US Inflation – January 2009 Update

The above chart shows the Consumer Price Index (CPI-U) up to December 2010 courtesy of the Bureau of Labor Statistics. Year on year inflation has risen from 1.8% in November ’10 to 2.7% in December ‘10. This index is going to be interesting to watch because month on month the index has actually fallen -0.2%.

I have taken the liberty of dividing the chart into two sections. The first red section runs from 1871 to 1932 and the second blue section runs from 1933 to present day. I chose this break point as during 1933 the US officially ended their link to the gold standard. I think this chart demonstrates a point that government will always choose to inflate debt away at the expense of savers if given the chance. They could not do this under the gold standard.

To demonstrate this arithmetic mean inflation rates have been:
1871 to 1932 CPI = 0.5% with deflation being a regular occurrence.
1933 to Present CPI = 3.7%

The CAGR CPI from 1871 to 1932 has been 2.1%.

Further Reasons Why I Use the Shiller PE10

Regular readers will know that to try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I use a cyclically adjusted Price / Average 10 Year Earnings (PE10) ratio for the S&P 500 to value the US stock market. The method used is that developed by Yale Professor Robert Shiller. My latest update is that for January ’10.

The first chart today shows the chart that I show each month which reinforces why I use this method. The R^2 value is low at 0.0566 and the correlation is also low at -0.15. That said however these values, along with a look at the trend line, suggests that some advantage may be able to be taken of the relationship. I must point out here how the x and y axes are calculated for this chart.

The x axis should not be an issue for any regular reader. It is simply the monthly PE10 ratio which is the real (ie inflation adjusted back to 1871) price of the S&P 500 divided by the real monthly average of the previous 10 years earnings. The y axis is the real price in 13 months time minus the real price in 1 months time plus the real dividend all divided by the real price in 1 months time. Hope that makes sense... It is also important to note that I then calculate these values every month to form the scatter chart that I show.

I have been thinking about the fact that I am only analysing the historical return on investment from the S&P 500 that can be expected for a period of 1 year. I am certainly not a 1 year investor and so I wondered what these charts would look like for 5 or even 10 year periods.
To do this easily I am going to switch from monthly data points to one data point for each year which I have chosen to be January for no other reason than it is the first month of the year. This is because before I can run the real return calculations I first have to calculate a total return for the S&P 500 going back to 1871 and this is easiest done with yearly data.

Now to the interesting bit. Firstly, as a comparison to the monthly chart above my second chart shows the 1 year real total return versus the PE10. Charts three and four then show the 5 and 10 year real total return versus the PE10. Examining the R^2 and correlations shows:
1 year, R^2 0.0462, correlation -0.21
5 year, R^2 0.1554, correlation -0.39
10 year, R^2 0.2725, correlation -0.52

This for me is really interesting. It suggests that the longer the period of time you hold the stocks or equities the more the Shiller PE10 becomes a useful measure for predicting future expected real returns. This reinforces why I am using the PE10 ratio as part of my retirement investing strategy.

As always some assumptions:
- Q1 ’09 & Q2 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.
- January ‘10 dividend is estimated as December ‘09 dividend.
- Prices are month averages except January ‘10 which is the 11 January ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

The Recession and Global Financial Crisis is Over. Back to the Boom in House Prices.

You’d be forgiven for thinking that it’s all over if you caught page 19 of the London Evening Standard which has the headline ‘London house prices surge past the pre-recession peak of 2007’. Apparently the suburbs of Mayfair, Knightsbridge, Belgravia, Pimlico, Chelsea, Kensington, Holland Park, Notting Hill and Regent’s Park have risen in price by 51% from their lowest point in March of 2009. As an added bonus they are now 3% above the previous high.

Can you spot a theme with the suburbs? It’s amazing what bailing out the banks, the Bank of England dropping the Official Bank Rate to 0.5% and around £200 billion of Quantitative Easing can achieve. It’s certainly helped some however I don’t think we’re out of the woods yet. Let me provide some further evidence.

