Here’s When Deflation Will Replace Inflation as “the Topic”
The price effects of deflation tend to occur in goods and investment assets simultaneously.
Indeed, David Rosenberg, who is the founder of an independent research firm, just wrote an article for the Financial Post (October 8) which is titled:
David Rosenberg: Deflation not inflation will be the topic when housing, equity bubbles pop
Here’s a brief quote from that article, which follows Rosenberg’s mention of the 2008 financial crisis:
The bubble this time around is even more acute, and the reversal in these asset values will hit even harder. The S&P 500’s cyclically adjusted price-to-earnings ratio (CAPE) multiple is 38.3x today and U.S. home prices have soared a record 20 per cent on a year-over-year basis. It now takes a near-unprecedented eight years of wages to buy a new house (the historical norm is closer to five years).
We do not have an inflationary future at all, and this will become apparent not just when these pandemic-induced supply issues are resolved, but when these asset bubbles pop. And they will pop.
Elliott Wave International agrees that a major reversal in equities and the housing market is at hand.
Regarding the U.S. housing market, here’s what the September Elliott Wave Financial Forecast had to say:
The downturn in prices from June is still just a blip, but there is further evidence of a dramatic change of tone in the market for homes. A survey by Redfin confirms that prices fell 0.2% in the four weeks ended August 1. “This is the first sign of the price rally petering out,” says Business Insider. The mad scramble, which had buyers piling into homes without the benefit of inspections or even in some cases seeing their new home, has also abated, at least a bit. According to Redfin, just under half of homes that went under contract in the last four weeks of July had an accepted offer in two weeks. That’s the first time the share fell below 50% since February. Also, for the first time since October 2019, the share of sellers dropping their price surpassed 5%. As in 2006, housing market economists say “homebuying demand remains strong and the market is tipped heavily in buyers favor.” We offered some anecdotal evidence of the frenzy in our area last month. Here’s an update from The Atlanta Journal-Constitution on August 26: “Metro Home Prices Flat—For Now.” According to the experts, the lull represents an “equilibrium that may prove short lived.” So they say. Our stance is that it will soon be replaced by an even more enormous crater than that of 2006-2011.
The doubling of consumers who say it is a “good time to sell” compared to 2006 is powerful confirmation of this outlook. It tells us that the astounding psychological power of a progressing mania continued to build, at least through June. When surveyed, many consumers recognize the current moment as a great opportunity to sell, but how many will? The answer is very few. Instead, many are rushing into second, third, or in the case of one retired couple profiled here last month, a 21st home. In a bid to make “second home ownership possible for more people,” a start-up company called Pacaso sells shares in a “corporatized house. The buyer gets one eighth of a share of ownership and the right to stay in the house 44 nights per year.” Back in the day, a preponderance of “odd lot” stock buying, units of less than 100 shares, was a dependable sign of an impending market high. Now that homes are being fractionalized, the stage is set for a very big reversal.
Insights into the Drop in Consumer Confidence
U.S. consumers are growing more pessimistic about the economy.
Indeed, the latest drop in the Consumer Confidence Index has reached a seven-month low.
Here’s an excerpt from a Sept. 29 article in TheHill:
The Consumer Confidence Index, a key indicator that offers a glimpse into purchasing attitudes among U.S. consumers, recorded another decline in September, continuing the streak of decreases seen in both August and July, according to new Conference Board data.
Falling to 109.3 from the 115.2 recorded in August, the new number indicates persistent pessimism among U.S. consumers, which in turn indicates lingering doubts about their individual finances. …
This most recent decline is now a seven-month low, according to calculations from Reuters, with these most recent readings being the lowest recorded since February.
American consumers also feel pessimistic surrounding the current business conditions in the U.S. Measured by the Present Situation Index, 19.3 percent of consumers described the business climate to be “good,” a drop from the 20.2 percent seen in August.
Is this a sign of a deepening deflationary psychology?
