Inflation continues to be useless | USAEMALL.com

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CPI and the Fed 

The August CPI inflation report was very good news, just like the three reports that preceded it. Inflation is at the Fed’s target or very close to it, and there is no particular reason to worry about it picking up again. 

Awkwardly for Unhedged, this fact is not at all obvious when you look at the numbers the way we usually do. We like to look at the month-to-month change in core inflation and annualise it — the dark blue line in the chart below. That figure has now risen smartly for two months in a row. 

The culprit — and this is a story of wearying familiarity — is almost entirely housing inflation. Here is CPI shelter inflation, on the same basis: 

I’m not sure why the official measure of shelter costs is jumping. It has leapt historically, and then returned to trend — see the increases in January of this year and September of last year. What we do know is that the private measures of rent inflation show no signs of a resurgence whatsoever. Here are the national rent indices from the real estate sites Apartment List and Zillow:

Note that rent inflation is lower than it was pre-pandemic in both indices. In the case of Apartment List, rent inflation has been negative for many months. Without rehearsing the tiresome niceties of the methodology that contribute to the lag in timing, CPI shelter just has to fall eventually. 

As an aside, it is notable that Apartment List’s index is usually lower than Zillow’s, and that the difference has grown wider in the past couple of years. Chris Salviati of Apartment List told me the difference is not methodology. Instead, it’s likely differences in the samples. Apartment List over-indexes to large apartment complexes — and particularly those in the sunbelt. Those complexes are facing competition from a surge in new multifamily construction. The institutional owners of the complexes also respond to market shifts more quickly than non-institutional landlords; they have access to more data and are “likely to place different weights on rent maximisation versus vacancy risk compared to mom-and-pop landlords”. 

In any case, inflation is beaten. And it does not look set to stage a comeback. The US economy is cooling gently. Many global economies, notably China’s, are cooling non-gently. Commodity prices are falling. Corporations have largely stopped taking price increases, and in some areas are offering rebates. Wage growth is decelerating (and wages are historically closely linked to rents).

Which leads us to the Fed’s Open Market Committee and its decision, in a week’s time, of whether to reduce its policy rate by 25 or 50 basis points. The futures market cut the odds of a 50-point cut from 34 per cent to 15 per cent after Wednesday morning’s CPI report, according to the CME. As we have just argued, there was nothing in the report to justify this. In fact, the report was another confirmation that a big rate cut would create little risk of resurgent prices. 

The economy, as we have argued at length in this space, looks fine despite a cooling labour market. But with inflation risks off the table, why mess around? Rates are quite restrictive and don’t need to be. A big cut would, if nothing else, improve home affordability, which is awful. In isolation, a 50- point cut makes sense. 

The Fed does not work in isolation, though. Its reputation for steadiness and for caution in the face of inflation is its critical asset, not just in this cycle but cycles to come. That, rather than the state of the economy, is why the cut will be 25 basis points.  

Apple revisited

A few days ago we pointed out — and not for the first time — that Apple has outperformed its Big Tech peers (except Nvidia) in recent years, despite growing more slowly than they do. This is sort of surprising. The best explanation we have been able to come up with (and it’s not very good) is that Apple’s business is perceived as super stable. The market has concluded that once a customer enters Apple world, they never leave, and spend ever-growing amounts within it.

Several readers wrote that we missed the obvious factor: Apple’s gigantic stock buyback programme. The company has bought back $417bn in shares in the past five fiscal years. Alphabet, the next biggest repurchaser in tech, has bought back $220bn; Microsoft and Meta have both bought back about $120bn. Consequently, Apple’s share count has declined the most: 

Of course, buybacks do support share prices, all else equal, to the degree they increase per share financial performance. But the reduction in Apple’s share count has not been great enough to move it up the Big Tech growth rankings. In terms of growth in earnings per share and free cash flow per share, Apple significantly trails Alphabet, Meta and Microsoft.

So the idea has to be that Apple’s buyback programme keeps its share price high over and above the impact it has on financial fundamentals. That is: Apple spends the cash it generates attempting to manipulate (in a totally legal and transparent way) its own share price. And it works.

This might be true, but I can think of two somewhat vague reasons to doubt it. One of them is Berkshire Hathaway, which on FT estimates sold $50bn in Apple shares in the second quarter of this year. Apple spent $29bn on buybacks in the same quarter. The theory before us is that Apple is such a huge consistent buyer of its own shares that it causes the price of its shares to be higher than it would otherwise be. But in the second quarter there was a much bigger single seller. And what happened during the quarter? Apple’s shares went up 24 per cent. Yes, lots of other stuff could have been going on. But still.

The second point is vaguer still. Apple’s shares trade a lot. Over the past six months, average daily trading volume, according to Bloomberg, is about 79mn shares a day. For Meta, the figure is a bit more than 18mn shares a day. But Apple’s market capitalisation is not four times Meta’s; only about 2.5 times. So shouldn’t Meta, trying to (legally and transparently) manipulate a less liquid stock, get more bang for its buyback buck? On a very (very) rough calculation, Meta’s buyback amounts to about 1.5 per cent of daily trading volume, and Apple’s is about 2.5 per cent. That’s using long-term averages and I’m sure buyback programmes are executed unevenly, but the argument remains. Adjusting for liquidity, Apple’s buyback is not all that much bigger than its peers. Can it really explain Apple’s significant outperformance? I know there are traders out there who will have a view on this. If you are one of them, and you are not an algorithm, please email me.

One good read

On corporate life cycles.

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