I don’t have to look far. Firstly, page 31 leads with ‘More bank losses feared after SocGen writedown’. Society Generale have issued a surprise profit warning stating they have to write down a further EUR1.5 billion on is Collateralised Debt Obligations on residential Mortgage Backed Securities after deciding to take a “stricter assessment” on their value. Now where have I heard those words before?

Until banks face up to their losses and clear their balance how can we move onto the next business cycle. At this rate we’re going to end up just like Japan. A further sobering thought is that this is all still going on and the peak of the Alt-A resets in the US are just starting now.

Secondly, page 33 tells us that ‘Flat manufacturing triggers talk of recession’s return’. Manufacturing output has failed to grow for a second month in a row leaving manufacturing output 5.4% lower than a year earlier.

That doesn’t sound like a boom to me. To me it sounds like it’s going to get worse before it gets better.

Australian Property Market (Alternate Data) – January 2009 Update

The Brisbane and Australian Eight Cities (Sydney, Melbourne, Brisbane, Adelaide, Perth, Hobart, Darwin & Canberra) House Price Index published by the Australian Bureau of Statistics catalogue 6416.0 suits my requirement to track Australian house prices as part of my retirement investing strategy. It however seems to have two flaws. Firstly the housing data is only published quarterly and secondly this housing data is then published over a month after the quarter ends.

I’m therefore looking for something that helps me keep my finger on the pulse a little more. Certainly monthly figures are desirable. I am going to therefore use housing data published by RPData and in particular I will monitor the Brisbane and Logan City numbers.

The above chart shows the figures to November 2009. With the Reserve Bank of Australia now over their global financial crisis panic and apparently in an interest rate raising cycle plus the government removing housing stimulus by reducing first home buyers grants I ask is the Australian housing market slowing. Brisbane median prices this month have only increased by $100 ($510,000 to $510,100) which is only 0.2% annualised and Logan City median prices by $1,000 ($370,000 to $371,000) which is still 3.2% annualised.

Is the property boom running out of legs?

US (S&P 500) Stock Market – January 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted Price / Average 10 Year Earnings (PE10) ratio for the S&P 500 to value the US (specifically the S&P 500) stock market. The method used is that developed by Yale Professor Robert Shiller. Background information here.

Chart 1 plots the Shiller PE10. Key points this month are:
- Shiller PE10 = 21.0 which is up from 20.6 last month. My UK Equities target asset allocation therefore drops from 18.3% to 18.1%. Additionally my International Equities target asset allocation drops from 13.1% to 12.9%.
- Shiller PE10 Average (1881 to Present) = 16.4
- Shiller PE10 20 Percentile (1881 to Present) = 11.0
- Shiller PE10 80 Percentile (1881 to Present) = 20.6. The Shiller PE10 has now passed through the 80 Percentile.
- Shiller PE10 Correlation with Real (ie after inflation) S&P 500 Price = 0.78

Chart 2 further reinforces why I am using this method. While the R^2 is low there appears to be a trend suggesting that the return in the following year is dependent on the Shiller PE10 value. Using the trend line with a PE10 of 21.0 results in a 1 year expected real (after inflation) earnings projection of 4.4%.

Chart 3 plots Real (after inflation) Earnings and Real Dividends for the S&P 500. Real Dividends are still falling however they are still above their long term trend. Real Earnings have a roller coaster ride continually, particularly since about 1990. If the Standard and Poors forecast earnings are to be believed however we continue to be above the long term earnings trend. These forecasts maybe aren’t so good though with the year getting off to a bad start – profits at Alcoa (the first to report for 2010) down and Chevron also announcing lower fourth quarter profits than forecast.

Assumptions include:
- Q1 ’09 & Q2 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.
- January ‘10 dividend is estimated as December ‘09 dividend.
- Prices are month averages except January ‘10 which is the 11 January ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.