This is from Robert Prechter’s book, Conquer the Crash:
The psychological aspect of deflation and depression cannot be overstated. When the trend of social mood changes from optimism to pessimism, creditors, debtors, investors, producers and consumersall change their primary orientation from expansion to conservation.
When the Sept. 3 Elliott Wave Financial Forecast published, the latest consumer confidence data was for August. Here’s a chart and commentary from that issue of the Elliott Wave Financial Forecast:
In June 2000, The Elliott Wave Financial Forecast pointed out that the University of Michigan Consumer Sentiment Index … does a pretty good job of sussing out the prevailing direction of social mood.
The main trends in consumer confidence have always been tuned to stock prices.
…. The arrows on the chart highlighting the low in 1980 and the low in August 1982 … show that consumer sentiment led the way out of an economic quagmire at the beginning of Cycle wave V. Now … they are even more dramatically leading the way into a new one.
This New ETF Aims to Protect Against Deflation
Do you fear that the U.S. is headed for a deflationary scenario akin to what Japan has been going through?
If so, as the saying goes, “there’s an ETF for that.”
Here’s an excerpt from a Sept. 21 Bloomberg article headlined “Nancy Davis Flips to Deflation in New ETF After $3 Billion Haul”:
Nancy Davis has lured billions to her ETF guarding against inflation. Now she’s looking to repeat that success with a product betting on the other side of the trade.
Her firm, Quadratic Capital Management LLC, is launching the Quadratic Deflation exchange-traded fund (ticker BNDD), it said in a Tuesday statement.
The new product will seek to profit in an economic climate of falling prices, weak growth and negative long-term interest rates. Like its established sibling with the opposing mandate — the Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) — the strategy aims to deliver by trading a mix of Treasuries and options.
“Some investors have expressed concerns that the U.S. will experience an environment similar to Japan given the debt increase and labor market,” Davis, who will manage the new strategy herself, said in the statement. “It’s prudent for investors to have tools available to them so that they are prepared for a wide range of economic outcomes and environments.”
Markets have been fretting over inflation for months on the risk that price pressures could prove less transitory than the Federal Reserve expects. Yet as key measures of reflation ease from multi-year highs, Quadratic is betting investor attention will return to the long-term deflationary forces of the pre-pandemic world.
Of course, no one knows how a particular exchange-traded fund or any other investment will perform.
Yet, Robert Prechter does mention a “safe asset” that “assuredly rises in value during deflation” in his book, Conquer the Crash (2020 edition):
Today, few people give cash a thought. Because interest rates on Treasury bills are “too low,” investors claim that they have “no choice” but to invest in something with “high yield” or “upside potential.” Ironically but obviously necessarily, the last major interest-rate cycle was also perfectly aligned to convince people to do the wrong thing. In the early 1980s, when rates were high, people thought that stocks were not worth buying. Now that rates are low, they think that T-bills are not worth holding. It’s a psychological trap keeping investors from doing the right thing: buying stocks at the bottom (when rates were high) and selling them at the top (when rates are low).
Now let’s dispose of the idea that the return on cash is always “low.” … [The chart below] is one picture of the rising value of cash in the United States, which appreciated 287 percent from March 2000 to October 2002 in terms of how many shares of the NASDAQ index it could buy.
Wouldn’t you like to enjoy this kind of performance, too? You can, if you move into cash before a major deflation. Then when the stock market reaches bottom, you can buy incredibly cheap shares that almost no one else can afford because they lost it all when their stocks collapsed.
Cash is the only asset that assuredly rises in value during deflation.
Also, in Japan, the value of cash appreciated 400% in terms of how many shares of Japanese stocks it could buy from 1990 through 2008.
Two Japanese Prime Minister Candidates Pledge to Whip Deflation
Japan’s decades-long battle with deflation persists, despite past pledges by government officials to defeat it.
Now, two contenders to become Japan’s next prime minister join the list of those who’ve offered stimulus plans.
