CPI Falling

[T-bone1]

I can't say I've seen anything but inflation in the US in my day-to-day life, but apparently the CPI is falling . . . is it possible that Fairfax was making a bet on the specific components of the CPI rather than a depression?  Or that they are just right and I am thick in the head?  Either way, I hope those derivatives work out for them (but I don't hope for a deflationary recession):

 

http://www.businessinsider.com/historical-cpi-in-one-chart-2013-11

[TwoCitiesCapital]

I can't say I've seen anything but inflation in the US in my day-to-day life, but apparently the CPI is falling . . . is it possible that Fairfax was making a bet on the specific components of the CPI rather than a depression?  Or that they are just right and I am thick in the head?  Either way, I hope those derivatives work out for them (but I don't hope for a deflationary recession):

 

http://www.businessinsider.com/historical-cpi-in-one-chart-2013-11

 

The Western world can't handle deflation because of the debt burden they have. Deflation is still the real threat in the near term. Inflation might be a longer term worry but being cautious and keeping cash/bonds in your portfolio probably isn't a bad decision. I, for one, am glad that Fairfax is hedged and has derivative exposure. It's a much cheaper way to expose myself to that directional call then to be buying the puts myself.

[ERICOPOLY]

How much are they influenced by A. Gary Shilling?  I hear he was at the dinner and the last AGM.

 

I've been watching his comments over the past 12 months and it sounds like he's rather bullish -- only 5 more years of this deleveraging and then he believes the US will go back to it's long run growth trend.  Not this "new normal" pessimism.

 

He predicted deflation 10 years ago, in 2003. 

 

So I wonder, are they listening to him?  Will they dump their CPI hedges relatively soon (next few years) given that the 5 years isn't much runway for these hedges to make a lot of money?

[obtuse_investor]

I have heard of this 5 more years theory too-- not just from Shilling, but also from Dalio.

 

In practice, these deflationary periods are very long indeed. Case in point is Japan.

[ERICOPOLY]

Were you to have a perfect knowledge of the future, the first 5 years of slow growth matter little to the overall intrinsic value of the economy.

 

That's why I was finding Shilling's comment relatively bullish -- in other words, not that much left to discount for.

[obtuse_investor]

On topic here is something with a crazy headline that is quite interesting...

 

Is QE deflationary?

Excerpt....

 

Is QE deflationary? Yes, quite obviously so. Consider:

A central bank that is deploying QE is almost certainly at the zero lower bound.

QE will only help get an economy off the zero lower bound if paired with a commitment to higher future inflation.

If a central bank is deploying QE over a long period of time, that means it has not paired QE with a commitment to higher future inflation.

Prolonged QE is effectively a signal that the central bank is unwilling commit to higher inflation.

QE therefore reinforces expectations that economic activity will run below potential and demand shocks will not be completely offset.

QE will be associated with a general disinflationary trend.

 

Full article: http://feedly.com/k/1bhBwZo

[vinod1]

I can't say I've seen anything but inflation in the US in my day-to-day life, but apparently the CPI is falling . . . is it possible that Fairfax was making a bet on the specific components of the CPI rather than a depression?  Or that they are just right and I am thick in the head?  Either way, I hope those derivatives work out for them (but I don't hope for a deflationary recession):

 

http://www.businessinsider.com/historical-cpi-in-one-chart-2013-11

 

I think Fairfax was expecting the 2nd dip like US had in 1932 and a very deep recession. Otherwise, they would not have hedged at S&P 500 value of 1062. Buffett came out with "Buy America" article when S&P 500 was at 900 a couple of years earlier. It could not have been due to valuation. GMO and even Hussman consider fair value to be about 1000 - 1100. Hedging would not have been for a mere 10-20% drop in value, they must have been expecting something like 30-40% from the hedge level of 1062 or S&P 500 to fall to something like 640 to 740. That is an economy in deep trouble and very deflationary.

 

Vinod

 

 

[ERICOPOLY]

Hedging would not have been for a mere 10-20% drop in value, they must have been expecting something like 30-40% from the hedge level of 1062 or S&P 500 to fall to something like 640 to 740. That is an economy in deep trouble and very deflationary.

 

Vinod

 

They could have expressed that degree of risk aversion with 10% or 20% out-of-the-money puts.  In other words, we can tolerate a little bit of pain, but not too much.  There has never been a solid argument that the kind of hedging they did was necessary to protect their business.  A 20% market decline only hurts their book value by 7% after taxes if they are 50% in equities.  Can't they take a 7% hit?  Plus, during that time they have bond gains and bond income to offset if there is really that much deflation.  Okay, they might not lose anything at all in that situation.

 

Instead, they implicitly hedged with a "we can't suffer any losses at all" stance (a straight at-the-money short on the market).  Or rather, they were expressing their confidence that the market was going down nearly for sure.  Prior to this round of hedging, they always hedged against the market continuing to climb (they used out-of-the-money index calls to do that).  Something seemed to change their mind that such hedging for a possibly rising market was no longer needed. 

[Ham Hockers]

On topic here is something with a crazy headline that is quite interesting...

 

Is QE deflationary?

Excerpt....

 

Is QE deflationary? Yes, quite obviously so. Consider:

A central bank that is deploying QE is almost certainly at the zero lower bound.

QE will only help get an economy off the zero lower bound if paired with a commitment to higher future inflation.

If a central bank is deploying QE over a long period of time, that means it has not paired QE with a commitment to higher future inflation.

Prolonged QE is effectively a signal that the central bank is unwilling commit to higher inflation.

QE therefore reinforces expectations that economic activity will run below potential and demand shocks will not be completely offset.

QE will be associated with a general disinflationary trend.

 

Full article: http://feedly.com/k/1bhBwZo

 

If you're interested in this, there's been a good debate going on in the last several days between Williamson and a bunch of others on various blogs. I'd recommend checking out Williamson's blog directly, as well as Krugman, Nick Rowe, and Scott Sumner.

[wisdom]

http://www.ft.com/intl/cms/s/0/6e3d05fc-8100-11e3-95aa-00144feab7de.html

 

deflation in europe

[Cevian]

It is important to keep in mind how the "new CPI" is calculated.

 

http://www.bls.gov/cpi/superlink.htm

 

http://www.investopedia.com/articles/07/consumerpriceindex.asp

 

http://en.wikipedia.org/wiki/United_States_Chained_Consumer_Price_Index

 

 

[obtuse_investor]

I wonder what method are Fairfax's CPI derivatives tied to.

 

This would be a worthwhile question to ask at the annual meeting, if not the Q4 conference call.

 

Alas, I can't go this year because I am expecting to be knee deep in diapers. New baby on the way.