With the rise of inflation in the past few years, many investors have been paying attention to metrics that they largely ignored for decades. Measures like the CPI and PCE have now become front page news when they are released each month. But despite quoting them all the time, many investors don't understand what goes into them and how they are calculated. In this episode, we try to correct that. We take a deep dive into the metrics that are used to measure inflation and the details behind them. We cover the CPI, PCE and the behind-the-scenes metrics like owner's equivalent rent that go into their calculation. We also look at more real time metrics like Truflation and look at what it all means from both an investing and financial planning perspective.
We hope you enjoy the discussion.
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[00:00:00] Welcome to Two Quants and a Financial Planner, where we bridge the worlds of investing in
[00:00:03] financial planning to help investors achieve their long-term goals. Join Matt Zeigler, Jack Forehand
[00:00:06] and me, Justin Carbonneau, as we cover a wide range of investing and planning topics that
[00:00:10] impact all of us and discuss how we can apply them in the real world to achieve the best outcomes
[00:00:14] in our financial lives. Justin Carbonneau and Jack Forehand are principles
[00:00:17] at the Lydia Capital Management. Matt Zeigler is managing director at some point investments.
[00:00:21] The opinions expressed in his podcast do not necessarily reflect the opinions of Lydia
[00:00:24] Capital or some point investments. No information on this podcast should be construed as investment
[00:00:28] advice. Securities discussed in the podcast, maybe holdings of clients of Lydia Capital
[00:00:31] or some point investment. All right guys, today's topic is going to be about inflation.
[00:00:37] Jack has quickly become our resident inflationary expert over there doing the research for this.
[00:00:44] So appreciate you kind of spending the time pulling all this stuff together because
[00:00:48] there's going to be a lot of charts and graphs in this episode. So hopefully people can
[00:00:53] watch it on YouTube to kind of get this full and complete picture. But before we get into that,
[00:00:58] you know, inflation is a tricky thing but it's an important thing in the sense that inflation,
[00:01:05] you know, effectively eats away at our purchasing power over time. So, you know, a dollar a year
[00:01:13] from now will be worth less in most cases, most chances than a dollar today. And it's important
[00:01:21] for investors. So, you know, you have let's say you have an investor that has a half a million
[00:01:26] dollar portfolio they can invest in something that produces a return or they can keep it in cash.
[00:01:31] You know, if they keep it in cash over time, they're losing their purchasing power by not
[00:01:37] giving it at least the opportunity to grow. And so, inflation is a very important, I think,
[00:01:43] concepts for investors just to understand and grasp. And I think, you know, in the past few years,
[00:01:50] we were in a very low inflationary environment up until, you know, I guess end of 2020,
[00:01:57] middle of 21, whenever inflation really started to spike up. And that's been on a lot of investors'
[00:02:02] minds and the Fed reacted, I think appropriately. And now we're still in this camp where,
[00:02:10] depending on who you talk to, and we've had plenty of people on the podcast, Jack,
[00:02:14] that have sort of some, our inflation is going to say higher for longer while others sort of are more
[00:02:21] you know, in the camp of the Fed has done most of its job here and, you know, we're getting closer
[00:02:26] to the 2% target. But maybe to start, let's just start out by talking about, you know, why
[00:02:33] inflation is difficult to measure and also like why we shouldn't go nuts and paying too,
[00:02:39] too much attention about it, but just sort of talk about the components of what goes into driving
[00:02:44] inflation. Yeah, the first thing for me is I was just thinking when I was doing the research for
[00:02:48] this and I was thinking like in January 2020, nobody cared about this at all. Like this whole
[00:02:52] thing I was researching, like it just didn't matter. Like inflation just didn't exist for so long
[00:02:57] that it's just funny. Like I don't know if you guys ever did, but I had no idea about any of this
[00:03:00] stuff. And I learned something and doing the research for this, but I literally knew nothing
[00:03:04] in January 2020 about this because there was no inflation and nobody cared.
