Bob’s Journal for 8/3/22
How Inflation Distorts Data
In times of elevated inflation, we need to be careful when examining economic and financial data.
Inflation distorts a lot of numbers, including gross domestic product (GDP) and corporate earnings. It is important to look at the real changes after adjusting for inflation and also consider the time period involved and how inflation changed over that period.
Consider last week’s GDP report. The nominal growth rate looks very good. In the second quarter, the GDP increased at an annualized rate of 6.28%. But a lot of that growth was puffed up by inflation.
Prices were much higher than a year earlier, so nominal GDP would be higher without much economic growth. When inflation is elevated, we can be in a recession though nominal GDP growth is positive.
It is better to look at real GDP, the focus of many reports. But even real GDP can be distorted.
Most reports touted second-quarter GDP as strong because the data said real GDP grew at an annualized rate of about 2.4%. But real growth from the first quarter to the second quarter was only about 0.60%. The real quarterly growth rate was 0.80% in the third quarter of 2022, 0.64% in the fourth quarter of 2022 and 0.50% in the first quarter of 2023.
For the last 18 months, real GDP growth from quarter to quarter has been low. The 12-month growth rate of 2.4% in the second quarter of 2023 looks decent primarily because real growth in 2022 was very low and was negative in the second quarter of 2022.
It is also important to factor in inflation when looking at corporate earnings. Higher selling prices can give a business higher revenue and earnings though its business really is declining. It becomes important to look at metrics such as units sold, number of employees and revenue adjusted for inflation.
Some companies in their earnings reports or on their calls will candidly say revenue was up because they were able to raise prices, but units sold were down.
Inflation also should be considered when looking at wages. For much of 2020 and 2021, wages were rising rapidly but were increasing at less than the rate of inflation.
But for most of 2022 and 2023, compensation has increased at a faster rate than inflation, providing real increases in income for many workers.
When compensation increases are broken down by income levels, those at the lower end of the compensation scale are seeing real after-inflation wage increases while upper-income workers are receiving increases that barely equal or are less than inflation.
One implication is that household spending is likely to remain strong as long as compensation increases at a rate equal to or exceeding inflation. That keeps a floor on inflation.
Another implication is that profit margins are likely to decrease unless businesses can raise their prices at least as much as compensation increases.
Beware Those “Studies found…” Reports
The media are filled with articles summarizing research recently published in academic and professional journals. Treat these articles with a healthy dose of skepticism, regardless of the topic.
One reason to be skeptical is that media reports often don’t highlight key details of the studies.
Most academic and professional studies include qualifications and cautions about the conclusions. Those statements are important but often are de-emphasized or excluded from media summaries.
Another reason to be skeptical is summaries often don’t assess the quality of a study. For example, a study that followed thousands of people over several years is more valuable than one that followed 50 people for a couple of months. Summaries often don’t report or downplay such details.
Other quality issues are whether the study was peer-reviewed before being published and how it was funded. Some studies have participants self-report their behavior and assume it is honest and accurate, while in others the researchers carefully monitor and control participant behavior.
But perhaps the most important reason to be skeptical of many studies is that an increasing number are fraudulent or dubious.
There’s a growing body of literature now on the number of studies that other researchers haven’t been able to duplicate. An essential element of good research is that others should be able to follow the same process and generate the same or similar results. Yet, reports are that in some fields about 80% of the results of published studies can’t be duplicated by others.
As a result, more and more studies are being retracted after questions were raised about different aspects of them.
The most recent high-level incident involved Harvard University professor Francesca Gino.
Ironically, Gino published four widely cited studies on honesty and rule-breaking that she parlayed into a consulting business on negotiations and other issues.
Last month, two of Gino’s papers were retracted. Previously, two others either were retracted or were alleged to contain falsified data. Harvard placed Gino on administrative leave.
I’d like to say this incident is an outlier, but it isn’t. It used to be that primarily social science studies had to be treated skeptically. But the fraud and questionable construction of studies also is occurring in what are sometimes called the hard sciences.
It is important to be cautious when reading an article that says “a recent study found…”
Uncashed Gifts Are Part of an Estate
A gift is only a gift when it is completed, according to the tax code.
In a recent case, an individual signed a power of attorney appointing his son as agent. Over seven years, the son used the power to make annual gifts from the father to family members.
In September of the eighth year, the father was assessed to be terminally ill. The son decided to accelerate the annual gifts and immediately wrote 11 checks from the father to family members totaling almost $500,000. The checks were mailed or personally delivered to the beneficiaries.
