Steak House Index (SHI) Update – October 12, 2016

The Steak House Index (SHI) Update – 10/5/16
October 5, 2016
This Just Got Real … and by “Real” I mean “Real Bad”
October 15, 2016

OK…we have a lot of ground to cover this week…as we’re updating both the SHI and the SHCI and I want to take a quick peek at inflation.   Something very interesting is happening with M2.   Ready?   Let’s jump in.

As always, if you need a refresher on the SHI, or its objective and methodology, I suggest you open and read the original BLOG: https://terryliebman.wordpress.com/2016/03/02/move-over-big-mac-index-here-comes-the-steak-house-index/)

And for another look at the SHCI, it’s purpose and construction, I suggest you read this blog, where we first rolled out the SHCI:  https://terryliebman.wordpress.com/2016/06/29/steak-house-index-update-62916/


Why You Should Care:  The US BEA publishes GDP figures the instant they’re available. Unfortunately, it is a trailing index. The data is old news; it’s a lagging indicator.  I’d sure like to know how the economy is doing in advance of the GDP release, wouldn’t you?

Personal consumption expenditures, or PCE, is the largest component of the GDP.  In fact, the majority of all GDP increases (or declines) usually result from consumer spending. Clearly this is an important metric to track.

It’s my hope the SHI can help.  I intend the SHI is to be predictive, anticipating where the economy is goingnot where it’s been.  Thereby giving us the ability to take action early.  Not when it’s too late.

And, of course, inflation – or its lack thereof – has been an off discussed topic, both of this BLOG and by FED commentary.   A meaningful move – in either direction – would have large implications for every American.  If we can be predictive here as well, we will be much better off.


Taking action:  Keep up with this weekly BLOG update.  If the index changes appreciably – either showing massive improvement or significant declines – indicating expanding economic strength or a potential recession, we’ll discuss possible actions at that time.


THE BLOG:   Alan Greenspan was interviewed earlier this month while attending the IMF and World Bank Annual Meeting in Washington DC.   Once again, he commented M2 is growing at an accelerating rate.  Interestingly enough, in spite of Dr. Greenspan’s prominence, wisdom and experience, no one seems to care.   Should we?   Let’s take a closer look.

For years now, inflation and inflation expectations have been almost dormant.   This notwithstanding the FEDs almost constant efforts to spur inflation back to the 2% annual ‘target’.

Yet, in reality, it’s not difficult for a country to create inflation:

hyper

Germany created hyperinflation when the country freely printed marks to pay off debts from WW1.   As we can see, creating inflation is easy – the problem is controlling inflation once created.  Germany’s economy was destroyed.

US inflation became untenable during the 1970s, the result of oil prices increases of about 10X by the end of the decade.  It took almost 20 or 25 years for the FED to put that genie back in the bottle.  Which is why central banks today treat inflation like the caged animal it is.    Too little (deflation) and consumption falls precipitously … too much (inflation) and price increases rage out of control.

Macro-economists would probably agree there are four primary triggers of price inflation within an economy:

  1. Commodity
  2. Wage/Labor
  3. Currency
  4. Money Supply

Someone once told me, “Everything we use came out of the earth or was grown on the earth.”  Essentially commodities.   Commodity price movement impact everything in our economy.

Bloomberg has a comprehensive commodities index.  Called the BCOM, Bloomberg tracks and ‘weighs’ prices of energy, grains, industrial metals, precious metals, ‘softs’, and livestock.   Here’s the most recent 5 year performance:

commodity

The BCOM peaked in 9/14 of 2012 at 152.   It bottomed on January 20th of this year at a reading of 72.87.  And now, we’re back at about 86.  An increase from the January bottom of about 19%.   Hmmm…it might be a bit too early to to definitively say it…but in the macro, commodity prices do appear to be firming.  They have a long way to go before reaching prior highs…but upward movement is clear.  Conclusion:  This may translate into higher production costs and, ultimately, price inflation.  We’ll have to keep our eye on this trend.

Labor shortages can cause wage inflation.  In spite of the low official unemployment rate – now 5% – we’re not seeing wage inflation.  This may change…but for now, there doesn’t seem to be much movement here.   In the FOMC minutes released today, the FED acknowledged the challenge:   “… it was noted that the unemployment rate and broader measures of unemployment had changed little since the beginning of the year.  Participants generally expected the unemployment rate to run somewhat below their estimates of its longer-run normal rate over the next couple of years, but they offered differing views about the extent of slack that currently remained in the labor market.”

A currency devaluation – against that of your trading partners – can trigger inflation.   The English pound is down about 18% against the USD since Brexit.   Meaning everything they import from the US just got about 18% more expensive.   The US has no such problem – for example, everything we import from the UK just got about 18% cheaper.   And the USD – if anything – continues to grow stronger against most major currencies.   This mechanism is actually deflationary.

Finally, an increase in money in circulation, known as M2, without a corresponding increase in GDP, can theoretically juice inflation.  Let me explain.

Imagine an economic system where the GDP equals 100 widgets.   And the supply of money is $60.   The ratio of money to GDP is 60%, and, effectively, each widget is worth 60 cents.   Now suppose the following year GDP doubles – to 200 widgets.  But the supply of money remains constant.   Now, $60 can buy 200 widgets, so each one is worth 30 cents.  That is massive deflation.  In this case, money supply fell to 30% of GDP.  Clearly, the opposite is true as well.