[00:03:07] I lived in terror of people asking questions about this topic because there's so many definitions
[00:03:13] and things that if somebody's like, well, how does inflation matter here? How does real versus nominal
[00:03:18] matter here? And then you're like, wait, how do I track PCE versus core PCE versus are they just
[00:03:23] talking headline versus that? Are they netting this? And I will confess having to look those
[00:03:28] definitions up a billion in one time because this is hard stuff to talk about as much as is super,
[00:03:35] super important to talk about. Well, thanks to your point, Jack, about that though. I think one of
[00:03:40] the things that I was very wrong about is after the financial crisis and during the 10 years after
[00:03:47] that with the Fed's balance sheet and all the monetary stimulus, I was always like thinking
[00:03:53] to myself, like inflation has to, it's right around the corner. It's going to be here. That was
[00:03:58] something I would think about a lot and we never got it. And so I think we just all became super
[00:04:04] biased or what's the word just not paying attention, not thinking it could ever come back because
[00:04:12] we weren't seeing it from things we thought we might see it from. Let me just go on the record and say
[00:04:19] a personal thank you to Colin Roche, friend of the show, regular guest for being one of the few
[00:04:25] people in my life in the early pre-MMT is everywhere face who kept explaining why things were inflationary
[00:04:31] at the time and kept me tethered to humanity and thinking about stuff so that I didn't miss out on a
[00:04:36] bunch of years worth of returns. But yeah, I know that pressure was real in surrounding all of us
[00:04:41] all the time. And to your point about living in fear about getting asked questions about this,
[00:04:46] like I currently do and you guys are about to ask me questions. So I had to basically come up with
[00:04:51] all this. This is not something like I've known forever. Like I learned a lot doing the research
[00:04:55] for this in terms of what goes into CPI and PCE and we'll talk all about all that but
[00:04:59] you know this is complicated stuff. There's a lot going on behind the scenes and you know I think
[00:05:02] you see so many people out in the media throwing numbers around and maybe not even knowing what those
[00:05:07] numbers actually mean because they have a certain point they're trying to know inflation is high,
[00:05:11] inflation is low, inflation is where target, whatever they're thinking like they throw a bunch of
[00:05:16] stuff around but you know I don't think they totally understand what they're saying and one of
[00:05:20] the things I want to ask Matt about before we get into this is like this is inflation is really
[00:05:25] really difficult to measure and I think that's really important for all of us to keep in mind whenever
[00:05:29] we see any there is no true inflation rate. Inflation is what's going on in your personal life with
[00:05:34] your own expenditures. And so it's so it's so tempting to see these numbers a bit like oh, inflation's
[00:05:39] 4.5 percent or it's 2.7 percent or whatever it is and we'll talk about what goes into these and
[00:05:44] all the things that lead to these numbers you see but it's also important to understand that no
[00:05:48] matter what number it is you see it's not necessarily the inflation rate that matters the most to you.
[00:05:54] Inflation is always personal we all have a basket of goods and services and whatever else that
[00:05:59] we consume and we have offsets for those if I'm working I might have wages if I'm retired,
[00:06:04] retired I might have assets or whatever else so it's your basket of goods and services is your
[00:06:09] basket and nothing in the media is ever going to reflect exactly your basket. So all that you can
[00:06:15] really do is have an understanding that sometimes prices are going up sometimes prices are going
[00:06:21] down sometimes counterintuitively your basket might be going down while everybody else's are
[00:06:26] going up and vice versa having some methodology having some way in your head or working with somebody
[00:06:32] you can help you think this way is I don't say worth it's weight and gold that sounds like an
[00:06:38] inflationary argument is worth its weight and something it's useful because we have to understand
[00:06:43] prices just change over time that's how this works and the prices you pay the prices you take
[00:06:49] they're going to change over time to this is the world we live in and you can't ever ever ever forget
[00:06:55] that. A great example that is housing you know if I'm a person with a fixed rate mortgage
[00:07:01] who owns a house or I'm a renter like housing is going up I feel those two things in very very
[00:07:06] different ways in one way I'm actually benefiting probably from what's going on and in the other
[00:07:10] way my costs are going up so it's just that that's an example of how people feel inflation you
[00:07:15] there might be a number this we'll talk about OER and stuff like that later but there might be
[00:07:19] a housing number inflation but how people feel that number is completely different depending on
[00:07:23] their situation. Yeah especially on the housing cost thing this is one of those like in the pandemic
[00:07:29] or whatever and people selling one house to buy another so I literally had this conversation
[00:07:34] this morning somebody's talking about oh we're going to sell this house we're going to move and
[00:07:38] it's no matter what you have to live somewhere or at least you know if you have wealth to live somewhere
[00:07:44] this is part of the calculation and so you can sell one house at an inflated price but you might be
[00:07:49] buying into something else that an inflated right price at higher interest rates all this stuff
[00:07:55] is personal all this stuff has to be taken into consideration because then it's going to determine
[00:08:00] what pressures are you on in the next phase if I own the house for years and now I'm going to go
[00:08:05] rent or if I owned one house and I paid off the mortgage and I'm going to go take on a mortgage
[00:08:09] by a new one it changes the composition of money that I have flowing out so these measurements whether
[00:08:16] they look at rents or owners equivalent rents or just home ownership or the cost of ownership and
[00:08:21] map all this stuff together you got to figure out what it means to you because you're the one paying
[00:08:26] the bill. One of the most common or popular inflation indexes is known as the CPI or the consumer
[00:08:37] price index that's what CPI stands for and that's made up of a number of different components
[00:08:45] so Jack maybe in your research talk us through I guess what you learned about the CPI in terms of
[00:08:58] what the weightings of these things are how it's calculated I mean what is the big sort of major
[00:09:04] insight here yeah we'll put this pie chart up on the screen because this was a little
[00:09:07] eye opening for me I mean I knew housing was a big part of the CPI but I probably didn't know
[00:09:13] that it was as big a part as it is you'll see even this pie chart I mean housing is 45%
[00:09:17] it used to be less but right now it's 45% of the CPI so that's a huge you know when we have all
[00:09:22] these debates about the lag and housing and stuff like that you know it's having a huge impact
[00:09:27] on the overall CPI because it represents 45% of it but and I don't need to go through all the percentages
