Signal stock

The stock market is embracing inflation now

Inflation is not a one-way street to recession. As long as consumers, organizations and governments receive revenue, rising prices are a backdrop of life – not a brick wall.

This reality now works in the stock market. Proof of this is the positive reaction to the latest GDP report, showing a second quarterly decline. Gone is the angst of the last quarter, with about two quarters signaling a recession. Excellent examples of the positive side exist in the components of GDP. For example, export…

Exports benefit from inflation

US exports are included in US GDP because the goods and services are produced in the United States. (And that’s why imports aren’t.)

After the early 2020 shutdown, there was a significant rebound in exports through early 2021. Since then, export growth has continued steadily at a 20% year-over-year rate . However, the BEA (American Bureau of Economic Analysis), responsible for the GDP, practically excludes any analysis of real data and even a presentation of basic data. Look in the full July 28 report, and the only unadjusted “current dollar” GDP data is in the last table, “Appendix Table B,” in the second-to-last line under “Addendum.” Fortunately, the Federal Reserve Bank of St Louis offers all raw data (actual, nominal) through its FRED data system.

Instead, BEA focuses on seasonally adjusted annualized quarterly amounts which they then adjust for inflation. Percentage changes in these amounts are then annualized. All of this may seem academically appropriate for comparing quarterly figures in normal times. However, abnormality has been the state of affairs over the past six quarters. To show how silly their adjustments can get, the dramatic drop in exports in Q2 2020 when everything was shut down worse by the seasonal adjustment of the BEA because the 2nd quarters are normally good export periods. In addition, the price drops during the quarter improved exports fall (inflation-adjustment in the opposite direction).

So let’s see what really happened to the “current dollar”, unadjusted exports in Q2 2022:

Quarterly exports: $746 billion

One-quarter change compared to the 1st quarter of 2022 = +$77 billion +11.6% (seasonally-adjusted and inflation-adjusted change from the BEA = +4.2%)

Year-on-year change since Q2 2021 = +$131 billion +21.3% (adjusted BEA change = +6.8%)

Why the big differences?

The main reason is the sharp rise in export prices. So why should exports be reduced by price gains? Good question.

The argument for reducing sales to US consumers is to see what “real” growth is. Think of the adjustment as converting dollar sales to unit sales – like a car manufacturer would. The reasoning is that if consumer spending increases by 5%, but prices increase by 4%, consumers only increase the items they buy by about 1%.

Okay, that’s great for American consumers. But what about non-US buyers of US exports? Is it really necessary to reduce by price increases? After all, if US companies are able to charge a higher price, isn’t that a good thing – a real increase in the valuation of goods by foreign buyers?

This thought process brings us to a larger question…

When prices move abnormally, how should price adjustments be calculated?

Think vehicle sales and chip shortages. We know that recent price increases have reflected normal demand in the face of reduced supply. But this then means that prices fall when supply returns. So why decrease sales now and increase them later just because of a supply problem?

No data to make such a normalized fit? Yes, you touched it. We live in an age where we only trust objective digital data. No subjective analog justification allowed. So non-artificial intelligence produces silly results that are reported and taken as gospel. Worse, we are faced with simplistic and serious rules (no thinking necessary). A good example is this negative two-quarter GDP recession signal.

The bottom line: So what should we do?

Unfortunately, that means we have to do the heavy lifting. Either that or hunt the others doing the work. It is a difficult time for investors to find reliable information and in-depth analysis. No wonder so many people rely on index funds.