The economic tea leaves look favorable

Here's my current reading of the economic tea leaves: 1) the September CPI inflation release confirms that ex-energy inflation continues on the 2% per year trend which has prevailed for almost two decades; 2) Small Business Optimism has rebounded strongly and confirms the presence of a V-shaped recovery; 3) very low real interest rates on Treasuries confirm that safety is extremely expensive, Treasuries are a bad deal for investors and a great deal for the federal government; 4) stock prices continue to drift higher, confirming an improving economic and favorable political environment; 5) commodity prices have staged a strong V-shaped recovery, which suggests the global economic outlook has improved dramatically; and 6) TSA throughput says air travel is recovering at only a modest pace (not everything is coming up roses).

Near and dear to my heart, meanwhile, was Apple's unveiling yesterday of its iPhone 12 models. I've been an investor in and a fan of AAPL for a very long time and have had optimistic posts on the company over the years. To my mind, the technological advances and capabilities of Apple's new models are breath-taking, not to mention beautiful to look at. This is one more of many examples of how advanced technology has enriched our lives by orders of magnitude while at the same time becoming accessible to just about anyone. Apple continues to impress, and I'll be ordering a new iPhone 12 Pro Friday morning.

Now for the charts:

Chart #1

Chart #1 plots the ex-energy version of the CPI on a log scale, superimposed on a line that increases at a 2% pace each year. I use ex-energy inflation because energy prices are by far the most volatile component of any inflation index—something the Fed cannot possibly offset or attempt to control. That inflation by this measure has averaged 2% per year for over 17 years is remarkable, although I would prefer to see inflation averaging closer to 1% or less.

Chart #2

Charts #2 and #3 show the impressive results of the September survey of small businesses. Overall optimism has surged in the past few months, as have hiring plans. Despite the still-existing legions of the unemployed, the majority of small businesses report having difficulty filling job vacancies with qualified people. Experience and education are still in demand.

Chart #4

Chart #4 shows the inflation-adjusted yield on 10-yr Treasuries. Nominal yields are a mere 0.7%, and the core rate of CPI inflation (CPI ex food and energy) is currently 1.7%. That leaves an investor with a loss of purchasing power of 1% every year for the next 10 years! (That means a real return of -1%.) This loss of purchasing power obviously hurts the investor, but it's a boon to the US Treasury, which gets to repay its obligations with cheaper dollars. Treasury has issued about $3.5 trillion of new debt since last March, so thanks to very low real interest rates (which are a function of very strong demand for the safety of Treasury notes and bonds) and ongoing inflation, the real burden of that debt will decline by about $35 billion every year for the foreseeable future. Those buying these bonds, of course, will suffer a $35 billion loss. 

Chart #5

Chart #5 shows the real and nominal yield on 10-yr Treasuries (blue and red lines) and the difference between the two (green), which is the market's expectation for what CPI inflation will average over the next 10 years: 1.75%. The bond market fully expects nominal yields to remain firmly below the rate of inflation for a very long time. That adds up to either a) tremendous respect for the prowess and power of the Fed, b) a huge amount of risk aversion on the part of the investing public, and/or c) a very negative view of the economy's ability to thrive for the foreseeable future. I'd say the latter two are the obvious choices: risk aversion is very strong and economic optimism is in short supply.  

Chart #6

Chart #7

Charts #6 and #7 show that air travel has picked up modestly in the past month to its highest pre-pandemic level. Yet it is still 65% below the levels which prevailed at this time last year. It's a slow takeoff for this industry.

Chart #8

Chart #8 shows the CRB Raw Industrials commodity index, which has staged a complete and V-shaped recovery over the past 5 months. This is a good indication that the global economic outlook has improved rather dramatically in the wake of the Covid shutdown fever which swept almost very country in the world (with a few notable exceptions like Sweden and Switzerland).

Chart #9

We finish with Chart #9, which by now is quite familiar to readers. On balance, stock prices have been edging higher over the past several years, but the Vix "fear index" is still elevated. The market is cautious, as it should be, because there still are plenty of unknowns in our future, the most obvious of which is next month's election, and the potentially huge changes in fiscal policy (most disturbing being higher taxes) that could be set in motion as a result. Bloomberg (alert: strong liberal bias) tells me the market is cheering Biden's lead in the polls, but I worry that his pledge to raise taxes and re-regulate the economy (e.g., Green New Deal) would deal a significant blow to our still-struggling economy and the present discounted value of future corporate profits (i.e., stock prices) if he wins.

If I were to guess the election result that is priced in to the market, I would say the market is discounting the polls—which show Biden with a strong lead—and betting that Trump's odds of winning are favorable: a replay of sorts of what happened 4 years ago. My confidence in this assessment is not high, but in my defense I note that 56% of Americans say they are better off today than they were 4 years ago. I also note that the NY Times' science reporter recently noted that "Experts are saying, with genuine confidence, that the pandemic in the United States will be over far sooner than they expected, possibly by the middle of next year." Moreover, the Trump administration's "Operation Warp Speed — the government’s agreement to subsidize vaccine companies’ clinical trials and manufacturing costs — appears to have been working with remarkable efficiency."

UPDATE (10/15/20): Just discovered this series produced by the NY Federal Reserve, which is a compilation of 10 indicators that are released on a weekly basis, so it's a pretty good coincident indictor of the economy's health. As you can see in Chart #10, things are improving in V-shaped fashion:

Chart #10