[00:09:32] one of the things that was most interesting to me and we'll see if you guys can figure this out but like
[00:09:36] what's interesting is not just what's on this pie chart but what's not on this pie chart like
[00:09:40] what's the one thing that's missing from this pie chart that you would think would be a huge
[00:09:44] portion of CPI the price of Bitcoin that would be a good one but that is not in there
[00:09:52] I would say energy that's right so the answer is energy and the reason is because energy
[00:09:58] is embedded inside of these other things energy exists in transportation energy exists in
[00:10:03] housing but that energy also indirectly exists in all of them because energy is an input cost to a
[00:10:08] lot of this other stuff that goes on so energy is kind of buried throughout this thing but it was
[00:10:13] interesting to be like see whenever you see any of these pie chart the CPI you don't see energy
[00:10:16] because it's not one of the official categories in there it's just it's it's exists within all the
[00:10:22] other categories on a pure planning thing and this is this is one of the important exercises we
[00:10:28] take clients through not on again there's a lot of embedded stuff and where you get to the assumptions
[00:10:34] but when people have questions in the planning process about how do we think about inflation
[00:10:39] we'll take a chart like this and you say okay this is CPI so think about your own budget or your
[00:10:44] own outflows your own expenses but like odds are and I can answer for myself like 45% of my
[00:10:54] my budget on a monthly basis for my wife and I 45% does not go into our housing costs
[00:11:00] and most planners will tell you like the rule of thumb is closer to like a third for things that
[00:11:04] you're gonna spend money on but take the snapshot of your life think about where your money goes or
[00:11:10] what percentage of the expenses that are truly expenses goes map it over this see how close that
[00:11:16] rhymes for you the either you guys when you look at this is there anything you're like I mean
[00:11:21] clearly Justin you're like 2.5% on a peril I'm not gonna address myself that's 25% or something right
[00:11:28] well I don't know if that that was the question I had I don't think this is this isn't like these
[00:11:34] figures are the percentage and correct me if I'm wrong here this is saying like take the 45%
[00:11:41] that's awaiting so if housing price inflation is up
[00:11:46] 3% year over year that 3% is yeah that's that's a 45% way in the overall
[00:11:55] that's a 45% way right overall I understand it's it's supposed to be it's supposed to represent you
[00:12:01] know where consumers are you know spending their money but it's supposed to be a representative
[00:12:08] basket of the consumer it's something they change over time like it recently just changed
[00:12:13] these things change periodically but yeah it's like it's impossible to figure out what a representative
[00:12:18] basket is because there's no representative person they don't exist and so because they have to
[00:12:22] kind of average it out because it's it's kind of interesting like with healthcare right like health
[00:12:26] cares 8% but healthcare as a percentage GDP is roughly 20% of our overall economy and so it's
[00:12:36] late and I think the 8% is probably accurate like at a family level barring any major healthcare
[00:12:42] catastrophe but you know with high deductible plans now and just the cost of healthcare I mean
[00:12:49] someone could easily have that be 25% in a given year if things go really bad so yeah
[00:12:55] I was thinking about this for myself and this will be a good lead into the next chart but like
[00:12:59] basically I've had like a bunch of healthcare expenses like with our family in the last couple
[00:13:03] years so that would be a bigger portion for me and as you guys know I wear the same shirt every week
[00:13:08] so the apparel would basically be zero so like it's a different you know and as we get into
[00:13:13] the next chart here that will show why it sucks for me because basically apparel has gone nowhere
[00:13:18] in the costs you know the apparel costs are not up at all so I'm spending zero on apparel which
[00:13:22] does not go up at all and I'm spending money on medical care which has gone crazy so this next
[00:13:27] chart breaks down basically the change in each of those sub components over time and it's
[00:13:32] basically what you would guess you know medical care has been going up the most housing's been going
[00:13:36] up a decent amount you know and apparel has not been you know going up at all that's been the
[00:13:41] biggest lag by a good margin I mean the the one thing that kind of concerns me on this one is
[00:13:48] I mean if anything there's like a shortage of healthcare workers in this country there's more
[00:13:53] people that need you know as the as the population ages I just think the pressure on pricing
[00:13:59] there is gonna continue to be very strong and probably drive those prices higher I know that's
[00:14:05] a little bit outside the topic but no I think that's true um what's also interesting is there's a
[00:14:10] lot of sub there's a lot of sub categories of all this so for instance if we were to carve college
[00:14:14] education out of education and communication it would be the highest on this chart by a wide wide
[00:14:19] margin it would be just destroying everything else but there's other stuff in there so it averages
[00:14:23] out over time um the other interesting one I found is that the uh food and beverage beverage is
[00:14:28] just alcoholic beverages so it sort of changes the way it gets dealt with over time because people
[00:14:33] like their their behavior in terms of drinking alcoholic beverages are very different than like I
[00:14:37] think they probably drink more of them in the recession so it's a little bit different than
[00:14:42] like what you might expect well and what's crazy um sorry Matt I'm gonna step on either but um
[00:14:47] look at like transportation in away so that like that probably is the the most volatile line on this
[00:14:56] chart and I guess that kind of coincides with the values of transportation over time and during
[00:15:05] recessions and stuff you know I think that's right I mean I think the shipping and stuff is uh
[00:15:11] you know like that can be a very leading indicator of economic problems like when stuff like that
[00:15:15] starts to tang um and that actually gets into maybe the next point here which is this idea of core
[00:15:21] versus headline um CPI and the difference is basically if we're trying to get the overall trend
[00:15:27] in inflation we may want to remove certain volatile components that maybe bounce up and down a lot
[00:15:33] and we're not getting at the overall trend and so that's basically what core CPI is and core
[00:15:38] PC as well when we get to that later like you take food and energy out because they tend to be very
[00:15:43] volatile um but more interesting like beverage stays in because it's alcoholic beverages so uh it's
[00:15:49] just a it's an interesting thing and the Fed tends to pay a lot of attention to core um so
[00:15:54] you'll always see it whenever you see any inflation reports they'll usually report both numbers
[00:15:58] because the the core is something that a lot of people pay attention to as alcoholic should
[00:16:03] that's why this is all vodka in here that's what they show's brought to you to date.