The father died within a week after the checks were written. Ten of the checks weren’t cashed or paid to the beneficiaries until after the father passed away.
The IRS determined that the value of those 10 checks should be included in the estate and subject to estate tax.
The Tax Court and a federal appeals court agreed.
A gift isn’t made until it is complete. When a gift is made by check, it isn’t completed with delivery of the check. The donor may revoke the gift until the check is deposited or is cashed and clears the bank. The donor can stop payment at any point until then. That’s why the gift isn’t complete until the check has cleared the bank.
(Estate of William E. DeMuth Jr. v. Commissioner, No. 22-3032, 3rd Circuit)
The Data
The Fed’s preferred inflation measure, the Personal Consumption Expenditure (PCE) Price Index, rose 0.2% in June following a 0.1% increase in May.
Over 12 months, the PCE Price Index increased 3.0% as of the end of June, down from 3.8% as of the end of May.
The core PCE Price Index, which excludes food and gas, increased 0.2% in June after rising 0.3% in May.
The 12-month increase in the core PCE Price Index was 4.1% as of the end of June, compared to 4.6% as of the end of May.
The Employment Cost Index increased 1.0% in the second quarter after rising 1.2% in the first quarter. Over 12 months, compensation increased 4.5% through the second quarter after rising 4.8% through the first quarter.
Personal income increased 0.3% in June, following a 0.5% rise in May. Wages and salaries increased 0.6% in June but income from assets declined 0.2%.
Personal spending jumped 0.5% in June, an improvement from 0.2% in May.
The Consumer Sentiment Index from the University of Michigan was 71.6 at the end of July. That’s down from 72.6 at mid-month but above the 64.4 recorded at the end of June. July’s number is the highest end-of-month level since October 2021.
Real GDP grew at an annualized rate of 2.4% in the second quarter, according to the first estimate. The final estimate for the first quarter was 2.0%.
Nonresidential investment increased at a much faster rate in the second quarter. Consumer spending grew but at a slower rate than in the first quarter. Spending on services increased by 2.1% but spending on goods rose only 0.7%.
Durable goods orders increased by 4.7% in June after rising 2% in May.
But much of the June increase was in volatile transportation orders. Excluding transportation, durable goods orders climbed 0.6% in June.
Orders for nondefense goods, excluding aircraft, considered a good proxy for business investment, increased 0.2% in June after jumping 0.5% in May.
Pending home sales followed three consecutive months of declines with a 0.3% increase in June. Over 12 months, pending homes sales fell 15.6% as of June, an improvement from a slide of 22.1% as of May.
The ISM Manufacturing Index increased to 46.4 in July from 46 in June.
The PMI Manufacturing Index for July was 49, up from 46.3 in June.
The Kansas City Fed Manufacturing Index declined to negative 20 in July from negative 10 in June.
The Dallas Fed Manufacturing Index improved to negative 20 in July from negative 23.2 in June.
The private sector created 324,000 new jobs in July, according to the ADP Employment Report. In June, it created 455,000 new jobs. Leisure and hospitality firms continue to lead the way, adding 201,000 new workers in July.
Job openings in June declined by 34,000 to 9.582 million from May’s level, according to the JOLTS (Job Openings and Labor Turnover Survey) report. June’s level is the lowest since April 2021.
The number of people quitting jobs in June decreased by 295,000 from May to 3.772 million. The two-year low was set in April at 3.765 million. A decline in the number of people quitting jobs is considered a sign that people are less confident in their ability to find new or better jobs.
New unemployment claims declined by 7,000 to 221,000 in the latest week. That’s the lowest level in five months.
Continuing claims, which lag a week behind new claims, decreased to 1.690 million from 1.749 million, the lowest level since January.
The Markets
The S&P 500 rose 0.23% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.53%. The Russell 2000 increased 1.48%. The All-Country World Index (excluding U.S. stocks) lost 0.30%. Emerging market equities advanced 0.51%.
Long-term treasuries lost 2.72% for the week. Investment-grade bonds fell 0.83%. Treasury Inflation-Protected Securities (TIPS) dropped 0.88%. High-yield bonds declined 0.08%.
In the currency arena, the U.S. dollar rose 1.14%.
Energy-based commodities increased 0.84%. Broader-based commodities lost 1.54%. Gold declined 1.02%.
Bob’s News & Updates
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