Is Inflation Around The Corner?

| October 14, 2010 | 0 Comments

I have a quick question for you.  Are you more concerned about inflation or deflation?  Off the top of your head, which do you think is the bigger issue?

If you’re having trouble answering that question, you’re not alone. Even the experts can’t figure it out.  There are a lot of moving parts.  And the situation is becoming more and more complex by the day.

I’ll tackle the topic of inflation and the economy in more depth next week.  But for now let’s focus on what’s coming next.

So how do we know if inflation or deflation is coming?

We can start by looking at the Consumer Price Index (CPI).  The CPI number for September comes out tomorrow.  It should provide a strong clue about where the economy’s headed.

Let’s take a look at what CPI is and how to understand tomorrow’s number.

Basically, the CPI is a cost of living measure.  It’s an index calculated each month from the prices of about 200 different goods and services.  These 200 items are divided into eight different categories.

The eight categories are then weighted based on spending importance.  For example, spending on housing is going to be weighted higher than spending on recreation.  Housing is clearly a more important expense than recreation.

In fact, housing is the largest component of the index, making up around 42% of the CPI’s value.  Transportation is next at 17%. Food is third at 15%.  Other categories include medical care, apparel, recreation, education, communication, and a miscellaneous catch all.

So what does the CPI number actually mean?

The CPI number shows the change in total cost of the 200 items from month to month.  You compare it to previous months to see if prices are rising or falling.

It can also show longer-term trends in inflation.

You see, the CPI was set at 100 for a base period between 1982 and 1984.  The most recent CPI (for August) shows the index at around 218.  That means overall prices of goods and services in the U.S. have more than doubled in just over 25 years.  (How’s that for a kick in the gut?)

The long-term data can be an interesting conversation piece… but let’s get to the bottom line.

The markets aren’t really concerned with the longer-term trends. Investors are more focused on the short-term implications.  They want to know if the economy is improving and if inflation or deflation is the greater concern.

Here’s a great example…

This year’s June CPI came out at 217.97… a drop from the previous month’s 218.18.  While it was only a 0.1% drop, it was the first time the CPI dropped after five straight months of inflation.  It immediately brought back fears of deflation.

What’s more, it really spooked the markets.

Get this… on July 16th, when the June CPI was released, the S&P 500 dropped nearly 3% in one day.  Make no mistake, the CPI can move the markets up or down dramatically.

So what should we expect tomorrow?

When the CPI is reported, the first number you’ll likely see is the change from the previous month.  So expect a small percentage change, positive or negative, most likely 0.5% or under.

I’m going to go out on a limb here and make a prediction for you. Just remember I’m not an economist.  (Although that means I’ll probably be right.)

Drum roll please…

The CPI is going to go up tomorrow.  Commodities had a big month in September and food is a pretty sizeable component of the index.  Also pending home sales increased more than expected and should mean the housing component increased as well.

All in all I expect to see an increase in the CPI.  And… we just might start hearing concerns over inflation.  Next week, I’m going to discuss what inflation concerns mean for Fed policy and the economy.  But for now, let’s get ready for an interesting Friday.

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Category: Bonds

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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