of consumer prices.  Yet I don't think $300k sounds right either.