A Shocking Set of Inflation Statistics...
By Tom Dyson
October 15, 2007
Steve Leuthold is one of my favorite investment analysts...
I discovered Leuthold a few years ago through his book, The Myths of Inflation. He published it in 1980. We had an old copy on our bookshelf. It used to belong to a public library. It still has the stamped checkout card inside the front cover. It's out of print now. I don't think it was ever a popular book, because secondhand copies are very hard to come by.
The book made a big impression on me. When Leuthold wrote it, interest rates in the U.S. were above 15%, and the public was busy preparing itself for a huge Zimbabwe-style inflationary spiral. Yet Leuthold's book predicted inflation would collapse and interest rates would return to 5%. This idea would have sounded preposterous at the time and might explain why the book didn't sell more copies.
Anyway, Leuthold has been around the markets for five decades, managing money and publishing some of the best stock research in the world. Today, I received the latest piece of research from his team. It includes this comment about inflation...
"Inflation is just about everywhere... at least, outside of the reported inflation numbers."
Since 2002, inflation has averaged 2.8% and has never climbed above 4.7%. That's according to official statistics. Leuthold argues the official statistics are "badly misleading" and inflation is much higher than most people realize.
My own research confirms this. Over the years, I've asked hundreds of people what they thought about inflation... from economists at Goldman Sachs to my own family members. I've found the public at large pays no attention to inflation. Most businesspeople take the official statistics at face value. Almost no one is worried about inflation.
Leuthold has his own way of measuring inflation. He calls this indicator the "Diffusion Index."
To calculate his Diffusion Index, Leuthold notes the prices of 70 different commodities every week. Then, he checks how the prices of these commodities changed over the previous 52 weeks. He takes an average of the results. For example, a 10% Diffusion Index reading in October 2007 means that the prices of the 70 commodities are up on average 10% since October 2006. A 50% Diffusion Index reading means the commodities are up an average of 50%. Now here's the shocker:
Right now, Leuthold's Diffusion Index has passed 90% for the third time this year.
Leuthold adds that gold, oil, and nonenergy commodities are all leading indicators of inflation. They have all broken out to new highs this month. Gold is up $90 an ounce since the Fed's surprise rate cut four weeks ago.
Next, Leuthold looks at the "industrial capacity utilization rate." The idea is, when an economy is running at maximum capacity, supply cannot increase, so prices have to rise to find a new equilibrium between buyers and sellers. The old rule of thumb says a capacity utilization rate greater than 82 signals inflation. Right now, it's at 82.5.
Finally, Leuthold follows wage inflation. Wages have risen at 4% over the past year. By the time higher prices start inflating wages, it's difficult to stop the train.
In sum, Leuthold thinks inflation is much stronger than the official numbers report. He doesn't know when the official numbers will reflect the true situation, and he doesn't care. It's creating an opportunity. All you have to do, he says, is buy the sectors that are already inflating. And that's energy and materials. In the 1970s, these sectors rose 373% and 181%, respectively. In the current cycle, energy and materials have risen 236% and 138% so far.
"The best approach to the stock market," concludes Leuthold's report, "has been to forget all about the Fed and the core CPI and to own the traditional inflation-sensitive stock groups. Your Dad's late 1970s stock portfolio probably would have been perfect..."
This is the opposite advice he gave in his book many years ago... and I expect it will prove to be just as accurate.
Good investing,
Tom
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