Bob’s Journal for July 27, 2023

Producer Prices Near Deflationary Levels, Consumer Price Inflation Remains High

Producer prices increases have slowed to almost 0% while consumer price increases remain high.

The Producer Price Index (PPI) for June increased only 0.1% after declining 0.4% in May. Over 12 months, the PPI increased only 0.1%.

The core PPI, which excludes food and energy, increased 0.1% in both June and May, and rose 2.4% over 12 months.

The Consumer Price Index (CPI) increased 0.2% in June and 0.1% in May. But it is up 3.0% over 12 months. The core CPI increased 0.2% in June and 0.4% in May. The core CPI’s 12-month increase is 4.8%.

The gap between the PPI and the CPI has been at historic levels for months. The current version of the PPI was initiated in 2011, and this is the largest gap since that inception.

I think a major reason for the gap is that prices for commodities and raw materials increased significantly during the pandemic because of supply chain issues and production bottlenecks.

Many of those issues are resolved, or businesses found substitutes or made other adjustments. With those changes, the increases in the PPI plummeted. The sharp drop in commodity prices over the last year is one example.

But the CPI has other influences.

The PPI tracks primarily the prices of goods with some services included. The CPI tracks a broad basket of goods and services. Prices of relatively few raw goods and commodities are in the CPI. Services are a high portion of the CPI and finished goods also are a significant share.

Demand for consumer goods and services persists at fairly high levels. The labor market is strong, keeping wage increases above the multi-decade average.

These and other factors keep a floor under the CPI even after the historic tightening the Fed engaged in during 2022.

The gap between the PPI and CPI helps profit margins at many businesses. While the businesses are paying higher wages, the prices of their other inputs aren’t increasing as rapidly as before. Also, strong consumer demand allows many firms to maintain or increase prices.

The Hidden Benefit of Annuities

Annuities have several advantages, but many people aren’t aware of a key one. That benefit greatly improves the performance of a retirement portfolio.

I’m talking about annuities that pay guaranteed lifetime income. These are the single premium immediate annuity (SPIA) and deferred income annuity (DIA), also known as a longevity annuity.

Of course, guaranteed lifetime income is a major benefit of these annuities. There are other ways to deploy retirement funds that might generate higher lifetime income or allow one to leave a larger legacy. But those results aren’t guaranteed. The money could run out or be substantially less than anticipated.

The cash flow from the annuity also is uncorrelated with the investment markets. The income continues to appear in your financial account regardless of what’s happening in the markets.

The biggest benefit is one you can’t find anywhere else and that most people don’t know about. It uses something known as mortality credits.

Mortality credits are why a SPIA or DIA will pay higher guaranteed income than a bond or other safe income investment.

An insurance company sells annuities to a large number of people. One factor it uses to determine the amount of income to pay is the average life expectancy of the group.

About half the people will pass away before the average life expectancy. Those people will receive less lifetime income than expected at the time they purchased the annuities.

When the insurer calculates the income it will pay each annuity owner, it doesn’t assume it will keep the extra money from those who pass before life expectancy. Instead, the insurer knows this will happen and plans to pay that money to the other annuity owners.

This extra money is known as mortality credits, and it enables the insurer to promise to pay its annuity owners more than it would be able to pay from investment returns alone.

Mortality credits are a feature of any annuity that pays lifetime guaranteed income, including some versions of fixed indexed annuities and variable annuities.

Mortality credits are one reason SPIAs and DIAs are better than bonds for the conservative portion of most retirement portfolios. They also are why surveys indicate retirees with annuities generally spend more in retirement, and spend with more confidence, than many other retirees.

Fraud Victims Owe Taxes on IRA Withdrawals

A recent tax case is one of the saddest ever and shows how the tax law often has intended consequences.

The taxpayers were a married couple who inherited a business from the husband’s brother. After couple of years, the husband discovered the business manager was stealing. He fired the manager and put his stepdaughter, his wife’s daughter, in charge.

After a couple more years, the husband closed the business and gave all the assets to his stepdaughter, allowing her to run the business as she pleased.

A few months later, the stepdaughter said the previous manager and other employees had used her stepfather’s personal information and merchant credit card account to defraud customers and employees. She said the credit card processors were holding her stepfather liable and would have him put in jail if he didn’t make restitution.

The scheme becomes detailed and elaborate from there. There was no fraud perpetrated on the previous customers or suppliers. The stepdaughter defrauded her stepfather and mother by creating fake documents purporting to list the charges against the stepfather. She also produced fake settlement agreements between the stepfather and the card processors.

The stepdaughter convinced her stepfather to let her handle all the negotiations and transactions. He never met with representatives from the card processors or even the man who the stepdaughter said was the attorney she hired for him.