This Sept. 7 Bloomberg article excerpt provides details:
Two lawmakers battling to become Japan’s next prime minister both pledged to launch stimulus packages over the short term and to defeat deflation over the longer term, as they laid out their platforms Wednesday.
Former Foreign Minister Fumio Kishida said he would inject tens of trillions of yen (hundreds of billions of dollars) to help a Covid-battered economy, as he set out his policies in the race for leadership of the ruling Liberal Democratic Party.
Rival Sanae Takaichi, who is seeking to become the country’s first female prime minister, also said she would swiftly consider an extra budget to aid the economy, though she refrained from putting a figure on the size of the package. The amount would depend on how much was really needed and required careful consideration, she added.
Takaichi, a former economics professor, said she would prioritize the country’s 2% inflation target over achieving a primary budget balance. She said the government’s preoccupation with trying to balance the books had contributed to the failure to reach the target so far…
In his 2020 edition of Conquer the Crash, Robert Prechter provided a historical perspective on Japan’s economy as well as past stimulus efforts by Japanese authorities to defeat deflation:
Japan had one of the strongest economies in the entire world, growing at a 9% rate for 20 years up to 1973, and then a pretty strong rate of about 4.5% through 1994. From there, it’s averaged about 1%.
The reason Japan is in trouble was expressed in a November 1, 2012 headline from MarketWatch: “Japan Is in Worse Than a Deflationary Trap.” But it’s not worse than a deflationary trap. It’s just a deflationary trap. Here’s what the article says: “Policy makers have spectacularly failed. Brutal deflation persists.
Japanese officials tried monetary stimulus, including zero interest rates and quantitative easing.” Does that sound familiar? And here: “Past fiscal stimulus has ballooned the national debt to 200% of GDP.” Does that sound familiar, too? And finally, “The most troubling aspect of Japan’s malaise may be psychological.” That’s the key to the whole thing. When social mood changes psychology from ebullience to conservatism, a trend of expanding credit shifts to a trend of declining credit and therefore inflation into deflation.
Highest-Priced Home in U.S. Goes into Receivership
Defaults and a developing deflation go hand-in-hand.
As Robert Prechter’s 2020 edition of Conquer the Crash states:
Near the end of a major expansion, few creditors expect even the weakest borrowers to default, which is why they lend freely. At the same time, few borrowers expect their fortunes to change, which is why they borrow freely. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts.
With that in mind, consider this headline and two subheadlines from a Sept. 8 CNBC article:
Most expensive home in America defaults on $165 million in debt, heads for sale
A Los Angeles megamansion once expected to list for $500 million has gone into receivership after the owner defaulted on more than $165 million in loans and debt, according to court filings.
The 105,000-square-foot Bel Air estate, known as “The One,” was placed into receivership and is expected to be relisted at a lower price.
Let’s now transition from news about a “California megamansion” to Elliott Wave International’s analysis of what is going on with the overall U.S. housing market. Here’s a chart and commentary from the September Elliott Wave Financial Forecast:
Two… indicators suggest that a home price peak may be close. The first arrow on the top graph on this chart shows the July 2006 peak in U.S. Median Home Prices. The arrow on the second graph shows the last major peak in pending sales, which came in July 2005, 12 months ahead of the downturn in median home prices. Now observe the arrows on the right side of the chart. A similar divergence is occurring, as it has been 11 months from the latest peak in pending home sales to a June peak in median home prices. The bottom graph is the U.S. National Association of Homebuilders Market Index. Back in 2005, the index peaked in June, one year ahead of home prices. The index registered its latest peak reading ten months ago, with a record high of 90. In December 2005, when the NAHMI was six months into a 43-month decline to January 2009, pundits argued that “housing is simply taking a much-needed breather.” EWFF showed a chart of the seminal decline in the Homebuilders Index in that issue and stated, “The housing market is in the process of falling into an enormous crater.”