[00:16:08] Absolutely interesting insights by the end of the podcast about uh about financial planning
[00:16:12] it's gonna get real it's sitting here sponsored by Tito's yes Tito's if you're out there if you want
[00:16:18] to sponsor this thing you know we have to take the money. We'll take tost eat us.
[00:16:25] Um what about I guess there's different ways to calculate it right like over different time periods
[00:16:30] yeah and this is where you can get really in trouble and it's just a different ways to calculate
[00:16:34] it and the different ways to exclude things you know you have a lot of people will report year over
[00:16:39] year inflation you know how much is it grown over the you know how much is that basket of goods
[00:16:43] up over a year but you'll also see things like three month and six month annualized
[00:16:48] which are more recent things and that can be really important because the one year thing
[00:16:51] can be very misleading at times so like if you think when inflation first came on after 2020
[00:16:57] when it starts spiking you know those shorter term things are going to give you a better
[00:17:01] view of what's actually happening than the longer one isn't the same thing with recently where
[00:17:06] it's rolled over you still have really high inflation ratings in the annual one for a while
[00:17:10] whereas the three and six month annualized were lower and and the big key with this is whenever
[00:17:15] you're hearing anybody who has an opinion on inflation they're they basically have a full
[00:17:20] menu of options in terms of what they can come up with to verify that opinion they have different
[00:17:25] they have three six month twelve month annualized they have core they have headline they can start
[00:17:29] excluding other stuff outside of you know the ex this that and the other thing they can take things out
[00:17:34] you know there's no matter what your case is you can make it with this data and that's why it's
[00:17:38] just so important to understand when anybody reports any inflation metric what is actually in that
[00:17:44] metric what's in the metric is it three months is a six month is it just month over month because if
[00:17:49] you don't understand that you don't understand how valid what they're coming up with it's
[00:17:54] the why am I reading this now to cite our friend Ben Hunt is one of the most important questions
[00:18:00] to ask whenever being presented with any one of these factoids if you will and it doesn't mean
[00:18:07] the fact itself is wrong or the reading is wrong just understanding that it's always being
[00:18:12] presented or served up to you in a way that proves a point and what you just said even it not
[00:18:18] even just the constituents of what's in the different inflation measurement it's the constituents
[00:18:25] it's the time period it's what things are corrective what things aren't inside that time period it's
[00:18:30] it's a friggin mess which is really convenient because it's kind of like proving you're right on
[00:18:34] the internet you can almost always find a point on the internet to prove why why you're right about
[00:18:40] something you can also always find inflation indicator to prove whatever crazy thing you want to say
[00:18:47] yeah Ben had a like a great tweet on we talked about our sever podcast breaking news where somebody
[00:18:51] hid effectively done an inflation figure like x a bunch of stuff energy housing food like they had
[00:18:57] basically taken like 70% of the CPI out as a way to show that inflation you know is very very low
[00:19:03] so how valid is it when you've taken 70% of the basket out and now you're saying that that's
[00:19:09] my case for inflation's low and people who think inflation's high do the same thing you can do it
[00:19:13] for anything it's just you got to know what you're seeing and it's so tempting in the world of social
[00:19:17] media to just see that headline number someone's reporting to be like oh yeah,
[00:19:21] you know inflation's inflation's dead because this number is reported or inflation is actually 7%
[00:19:25] because this number likes you know you have to look behind the scenes and see what it is you're getting
[00:19:30] a real world ramification of this without just punching at the pundits who say stupid stuff is
[00:19:37] this can also show up in your own life you might have something like you were talking about health
[00:19:41] care costs or whatever else before there's a lot of stuff like this sometimes we experience a change
[00:19:49] in the cost of something in our lives it might be at deal with some people who need to rethink
[00:19:54] the nanny that they hire because they're having an extra kid the other day unexpectedly
[00:19:59] thinking about the way price changes can show up in our life like as surprises as a point in time
[00:20:04] we still need the tools in the language to identify what those things are and then what corrective
[00:20:10] mechanisms or protective measurements we can or can't take against that thing like if you have
[00:20:17] to move if you sold your house and you have to move in real estate prices are running away
[00:20:21] these are real problems people saw so understanding all these different measurements can be useful
[00:20:27] to map back in all sorts of other ways too so let's talk about shelter a little bit and the
[00:20:32] components that go into that and Jackie mentioned we are earlier but just walk us through that
[00:20:40] methodology for that yeah you know one of the important things with shelters to understand this is
[00:20:43] very hard to do you know you've got people like how do people live in places across the country they
[00:20:48] typically either rent the place or they'll own the place and so you want to reflect both of those
[00:20:53] things when you think about what how much shelter the price of shelters increasing so you've got on
[00:20:59] one hand so it's got two components one one hand is rents paid and the other is OER which is
[00:21:03] owners equivalent rent which is an idea basically that if someone owns this house if they had to rent it