Over time, the couple gave the stepdaughter millions of dollars, including distributions from the IRAs of her mother and stepfather, purportedly to settle the claims.

The couple paid income taxes as they took distributions from their IRAs.

Eventually, the couple discovered the only fraud perpetrated was by the stepdaughter on them. She eventually was prosecuted and sent to prison.

Historically, the couple would have been able to claim a theft loss deduction and recover most of the taxes paid. But Congress suspended the theft loss deduction for the years 2018-2025.

Instead, after learning of the fraud the couple filed an amended tax return claiming a refund for the taxes paid on the IRA distributions. They argued that the distributions either shouldn’t be included in gross income because of the fraud or that the amount they transferred to the stepdaughter should be deducted from the income as businesses expenses.

The court ruled that though the taxpayers didn’t enjoy the benefits of the IRA distributions, they had to include the amounts in gross income. If the stepdaughter had fraudulently directed the IRA custodian to make stock sales and distributions from the IRA without the couple’s consent, the couple might not have been taxable on the distributions.

But the couple had full control over the accounts and put in the orders for the distributions. They also voluntarily gave the distributions to the stepdaughter. So, they had to include the distributions in gross income.

Also, though the couple believed the money was being used to pay business-related expenses, it wasn’t actually used that way. Because the money wasn’t used to pay business expenses or for legal fees associated with a business, the amounts weren’t deductible as business expenses.

(Gomas v. United States, U.S. District Court for the Middle District of Florida, Case No. 8:22-CV-01271, July 17, 2023)

The Data

The Consumer Confidence Index from The Conference Board increased to 117 in July from 110.1 in June. That’s the highest level since July 2021.

The Conference Board said confidence increased in all age groups and income levels. Even so, 70.6% of consumers said a recession was either somewhat or very likely in the next 12 months.

The Leading Economic Indicators Index from The Conference Board declined by 0.7% in June, following a 0.6% decline in May. The index is down 4.2% over six months.

The index has been declining for 15 months which, according to The Conference Board, indicates the economy is likely to be in a recession in late 2023 or early 2024.

The economy was growing in the first half of July but at a slower rate than at the end of June, according to the PMI Flash Indexes.

The PMI Flash Manufacturing Index improved to 49 in mid-July from 46.3 in June. Since the mid-July number was below 50, that indicates manufacturing still was contracting.

The PMI Flash Services Index declined to 52.2 in the first half of July from 54.4 at the end of June.

The PMI Flash Composite Index for the economy declined to 52 during mid-July from 53.2 at the end of June.

Existing home sales declined 3.3% in June after increasing 0.2% in May. The number of existing homes sold in June was the lowest in five months.

Sales fell primarily because there weren’t enough homes for sale. That also explains why the median sales price of existing homes in June increased to $410,200, the second-highest level since the data has been kept, despite the low level of sales. The record median sales price is $414,000, set in June 2022.

New home sales declined 2.5% in June after increasing 6.6% in May. The number of new homes sold in May was a 15-month high. Sales in the South and Northeast increased in June while sales declined in the West and Midwest.

The median price of a new home sold in June was $415,400, down from $432,700 12 months earlier. The average price of a new home sold in June was $494,700, compared to $472,000 12 months ago.

The S&P Corelogic Case-Shiller Home Price Index increased 1.5% in May after increasing 1.7% in April. The index has risen four consecutive months.

Despite the recent increases, over 12 months the index was down 1.7% at the end of May, the same as of the end of April.

That 1.7% decline over 12 months, as of the end of April 2023, was the largest since April 2012.

The FHFA House Price Index increased 0.7% in May, the same as in April. Over 12 months, the index is up 2.8% as of May, which compares to 3.1% as of the end of April.

The Philadelphia Fed Manufacturing Index increased slightly to negative 13.5 in July from negative 13.7 in June. The survey did indicate that most businesses expect conditions to improve in the next six months.

The Richmond Fed Manufacturing Index fell to negative 9 in July from negative 8 in June.

New unemployment claims decreased by 9,000 to 228,000 in the latest week. That’s the lowest level of new claims in two months.

Continuing claims, which lag a week behind new claims, increased to 1.754 million from 1.721 million. That is the largest increase in three months.

The Markets

The S&P 500 rose 0.28% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 1.43%. The Russell 2000 lost 0.54%. The All-Country World Index (excluding U.S. stocks) added 0.26%. Emerging market equities advanced 1.10%.

Long-term treasuries lost 0.62% for the week. Investment-grade bonds fell 0.21%. Treasury Inflation-Protected Securities (TIPS) added 0.18%. High-yield bonds decreased 0.34%.

On the currency front, the U.S. dollar advanced 1.52%.

Energy-based commodities increased 4.45%. Broader-based commodities rose 3.99%. Gold declined 0.64%.

Bob’s News & Updates

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I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.

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