So, in theory anyway, it makes sense price stability within an economic system – neither deflationary or inflationary – is somewhat dependent on a consistent relationship between the money supply and nominal GDP.   And since 2011, this relationship has not been consistent.

Here’s a chart measuring M2 as a percentage of nominal GDP – for the last 57 years. The data range for the chart below begins in January of 1959.   It ends 226 quarters later on April of 2016.  This is an ‘index’ chart:  1/1/59 = 100.   The graph shows movement every quarter from that date:

m2

It’s easy to see the M2/GDP relationship was relatively stable between 1959 and 1988.   Then M2, as a percentage of GDP, fell.  In theory, this injects deflationary pressure into the system.

Today, the opposite is happening.  Take a look at the data since 2011:

m2-chart

It’s clear:  US money supply (M2) as a percentage of GDP has been increasing at an increasing rate.  What causes M2 to increase?   This is a bit more complex, but the FED does play a part in the ‘creation of money’ thru bank reserves.

Respected folks like Milton Friedman and Alan Greenspan have often opined events like those above are inherently inflationary.  Perhaps this was more true when the US financial system was more ‘closed’ … contained within our borders.   Today, global influences are far more pervasive.  Which might explain why in spite of a 20% increase of M2 against nominal GDP inflation has been invisible.

But this relationship is worth watching.  The change is large.  At question is whether it’s meaningful.  If the trend continues, it may, eventually, actually spur inflation.  To date, it appears impact appears to have been negligible.  I say ‘appears’ because we don’t know what would have transpired without this change.  In other words, might we have experienced deflation absent the M2/GDP growth rate?  We’ll never know … but it is an interesting question.

Rest assured, we’ll keep a close eye on this developing story.  (If you want to read some of the FEDs comments on this topic, click on this link:  https://www.federalreserve.gov/faqs/money_12845.htm)

OK … once again, my meanderings have made me hungry!   Yes, I see correlation and causation here!   Let’s jump over to the steakhouses.  Is Mastros still as popular as an oasis in the desert?   Is The Capital Grill still as unpopular as a leper at a nudist colony?

Yep, pretty much.   More of the same:   Mastros is fully booked (the first open table is 9:30) … TCG is completely available.   Ouch.

shi

This week the SHI is a negative (-2) – identical to the reading 2 weeks ago.   In fact, the only difference from last week is the 9:00 pm slot at Mastros and the 7:00 pm slot at Morton’s are not available this week.   Once again…very, very consistent.   Here’s the updated trend since inception:

shi-trend

Is the ‘Steak House Composite Index’ showing the same consistency? Let’s take a look … but first, a quick refresher:

The SHCI combines and weighs 3 components using consistent methodology:

  1. The SHI, as it taps directly into consumer spending, is weighted at 60%.
  2. The LMCI, our labor market health barometer, is weighted at 20%.
  3. The ’10/3 spread’ – a barometer of bond market confidence – will also be weighted at 20%.   (However, to ‘right size’ the value in relation to the SHI and the LMCI, we will multiply a positive reading by 10X and a negative reading by 20X.)

OK … let’s take a look at the treasury spread and the Labor Market Conditions Index:

  • UST 10 Year/3 Month ‘spread’:   The 10Y/3mo spread from 10/6 is 1.42% – up about 1/8% since last month.   This spread increase is indicative of continued economic growth.
  • Labor Market Conditions Index:  The most recent LMCI reading is September – and we’re seeing a decline from August.   Further, it’s interesting to note prior index readings have been adjusted – downward.   Not good.

Here is the chart from last month (blue) and a new chart for this month (green):

lmci

lmci

Hmmm … every month since April has been adjusted downward.   Here’s what the FED says about LMCI revisions:

“Users should take note that the entire history of the LMCI may revise each month. Three sources contribute to such revisions. The first source is new data that were not available at the time of the employment report. In particular, at the time of the Employment Situation report each month, the quit rate and hiring rate will be missing for the last two months of the sample because the Job Openings and Labor Turnover Survey is published with a longer lag than the model’s other indicators.  In subsequent months, as these data become available, the LMCI will revise.”

Finishing the math, today’s SHCI calculates to 7.68.   This is an improvement over last month’s reading of 6.56 … but not a meaningful change.  Thus, it appears all our index readings are quite consistent once again this month.  Remember:  This does not mean the US economy is recession-proof?   Recessions usually result from exogenous shocks to the system.

But not always.  Sometimes they’re insidious, developing slowly over time, without notice.  It’s signs of this type of recession we’re watching for.

Of course, as I’ve said numerous times in the past, no one indicator or metric can predict future economic performance.  Yes, not even the SHI.  But when viewed in the aggregate, the SHI – at least thus far – seems to be highly correlated with the direction of the economy at large.

The SHI and the SHCI once again suggest our economy is still chugging along, slow and steady.   🙂

  • Terry Liebman

1 Comment

  1. […] current, more accurate information becomes available.   You may recall from my October 12th blog (https://terryliebman.wordpress.com/2016/10/12/steak-house-index-shi-update-october-12-2016/) the June, August and September LMCI readings were […]