At the Value Investor Conference this week, Kevin Gibson of Eastspring Investments discussed an amusing chart. It showed the path of corporate earnings over time, overlaid with analysts’ forecasts of said earnings. Changes in the latter lagged changes in the former by pretty much the same margin all the time. Why? Because most analysts don’t read the future, they read the past.
They look at last year’s results and assume the next year’s will be the same plus a bit. They “echo, they extrapolate, and then they miss the turning points”. The same is true of almost everything. In the 1960s it was true of Japan.
Charles Brandes, one of America’s great value investing gurus, noted in his session that no one wanted to invest in Japan then. It was seen as a far-off place that made nothing but cheap toys and would keep doing that: so much so that no one noticed its technological transformations. The result? Most investors missed the start of one of the greatest bull markets ever in the 1970s.
Today it might be true of inflation. Inflation as measured by our consumer price index turned negative last month, leading to some predictions that it will go still lower, but many more that it will simply revert to the low levels we have grown used to, hovering around 1%-2% for years to come. No one has predicted that we are near a turning point and that in three years’ time, inflation will be well over 2%.
We’ve written before that super-low interest rates and quantitative easing (QE) are by their very nature deflationary (they encourage the kind of oversupply that can only suppress prices), but that doesn’t mean inflation is gone forever. Central banks may come to their senses and raise rates at some point, but there are clear inflationary forces abroad in the economy too.
LA has just become the largest US city to raise the minimum wage to $15 an hour. Seattle and San Francisco have already done this and New York is also about to “call time on low wages”. Is that inflationary? It could be. The rise will come incrementally and not be fully in place until the end of the decade, but most fast-food workers are now paid $9 an hour: $15 represents a 66% pay rise.
There are stirrings in the UK too. With employment rising and our tax credit system a deterrent to full-time work, real (post-inflation) wages are rising for the first time since 2007. It may not be enough to overcome the deflationary poison of QE, but, added to the fact that there is no other way for our government to deal with its debt than to inflate it away (and that all governments that want inflation get it in the end), it should act as a reminder that, when it comes to thinking about the future, using the “echo and extrapolate” method isn’t enough.
PS. We’ll be talking about this and much, much more at the MoneyWeek conference on 12 June – hope to see you there! Book your ticket now.