Wall Street experts disagree how high inflation really is
NEW YORK » If you want to buy home computers, fiber optic cable or blood tests to detect sexually transmitted diseases, you're in luck -- prices for all are falling.
But if you want WD-40, Milwaukee Brewers tickets, a Sealy mattress or electricity, prepare to pay more.
Inflation is nowhere near its all-time highs, but it is extraordinary in another respect: It's widely uneven. As a result, there's disagreement on Wall Street about whether inflation is much higher or much lower than government data would have investors believe.
The argument is more than academic. The Federal Reserve has raised interest rates 12 times since June 2004 in an effort to combat inflation. Those who say inflation is no problem worry that continued Fed rate hikes will slow the economy enough to cause a recession. Those who say inflation is on the march worry the rate hikes haven't been enough to keep rising prices from sparking a recession.
While it's easy to get a number that is supposed to represent inflation -- the consumer price index -- some investors question whether the CPI is accurate.
The monthly CPI measures the prices of a fixed basket of goods bought by a typical consumer, including food, transportation, shelter, utilities, clothing, medical care and entertainment. "Core" inflation strips out increases in energy and food costs, which are volatile.
In the past, an inflation rate of 2 percent or 3 percent meant prices universally were rising at that rate, said Seth Klarman, president of Baupost Group LLC, which manages about $5.4 billion.
"Now, some commodities are up 30 or 40 percent, others are in decline," Klarman said in a recent speech at the Value Investing Congress. This disparity is one factor that may cause investors to realize "that inflation is higher than the government is acknowledging," he said.
Housing is the largest component of the CPI, accounting for almost 42 percent of the index. To calculate how much home owners would pay if they rented, the CPI used a measure called "owners' equivalent rent." To find that number, the Department of Labor, which puts out the CPI, tries to find out how much homeowners would have to pay to rent an equivalent of the home they own.
The problem is that rental prices haven't gone up alongside the prices people pay to buy houses. As buyers' prices have zoomed, rental prices have only inched higher. This is likely a result of the housing bubble, said Dirk van Dijk, director of research at Zacks Investment Research Inc. Many people who buy homes are moving out of rentals; that means there are more vacant rental units, which means lower rent, which means this integral component of the CPI is artificially low, the argument goes.
"There's no measure for housing inflation," Klarman said. "That's just wrong."
Those who say inflation is no worry point out that wages are growing at the lowest pace on record and the unemployment rate is still high for an economic recovery.
"Inflation is headed lower, not higher, over the next 12 to 18 months and continued slack in the labor market is the key reason," a Merrill Lynch report said.
Asked about inflation, Ajay Singh Kapur, chief global equity strategist at Citigroup, said "To me, it's moving sideways."
Even the regional Federal Reserve banks don't agree on which direction prices are taking.
The October Federal Reserve's Beige Book, which compiles economic reports from the Fed's 12 district banks, said, "While a number of districts noted increases in prices of final good, others continued to report that those prices remain relatively stable."
Why are prices moving in the directions they are?
Dell Inc. warned that its computer prices are falling. That's because there's little that's unique about them -- one personal computer is nearly the same as any other, and competition drives prices lower.
As for fiber optic cable, ever since the telecom boom went bust in 2001, there's simply been too much of it. "We anticipate pricing pressures will continue into 2006 and beyond," Corning Inc. said in a recent filing with the Securities and Exchange Commission.
Then there's Gen Probe Inc., which said in a filing that it expects "increased competitive pressure" in its sexually transmitted disease and blood screening products.
And what about the prices that are climbing?
Household lubricant maker WD-40 Co. said it is raising prices for its products because prices for its components -- aerosol cans and petroleum -- have increased.
Sealy Corp. announced a price increase for its mattresses in late October, blaming a shortage of foam and rising prices for petroleum, which is used to make foam, along with increased demand for lumber after the Gulf Coast hurricanes.
As for the Milwaukee Brewers, the team is raising ticket prices by an average of 8 percent in the hopes of improving its product. A team executive said revenue from higher ticket prices would be reinvested "in the three areas fans care about most -- the major league roster, the farm system and enhancing the fan experience at Miller Park."