[00:21:09] like what would it rent for so what we're trying to do is get the consumption value of the house
[00:21:14] and not the change in value of the house because this is this is like a CPI type thing we're not trying
[00:21:18] to reflect like the change in home prices here we're trying to reflect someone's consumption of houses
[00:21:24] housing and so those are the two components is on one hand there's rents paid and on the other is
[00:21:29] owners equivalent rent which is basically if this house did rent what would it rent for now one of
[00:21:34] the interesting things on rents paid is what what they're using is pre-existing rentals so someone's
[00:21:40] in a rental the landlord raises the price that's what they're using in CPI there's another way to
[00:21:45] look at this which is what the zillow type index as you'll see look at which is a house is on the
[00:21:50] rental is on the market it's changing people what does it rent for and that's important because
[00:21:56] the speed which the constituents those go after and the speed at which they change are different
[00:22:02] you know when you start to see like we did in 2020 you start to see a big increase in the market
[00:22:06] well where are you going to see that first the first place you're going to see that is in stuff
[00:22:09] that's on the mark you're going to see people like stuff that's up for rent right now I can raise
[00:22:13] the price if someone's on an existing lease I can't raise the price and so this gets into what
[00:22:17] we'll talk about a second but it's just important to understand like what's going on behind the
[00:22:22] scenes there because there's different ways you can measure these things and there's no right
[00:22:25] way to do it and they can lead the very different conclusions if just as a side note like the whole
[00:22:32] data aggregation part of this is pretty amazing when you think about it I mean this all that rent
[00:22:38] data has to be captured and then centralized and you know like what are the Federal Reserve you
[00:22:48] know has built over a hundred year period in terms of being able to accurately get at this stuff
[00:22:53] is just pretty pretty amazing when you think about it um to your point Jack or let's on the rents
[00:23:02] I know Jeremy Segal when he was um he was he was sort of right on inflation coming and then I think
[00:23:11] he was kind of right also on inflation coming back down one of the criticisms he had is this lag that
[00:23:17] happens with rents that the the following rent prices doesn't because of the lease issue doesn't
[00:23:26] get reflected in inflation numbers as quickly as some of the other components correct right there's
[00:23:31] two different things going on here one is we're using currently rented properties not properties on
[00:23:35] the market so if you if you assume your average person if you assume like one year lease is a pretty
[00:23:40] standard then you might say your average person might have like six months left on their rent like there
[00:23:44] some people to just sign leases or some people that are coming to the end so you could see there
[00:23:48] could be like a six month lag before there's even the potential for those people's rent to go up
[00:23:52] so you see something happened in the market it takes a while the other thing is you can argue it's less
[00:23:57] likely if somebody's already in a property it's less likely you're going to raise the rent on them
[00:24:02] than if you're putting in a new tenant so that can also impact this if I'm only using existing
[00:24:06] properties it might be less likely that rent is going to get raised um and the second component of
[00:24:12] this is the sampling which is you know that they take these rent samples every six months so if
[00:24:16] you're only taking if you take the rent sample after six months what they effectively do is they assume
[00:24:21] whatever happened in the prices of rent that went up 10% or whatever they assume it equally happened
[00:24:27] over those six months they you know they don't have any data in terms of what happened inside of
[00:24:31] there and so that can also create a lag because there's not going to be another sampling you know
[00:24:35] depending on when it happens for six months so it can be both of those together create a situation
[00:24:40] where this is lagging you know what's going on in the real world and going back to what I said before
[00:24:45] there's other indicators out there like zillow does one that that try to track what's going on in
[00:24:49] the real world and that they use changing properties versus the existing properties and so that's
[00:24:55] why you can see these huge different numbers um you know the zillow thing if you see a change
[00:25:00] in the market the zillow thing is going to pick it up pretty quickly whereas you know CPI is going
[00:25:04] to take a while and that's what we're seeing right now we're still seeing those price increases
[00:25:08] in owners equivalent rent working their way through the system and it's going to supposedly end
[00:25:11] soon here but from that occurred like a long time ago there's always the fascinating aspect of
[00:25:18] especially with this stuff like the rolling figures and the owners equivalent red and like the
[00:25:22] leases so for working with a client who has commercial real estate exposure or is a commercial
[00:25:29] real estate broker or is all these different levels it's kind of you can also look at
[00:25:35] or we like to talk to people about what they're seeing in different industries and where they see
[00:25:39] opportunities in the stuff too because it's like because of all these lags because of all the
[00:25:43] quirks in this thing you can kind of tease apart where money is flowing in the economy because
[00:25:48] there's some weird bottleneck around what's going on and it's really interesting to think about
[00:25:53] a two from from the with our investor hat is uh hat on what are the opportunities that are created by
[00:26:01] there's too much office space available or the rents are going up because of whatever else or
[00:26:06] somebody's trying to make something else fit like like within all these measurements do you guys
