10.24.2022
History has shown inflationary regimes tend to last for years. How have commodities performed during these regimes, and what does it tell us about profiting in the future? Read on to find out…
THE BIG PICTURE
Earlier this month, October of 2022, I read an article by David Schassler (DS) of VanEck. It’s title, Think Inflation’s Ending? Think Again, caught my attention. DS argues "…the market remains overly optimistic about the return to 2% inflation by 2024. Previous inflationary regimes suggest this may not be realistic.” A few paragraphs later DS continues, “Once inflation breached 5%, it took, on average, 18 years to fall to 2% or lower!” His research is based on G10 countries with data going back to 1960. His estimate for the United States is 12 years on average.
This statistic is startling. Inflationary regimes have lasted, according to DS, 12 years on average in the United States. The idea of trust but verify comes to mind. Let’s take a look for ourselves.
THE CPI DATA
The Consumer Price Index (CPI) data, a common measure of the change of prices paid by consumers for a basket of goods and services, has a rather bumpy history. Originally published in 1919 but estimated back to 1913, the CPI’s calculation has been revised many times including 1940, 1953, 1964, 1978, 1987, 1988, and 2018 - to mention a few. You can read about those changes here.
When endeavoring to investigate the CPI, all of the charting services I use only has data going back to 1947. That excludes 34 years of history dnd almost 2 of the 4 20th century inflationary regimes. We were able to find the numbers going back to 1913 here. We worked with the data, which is not seasonally adjusted, to format it and then import it into Optuma for further analysis.
The chart below shows the Year-over-Year (YoY) change in CPI going back to its inception in 1913. To have a better look at the conditions mentioned above by DS in his VanEck article, we have added a script which highlights the series in orange. The highlighting begins when the YoY CPI breaches 5% to the upside, and it remains highlighted until the YoY CPI falls back down to 2%. The chart reveals 4 major inflationary regimes during the 20th century.
Year-over-Year Change In CPI. Click to enlarge.
Next is a table which details the duration of these inflationary regimes. Our calculation matches DS’s calculation of 12 years as the average duration of these inflationary regimes. The median duration was 13 years. The minimum duration was 5 years. The maximum duration was 18 years.
Duration of Inflationary Regimes. Click to enlarge.
DS then goes on to write about the inflationary waves of the 1940s and 1970s, “Both [of] these events demonstrated that inflation is, typically, neither a linear nor an isolated event. Inflation is expected to come in waves with several different peaks and troughs.”
Grouping inflation into 4 regimes, as we have done above, smooths away the inflationary waves DS describes. The next table ungroups the 4 regimes to detail each constituent wave. The quantification is still the duration of each wave from the time it breaches 5% to the upside until it subsides back to 2%.
Detailed Duration of Inflationary Regimes. Click to enlarge.
Looking at the waves of inflation this way turns the 12 year average regime into more discrete 4 year waves. The median wave was 3 years. The minimum wave was less than 1 year. The maximum wave was 17 years.
The whole point of DS’s article in his own words is this, “Investors should brace themselves for an extended period of rising and falling inflation, with a mean level significantly above the Fed’s 2% target. Real assets are a time–tested inflation hedge, so if you haven't already, you may want to consider them.” Again, we want to trust but verify.
ENTER MARTIN PRING...
The main way we can judge if “real assets are ... time-tested inflation hedge[s],” is by finding a data series of real assets which goes back far enough to analyze its performance during the 4 inflationary regimes. For that, we can turn to the CRB, The Thomson Reuters Commodity Index. The CRB, purchased by Refinitiv some time after 2018, is an index that holds futures contracts on 19 commodities. Its weightings change through time, though as of October 2022 it holds roughly:
39% in energy
7% in precious metals
13% in base metals
34% in agriculture
and 7% in livestock.
Once again, my charting services had limited data. One went back to 1956 and the other to 1995. To be fair, the CRB was created in 1955. Either way, that left us us missing 40 years' worth of data spanning the first two inflationary regimes of the 20th century entirely. However, once in a while we get very lucky. One of the brightest spots in my network of fellow technicians is the inimitable Martin Pring.
