Seriously, WTFlation?!?!
Financial market pundits are throwing around all sorts of “flationary” terms of late. Some of these terms have meanings that are mostly understood by the average reader and others are certainly more obscure and confusing.
One thing each of the terms has in common is that it’s usually followed by an assumed “conclusion.”
You know, something like this: “Hey you guys, obviously inflation is coming. Buy gold!”
I’m not here to put anybody down or contradict any of the assumed conclusions. I just want to clear up what each of the terms mean and, more importantly, have a look at the underlying processes and mechanisms that most pundits are referencing when they use these terms.
To me, it’s more useful to think in terms of processes and mechanisms and how each lever can push macro conditions to favor certain outcomes.
For some of you this will be a simple review. Fear not, I’ll keep it brief when touching on each term and try to illustrate some important perspectives to think from when we hear the words in investing related discourse.
The Flavors of Flation
Inflation
I think this term is, at least superficially, fairly well understood.
Inflation is a continuous upward movement in the general price level of “things.”
Most often when someone is using the term inflation he/she is referring to CPI – Consumer Price Index – which is “the general price level” of a specific basket of basic goods.
Some key points to keep in mind.
- That basket of goods has a rotating list of contents and can be manipulated to optically influence CPI.
- Just because there isn’t inflation with respect to the CPI basket of goods that doesn’t mean there will not be inflation in other goods and assets.
I mean, just take a look at the inflation in financial assets over the last year for example. Since we’re focused on investing here it’s definitely something to keep in mind.
The mechanisms at play are always supply and demand.
Inflation for a particular good, asset or service occurs when the demand versus supply ratio increases.
It can also occur when money supply increases and there is then more money chasing a constant or shrinking amount of that good. Just imagine we magically increased the bank balance of everyone in the world by 100x – do you think the price of a hamburger would remain the same?
Deflation
Ok, let’s keep this short. This is just the opposite of inflation and thus the mechanisms and processes are inverted.
Deflation is a decrease in the general price level of goods.
Obscured in this definition we again have some competing mechanisms however. Just like with inflation, deflation can occur in some goods and/or assets while being absent in others.
Technology and automation are good examples to keep in mind with regard to this. If automation can vastly increase the quantity of production of a good while simultaneously driving down the cost of production we should see a deflationary effect.
We saw this with the industrial revolution and again with the technology boom. Mass production, assembly lines and automation are all deflationary forces when applied to a good.
Deflation also happens to the price of a good when demand for it falls.
Widespread deflation is generally bad for the stock market.
Disinflation
Pretty useless term in my opinion.
Disinflation is the term used to describe a slowing rate of inflation. Just remember that it isn’t the same as deflation. Let’s go ahead and move on.
Reflation
There’s something different about this term. It describes a monetary policy as opposed to an effect.
Reflation is a fiscal or monetary policy designed to expand a nation’s output and diminish the effects of deflation.
Some reflationary policies include lowering interest rates, printing money and lowering taxes. These policies get more money into the economy and reduce its friction when changing hands, thus encouraging exchange of value among participants.
Stagflation
I’ll admit I didn’t know this term a few years ago and had to look it up. It turns out to be a pretty useful concept to keep in mind as it describes a precarious scenario that investors in particular should be aware of.
Stagflation occurs when prices are rising (A.K.A. Inflation) while the economy is simultaneously suffering – meaning there is relatively high unemployment and/or slow economic growth.
This is pretty bad for obvious reasons. Stuff costs more but there currently aren’t jobs (high unemployment) nor even jobs on the horizon (little to no economic growth) to pay people wages to afford the higher prices.
The canonical example of this is from the 1970’s when global oil prices soared. This forced price increases in developed countries that depended on oil for energy and to produce and transport goods. Since oil was imported this oil price increase not only forced general prices up, it also slowed production and transportation of goods as fewer people could afford to buy them (decreased demand due to external forces.) This kind of effect is recursive, or self-perpetuating.
Ok. There you have it. Those are the Flation terms presented, hopefully, in a digestible and useful way.
Putting Your Knowledge to Work
I didn’t sit down today prepared to write about any particular examples. But that doesn’t mean there aren’t any immediate take-aways.
We’re all well aware of the money printing that has taken place over the last year.There are 3 ways to “resolve” that issuance or debt.
- Inflate it away. Make it so that the cost of a hamburger today increases in the same proportion as the amount of new money printed compares to the old money supply.
- Grow our way out of it. Make it so that our economy justifies the new wealth creation by actually creating value for society accordingly.
- Default and let the house of cards collapse.
Government preferences are going to look something like this:
2 >>>> 1 >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>3
Investing is about anticipation, or predictions about the future. Like it or not, the government is a major player in the financial markets – and in a number of ways. Not only do they intervene when necessary they also set policy, like taxes, to incentivize both businesses and individuals to stimulate the economy toward growth.
If we can anticipate the general moves the biggest player in the game is going to make we can position our portfolios well.
I think it’s reasonable to plan as though there will be a (government incentivized) push toward growth and employment followed by an easing into a period of inflation that can be supported by that growth. At least optically that’s how it’s going to appear in the medium term.
In which industries are governments going to make the biggest push to stimulate the economy and create jobs? Surely the ESG sector is going to get a good push. What else?
Commodities and technology used in the production and transportation of stimulated industries is also a good place to look.
Right now there are small, microcap companies well positioned to ride this wave of change and stimulus out of the penny stock realm and enrich both society and investors.
What are you looking at in the microcap space?