[00:26:11] ever think about through other ways that these measurements apply i don't want to derail the
[00:26:15] conversation but we do have conversations about hey this is a sign this price is going up are you
[00:26:22] shifting your tactics in your you know your real estate empire or in your commercial brokerage business
[00:26:27] to go like this can't continue or this is a problem yeah i know whatever like whenever i think this
[00:26:34] can't continue it always continues in my life so uh you know yeah my my tactics probably shouldn't
[00:26:38] be shifting too much based on stuff like that um based on my own personal track record
[00:26:43] so the next chart is showing basically the one year percent change of
[00:26:51] CPI and housing prices basically it looks like for the housing prices it's using the case
[00:26:57] shell or home price index and then using CPI shell perks um and i'll let you sort of comment on
[00:27:03] that chart but one of the things that's kind of amazing to me so the yellow chart is the
[00:27:07] one year change in home prices and it just goes to show you would never have thought like pre
[00:27:13] 2005 in this country that you could have you know housing prices go as high as like if you look at
[00:27:22] the standard deviation right it's like on the low end you have like almost a 15% drawdown
[00:27:28] in housing prices and on the high end you have uh yeah so these are different you have i think on the
[00:27:35] left towards 05 and 06 you had you know housing prices that were up 15% year over year so you know
[00:27:44] it's a it's a you know it used to be housing would appreciate you know 3% a year kind of like cloth
[00:27:50] where you know maybe a little bit of variation but then we had that bubble in real estate
[00:27:55] and then obviously the great financial crisis and then the big spike sort of after COVID so
[00:28:00] anyway it's just an observation with that jack do you want to yeah no you're right we have had a lot
[00:28:04] of volatility here and the point here is the same thing the point I was making before with zillow like
[00:28:08] this is CPI shelter lags these real time things so if you look at housing prices or if you look at like
[00:28:13] rents through zillow like you would see basically them moving ahead of CPI which just this is just
[00:28:18] demonstrating the lag we talked about before and you know one of the interesting points I want to
[00:28:22] bring back on this related to the zillow in the CPI is it's you know there neither one of them is
[00:28:27] exactly right about this because if you think about it like if I wanted to get the actual change in
[00:28:31] rents throughout the economy I'd probably want some blend of like properties that are on the market
[00:28:36] now because some people are actually changing properties and existing properties because those
[00:28:40] people aren't going to see the extreme changes that probably for the properties on the market are
[00:28:44] so it's like there's probably like a blend of both of them in terms not in terms of the timing but
[00:28:48] in terms of like the groups you include that would make sense like and that's why this is also
[00:28:52] complicated is like there's just so much going on behind the scenes if you want to reflect
[00:28:57] that true consumer but you also can't because let's a match point before if on the person who's
[00:29:02] in the existing property then that's the only one that matters to me if I'm the person that has
[00:29:06] to go rent the new property then that's the only one that matters to me so it's like the we're trying
[00:29:10] to create these averages but they don't reflect any single person specific situation
[00:29:16] but we still have to collect these averages because we still have that was so yeah and that's like the
[00:29:20] to be nice to the people collecting these averages if we didn't have this data to try to start
[00:29:28] to make sense of some of this stuff then there's so many other things you just can't do and that's
[00:29:33] everything from Fed policy to the degree you want to say you can or can't do Fed policy to like
[00:29:39] planning about the future because that's really what a lot of this boils down to is do we have some
[00:29:43] way of understanding how we want to approach planning about a future and this stuff is really messy
[00:29:50] to gather to have useful information to make any plan with it's annoying to some extent too because
[00:29:54] it's like we you're like we have all this technology we have the technology companies like
[00:29:58] give me the rate of inflation like do do of like does not have this this lags by six months and this
[00:30:03] is this and like you know just give me the rate of inflation and it's much harder said than done
[00:30:08] but it's interesting to me like when you think about the reactions to these CPI reports like if
[00:30:12] it's 0.1% up or down like there's this major reaction to it but by the same token we know that
[00:30:18] effectively like the component that's 45% of the CPI is dramatically lagged with what's actually
[00:30:22] going on in the real world yet we care about this 0.1% once or you know up or down like it's just
[00:30:28] interesting to me like that we've these measures matter even if we understand there's like major
[00:30:34] issues behind the scenes in terms of if they're representing anything close to real world inflation
[00:30:38] right now right because what does this do to your expectations over and over again with all these
[00:30:43] charts just like what is this doing to your expectations and yeah the 0.1% the 10 basis point change
[00:30:51] in the reported figure that sends markets off to do something completely chaotic when you start
[00:30:56] to think about it like this it's like duh I mean with match reading is interest rate features it's
[00:31:02] a huge deal but you know for the rest of us you know if it's not as big of an issue if I had a nickel
[00:31:08] for every you know nickel I made on orange juice features this your alone I would just be
[00:31:13] and if we haven't confused you enough we're going to now introduce another
