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Market's Inflationary Expectations


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Investors in the spring of 2016 could have gotten ahead of events by aligning their portfolios to “a world of lower expected capital market returns and higher forward volatility.” That, at any rate, was the upshot of a thoughtful analysis by Eric J. Wiegel of Global Focus Capital, a Boston based asset allocation advisor. Why does Wiegel think so? Because the market’s inflationary expectations are/were too low.
With the benefit of a year of hindsight ... was Wiegel right?
So far as I can tell ... no. In particular, the market's inflationary expectations as of the spring of 2016 for the following year were accurate, and following Wiegel's effort to outguess the market would nought have availed. There was no upsurge in inflation numbers in the months after Wiegel wrote, and in fact investors have since then benefitted by higher than expected capital market returns.

In the five months before and contemporaneous with Wiegel's article, the inflation rate (annualized, that is, multiplied by 12 in each case) was: 1.4, 1.0, 0.9, 1.1, and 1.0.

In the following five months, the inflation rate was: 1.0, 0.8, 1.1, 1.5. and 1.6. As you may already have noticed, there was a slow upward trend in that sequence, but it wasn't really anything out of line with market expectations as of the spring.  

Inflation continued to tick up until February of this year, when it hit 2.7, an altitude it hadn't seen for five years. But since then it has headed back down again: 2.4 in March and 2.2 in April. None of this qualifies as an inflation surge of the sort Wiegel seemed to have in mind. 

Volatility?  I've just quoted Wiegel's observation that IF there had been an inflation surge, "higher forward volatility" would result. It probably would have. But in fact, volatility is at a 23 year low.

None of this is to criticize Wiegel. Economic forecasting is a tricky business, and even the most careful and scholarly analysis can go wrong. Perhaps that is the take-away from this little reality check.

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