Inflation For Idiots

In its 9/05 CPI report, the Bureau of Labor Statistics again
but still belatedly acknowledged the growing impact of rising
fuel costs on inflation. The whopping 1.2% increase in the
monthly CPI puts the yr/yr rate of inflation at 4.7%. Note
though, that the BLS is still fibbing about the "core" rate of
inflation which it posted as 2.0% yr/yr. ("Core" inflation
excludes the volatile foods and fuels components of the CPI).
Apparently, no one at BLS ever goes shopping, because if they
did, they would know prices are popping up like dandelions in
springtime.

The statistical scam here, I think, is to more fully load the
fuels prices into the CPI first, which they are doing, and then
to start loading the effects of the several year fuels price surge
into the core, with the hope that the worst of the price surge
in the food and fuels component is now behind us. Then, as the
"core" inflation rate rises, the Street can say, "look the
leading edge of inflation is simmering down."

Now, don't get all indignant, Presidents have been cooking the
economic statistics for years now. Johnson and Nixon were
heavy handed chefs. Clinton was by far the most earnest and
attentive fibber, and George W. is just in-your-face cynical.
Fed chairmen from Arthur Burns to Greenspan have been their
willing accomplices.

Some of the idiots out there are going to try to keep the old
scam going. Here's Morgan Stanley chief economist Steve Roach:
"Energy is being driven by a unique set of forces -- supply and
demand -- that are not bearing down on other goods and services."
Guess Steve does not go shopping either.

So, where does all of this leave us? Well, based on 4.7% inflation,
Fed Funds should be at 6.5%. Long Treasuries should be at 7.5%
and the p/e ratio for the S&P 500 should be 15.3X with an index
value of 1146. Interest rates are so low relative to these indicated
levels because rates are being priced off the low "core" rate readings.
Depositors are being ripped off and bondholders are surrendering
wealth after taxes on the income streams are figured in.

I am expecting fuels prices to ease because those markets should be
coming into better balance. I also expect the "core" inflation rate
to go up. For example, US produced auto prices have returned up to
ordinary retail from the employee discount levels. Moreover, the
BLS will have to start showing the effects of higher fuel costs
on all items or the fib will grow too large to correct without major
dislocation.

My best guess now is the CPI, measured yr/yr, will slowly drop back
into a range of 3-4%. From my perspective, that implies that interest
rates remain too low and that the current market p/e of 15.9x estimated
12 mo. operating earns. through 9/30/05 is reasonable.

Realistically, given the hanky panky with the inflation rate,
each player has to decide for himself or herself what a reasonable
inflation estimate is and factor that into his/her return
expectations for the capital markets.