[00:31:17] index personal consumption expenditure index also known as the PCE so what is this and how does
[00:31:25] it differ from the CPI so this is a little bit yeah this is important because the Fed likes
[00:31:29] this measure better the Fed tends to pay a little more attention to PCE it's issue by the Bureau
[00:31:34] of Economic Analysis versus the Bureau of Labor Statistics which I don't even know why we have to
[00:31:40] have both of those things but we do yeah and one of them does one and one of them does the other
[00:31:46] and you can kind of see so there's a bunch of differences in this first chart I put up
[00:31:50] there's only really one difference we have to worry about like there's different formulas
[00:31:53] there's different scope there's all that stuff but if you look at this pie chart in terms of
[00:31:56] what accounts for the actual differences it comes down to weight the basket is different for the
[00:32:02] PCE than it is for the CPI and those weights drive a lot of the difference and so if we go to
[00:32:08] this next chart this is actually a cool chart I found on the web here this this actually shows the
[00:32:12] difference and again there's really one thing you have to concern yourself here with which get to
[00:32:16] what Matt said before which is 42% might be a little bit high for your typical persons you know
[00:32:22] exposure to housing well then this kind of corrects that to some degree this has 32% exposure to
[00:32:27] housing instead of 42% exposure to housing and so that ends up being the major driver of the
[00:32:32] difference between PCE and CPI over time what probably concerns me the most about this PCE
[00:32:39] is 1.2% in tobacco she's it's going on with that yeah people are people are still smoking these days
[00:32:48] it's surprising but nonetheless they don't want to hear from me about that we have we all have
[00:32:52] these well whatever what on future training I've also changed smoking I've broken up for the three of us
[00:33:00] I think I think Jim Simon's even quit Matt like he knows to be he knows to be he notoriously smoked
[00:33:05] his entire career but I think he might have finally like shut it down he'd be like giving
[00:33:10] interviews on the stage we smoking yeah man you know in the office like all the people that had
[00:33:16] to work for him all these Matt and mathematicians like the room just full of smoke it could have
[00:33:21] been the greatest you know environment out there by the way just really good let's say clearly the
[00:33:27] adjustment inside of the chart here is Jim Simon's pre smoking is on one side and Jim Simon's
[00:33:33] post smoking is outside I guess CPI does not account for Jim Simon's directly as a separate
[00:33:37] aligned item in the PCE does account for Jim Simon's but he's included versus excluded yet
[00:33:43] and just in case anyone doesn't know Jim Simon's is he's the founder of Renaissance probably
[00:33:47] the most successful best performing hedge fund out there is a Renaissance technology yeah just
[00:33:52] it doesn't decide for anybody watching for you guys as well like acquired did did Renaissance
[00:33:57] for their latest episode oh yeah it's really good I haven't heard it yet yeah just like it's
[00:34:02] like basically a three hour deep dive into like the entire behind the scene story of Renaissance which
[00:34:07] is a which is a pretty crazy story so I would definitely recommend that for anybody who uh and for
[00:34:11] anybody who hasn't tried the acquired podcast before it's really really good all right um moving on to
[00:34:16] the next I think you were just highlighting housings way yes this is just driving the same point
[00:34:21] we drove home before which is it just shows how the how housing is a huge driver of the difference
[00:34:27] between CPI and PCE and an overtime CPI tends to be higher than PCE um it has a little bit higher
[00:34:33] average and you know throughout this this situation we've been dealing with here with inflation
[00:34:36] it's also a bit higher um CPI is tended to be ahead of PCE so that's just something to know and
[00:34:42] this is a good chart I thought the drove home that point um with a bunch of crazy bars
[00:34:47] so it looks like given this next chart that KCE is coming in lower than CPI and to your point about
[00:34:56] the said sort of likes or waste PCE more yeah that's kind of a good this is a good trend in in the
[00:35:05] sense and it might play into like what I didn't listen to all of Powell's testimony yesterday
[00:35:09] or press conference but the market obviously like what it heard so I'm guessing you know
[00:35:14] they're they're thinking they're closer than they are closer to their target 2% target and so
[00:35:20] yeah they're thinking with their might they're sticking with the cuts this year but you know
[00:35:23] what this is getting into is so there's a different way to do this so the previous ones are kind
[00:35:27] of these lagging indicators it's like let's look at what's going on in the past and let's try to
[00:35:30] figure out what's going on and owners of equivalent rent and lags and all this stuff there there's another
[00:35:34] way to do this which is let's try to create real-time measures of inflation that aren't as delayed
[00:35:39] and there's kind of two ways this has been happening one is the Cleveland Fed has something called
[00:35:43] the nowcast um which is what of this chart I'm showing is right here um so the Fed is attempting
[00:35:48] they're testing different measures to say like can I do something that's a little more real time and
[00:35:52] so what you're seeing in this chart is the year over year change and again you have to be careful
[00:35:56] not three months not six months year over year but three year over year in the different measures and
[00:36:00] you can see their their real-time CPI and core CPI are higher um core is higher than regular
[00:36:05] in PCE is lower in both cases um so that's one way we're trying to do this in a real-time basis and
[00:36:12] the other way is the private market is tried to do this as well this site called true-flation