Martin was generous enough to share his personal CRB data going back to the 1800s! That is one of the things that makes him incredible. His truly long-term data allows us to understand the larger cycles at work. This in turn helps us contextualize the present. His long-term data also helps to overcome our recency and availability biases.
I highly recommend you sign up for his monthly Intermarket Review at Pring.com, and his books are must-reads for anybody interested in technical analysis and financial market history. You can also sign up to Stockharts.com to read his members only blog posts.
Please accept a big thank you for all you have done, continue to do, and will do in the future. Thank you for sharing your data with us Martin.
While the CRB Index itself only dates back to 1955, Martin overcomes this by splicing it together with U.S. Wholesale Prices to create a longer dataset that represents the performance of commodities, or real assets, further back through time. This is a big deal, and I am very grateful for him. Now we can learn together.
The next chart shows us Martin’s Spliced CRB Index data going back to the 1890s!
CRB Index & CPI. Monthly. Click to enlarge.
We can see that the CRB Index has performed well during inflationary regimes, though price did go sideways from 1989 to 1997 during the 4th inflationary regime. Looking to the rightmost section of this chart, it looks as though we might have begun the first inflationary regime of the 21st century. If we have, based on historical precedent, there is roughly a 75% chance of commodities continuing to rise until inflation falls closer to 2% and stays there.
The next chart also features Martin’s CRB data. This time, the CRB data is adjusted using the CPI to illustrate the real, that is inflation adjusted, returns for the CRB.
Inflation Adjusted CRB Index & CPI. Monthly. Click to enlarge.
Unfortunately, there is no denying the fact that this data series is less encouraging than the the nominal which was not adjusted for the effects of inflation. The real price of commodities has actually fallen during 3 of the 4 inflationary regimes. That said, there were certainly some incredible waves to ride as the inflation ebbed and flowed through each larger regime.
THE CONCLUSION
The first chart above shows the 4 major inflationary regimes of the 20th century. It also shows us today’s inflation, which looks significant. While it is not a 100% certainty, each previous time inflation has risen to the current levels, inflation has remained in an inflationary regime for many years to come. Each regime lasted 12 years on average, with a more granular look revealing waves of 4 years on average.
As shown on the second chart, on a nominal basis, not adjusted for inflation, the CRB Index rose sharply during the first 3 inflationary regimes of the 20th century. The third chart reveals the CRB's real returns. It shows that inflation ate away at the CRB’s gains during 3 of the 4 regimes, except for the 2nd one from 1934 to 1952, using a buy-and-hold strategy.
Here again is DS of VanEck, “Investors should brace themselves for an extended period of rising and falling inflation, with a mean level significantly above the Fed’s 2% target. Real assets are a time–tested inflation hedge, so if you haven't already, you may want to consider them.”
What can we conclude about his quote having looked at the data ourselves?
It is impossible to extrapolate any statistically significant probabilities from the data. We only have four occurrences and, while human nature does not change, the economy has certainly changed since World War II ended in 1945.
That said, as prepared market participants, we must have plans to deal with all of the possible scenarios which might unfold. For now, it seems likely that the base case should be to expect persistent inflation in the years ahead, appearing in waves with peaks and troughs. While we are almost 1.5 years into our current inflationary cycle, history shows that this is not likely the end of the larger inflationary regime. We do have one a caveat regarding the second part of DS's conclusion about real assets. We have seen for ourselves by looking at the CRB’s historical real returns, a buy-and-hold strategy using an average of commodities is more likely to lose real value than not. This has been true during the last 3 of 4 sustained inflationary regimes.
WHAT'S NEXT?
It is our belief that active portfolio management, specifically the relentless drive towards relative strength coupled with disciplined risk management, will be vital to profiting from the likely inflationary period ahead. This is why, with great excitement, we are formally announcing ahead of November first, we will begin to publish and maintain a portfolio of ETFs which benefit from inflation for our readers. The portfolio's objective will be to consistently outperform the DBC ETF, which will serve as our benchmark. Stay tuned.
As always, thank you for reading. Please reach out with any feedback or comments. I would love to know if you agree, disagree, or don't care at all. Louis@eastcoastcharts.com
This article is for educational, informational, and entertainment purposes only. Trade at your own risk. The author may or may not have a position in the securities mentioned. Read our full disclaimer here.
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