Johnson: Don't Underestimate Inflation

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here with Bob Johnson, he's our director of economic analysis. He thinks investors are underestimating the potential of inflation. We're going to dig into that a little bit more.

Bob, thanks for joining me.

Bob Johnson: It's great to be here today.

Glaser: Let's look at the inflation numbers that just came out this week. There didn't seem to be anything that was that out of line. Why do you think that we're kind of underestimating the threat of inflation here?

Johnson: Absolutely. I mean, we did get the numbers this week, and it showed the headline number, that's the all-in number, if you will, came in at 0.3% month to month. That annualizes to 3.6%, and that's a pretty nasty number. Yes, people were expecting a relatively high number based on gasoline prices and a few things that were known in advance. Nevertheless, that's a pretty high number for a headline number, especially if you remember that the new Social Security checks with the new amounts went out and they had 0.3% for the whole year in there. And so here we got inflation of that much in a single month. So clearly those people on Social Security are disadvantaged when you look at the headline CPI numbers.

Now even the core was about 0.2%, which annualizes to 2.4%. That's not all that far from where it's been. The core has held in very steady over the last year kind of in that 2.2%, 2.3% range, and our thought is that number is going to creep up a little bit this year with some of the labor shortages to something that's more like 2.4%. So, that number will be higher, but the scary thing is now, this year energy prices will likely be up from a year ago because of the big dip we had at the beginning of last year. And it's not happening again this year by the way, at least in January. So, that would seem to indicate that the headline inflation number would be even higher than that. We could be up in 2.5%, 2.6% range. And the only thing that's keeping that from being worse is that food prices are continuing down.

Glaser: Where does that leave the Fed, then, if they are looking at numbers like this and the potential for that headline number, that core number, to keep moving up? Do you think they are going to act more aggressively? Do they think they are out in front of this?

Johnson: Again, in terms of the Fed and inflation, I mean that's clearly one of the things that they are supposed to be watching. And certainly one of the things has been that their preferred measure of inflation is a little bit different than the CPI. And that one's still kind of relatively near 2-ish. But the real CPI--what people are paying--is running a little higher than that, and I think that's got to scare them a little bit. I think they may be forced to act. And certainly if food prices crept up or we had anything dislocate in the oil industry--which isn't my first bet by the way, but I think food could be an issue that surprises people--then they could have a real issue on their hands in terms of headline inflation, and I think they would probably be forced to act.

Glaser: We got a few other pieces of data this week including industrial production. This has kind of been bouncing around and it's been doing so for some time. Are there any prospects of improvement in the industrial space?

Johnson: Yes. Just so everybody doesn't get confused, the headline number probably looked pretty good--people are going, what is he saying? It was up 0.8% if you read headline industrial production this month. But most of that all had to do with a big bounceback in energy: Recall November it was unusually warm, and we had really poor numbers from the utility sector, and this month was just the reverse of that.

Now, I always like to look at the numbers just with manufacturing, no mining in there, no utilities in there, it's about 70%, 75% of index. It's what we really think of as industrial production. And those numbers didn't look good at all. I mean we were up maybe 0.2% month to month. At least it didn't go down I suppose. But the year-over-year three-month moving average that we like to use--for the last six, seven months that number's maybe gone from minus 0.2% to close to plus 0.2%. Hardly anything to get very excited about in terms of industrial production. We keep on saying things have bottomed, and we will take some credit for being right on that. But unfortunately, it hasn't been by very much, I mean it's moving up glacially. Certainly, one of my big disappointments has been, as you know, I just want to hope that one of these sentiment indicators turns out to be a good leader. And certainly, we have seen big takeoff in purchasing manager surveys where people, the outlook in the months ahead, and certainly when we look at that data it's been exceptionally bullish in tone, and it just didn't turn up in this month's industrial production numbers.

Glaser: Speaking of that sentiment data, builder sentiment, homebuilder sentiment, was out as well. That actually came down a little bit from the postelection high.

Johnson: It did. That was one of the numbers that rallied big-time after Trump's election, and that was one that kind of surprised us, how well it did. I mean, it was the best number of the year by quite a bit. And I think this number that we got this month, the 67 is the second-best number of the month. But it is down--it just shows that maybe some of that sentiment momentum, people are stepping back and saying, well maybe it's good but maybe not that good. I certainly don't think it's in a massive term yet. But I certainly think that everybody is beginning to question a little bit, and you are seeing in the stock market even, about exactly what's going to happen. People are now not going just off a bit of a hope they are starting to say OK, show me the money, so to speak.

Glaser: Bob, as always thanks for being here.

Johnson: Great to be here today.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.