[00:36:17] has created a very you know I think a pretty complicated system to try to do this as well
[00:36:22] and so they every day report a daily inflation rate and so I pulled the one from today
[00:36:26] it's 2.23 percent so the idea being with their lower you know with their more real-time data
[00:36:33] they're getting lower figures than the Fed is getting on terms of inflation so this for those who
[00:36:38] believe in true-flation this is an argument that inflation is lower than what we're seeing um you
[00:36:44] know in terms of the Fed numbers jack let me ask you this question first they put true in the name
[00:36:50] doesn't that mean it's right it happening yeah I think so okay at least from what I've said
[00:36:55] they left out the e there's I think that makes me skeptical I think that's like a stronger version of
[00:37:00] true so I think I think it's more true if it's in the name yeah so all this stuff we talked about
[00:37:04] before about the different measures and everything you can pretty much ignore that now um this is
[00:37:08] this is now true um so then this is the real rate of inflation it's actually a pretty catchy name
[00:37:12] you think about it like if you want to uh if you want to challenge the standard numbers and you
[00:37:16] you want to put something out there this real-time like true-flation is actually a good a good name
[00:37:20] to use for that it makes me think of um I've got one of the many print books and it's got all the
[00:37:27] letters that like Prince wrote notes that he took himself like pictures of him and he would regularly
[00:37:31] write like instead of the word two or T.O. or T.O. he would just write the number two and you know
[00:37:37] see would always just be the letter is basically texting like a teenager before teenagers texted like
[00:37:41] teenagers well ahead of the time yeah well ahead of the time more stay at otherwise true-flation kind
[00:37:48] of feels like that I really appreciate too and they're very catchy graphics that they also tell
[00:37:52] you the US government also abbreviated reported rate below I think that's really helpful to see
[00:37:57] under there how a contrast and the one the one thing I would point out with this is there is a
[00:38:03] a downside to this in that a lot of the prices the Fed is using to measure inflation or sorry
[00:38:09] the BLS is using to measure inflation are not necessarily observable on a day-to-day basis
[00:38:14] and this is the point that Bob Elliott made and we had him on our podcast we asked him about
[00:38:17] true-flation and he's not a big believer in the accuracy of this number and that's basically
[00:38:21] what he was getting at is you have to be able to report pricing on a day-to-day basis you have to
[00:38:26] be able to observe pricing on a day-to-day basis and if a lot of the components that you measure
[00:38:31] are not measurable on a day-to-day basis or observable on a day-to-day basis then you don't get an
[00:38:35] accurate number so there's advantages to true-flation in that they are using real-time numbers but
[00:38:40] there are also I think our disadvantages in that they face a battle that they can't overcome
[00:38:44] in terms of some of this stuff just can't be measured on a day-to-day basis and so you may not get
[00:38:49] a more accurate number because of that so that's just something I want to point out on the downside
[00:38:52] of like these real-time type measures it's in the just that word observable might actually be the
[00:38:58] most truthful word in this thing it's there's a reality there's some of this stuff that is
[00:39:02] observable to you just like there's some of this stuff that matters to you or doesn't really matter
[00:39:07] to you in this moment and when taking these snapshots understanding what's being included and not
[00:39:13] it's a really useful word to use here you know I like to think that I can kind of go to a company's
[00:39:18] website sort of figure out like what the business model is but it's hard like I'm looking at
[00:39:24] this true-flation like yeah they have this measure but just trying to figure out like what they do
[00:39:28] is not that straightforward to me yeah I don't know that I don't know if they sell premium data or
[00:39:34] if they've got some they've got like some tokenizing and index-based stuff that they're doing
[00:39:40] there's so there's it's weird they have this index and I mean they have some pretty huge backers
[00:39:46] but looks like they're they're they're well well well funded but yeah and it's a great idea you
[00:39:50] know getting back to my point before like we have all this technology out here like why can't we get
[00:39:54] a more accurate measure of inflation so they're actually trying to tackle that problem the problem
[00:39:58] is just a very difficult problem the technical because the true rate of inflation on any given day
[00:40:03] is not a you know it's not a number you can figure out so the ideas can you get closer to it with this
[00:40:08] real-time data and with what they're doing then these lag you know PC and CPI type numbers
[00:40:13] so let's get into why
[00:40:17] this matters or is important or how it affects investing decisions or
[00:40:25] different types of assets that are out there and just sort of sort of book into this with some
[00:40:30] maybe practical advice because we've kind of got this has been good we've gotten into weeds on
[00:40:34] inflation and there's you know we could go on and on on on on this topic for sure I mean this
[00:40:40] is really just the tip of the iceberg in terms of explaining at you know a high level what goes
[00:40:46] into inflation in the different ways that it can be can be measured but um you know the point
[00:40:52] you made earlier Jack was was a really good one which was you know up until 2020 or 2021 no one had
[00:40:59] inflation on their minds and so it's it's hard to predict and I remember someone saying
[00:41:05] somebody came on the podcast and I thought that it was really good and um you know inflation is
[00:41:11] like toothpaste right like when it comes out it's very it's very hard to put back in so inflation
[00:41:17] can get kind of out of control if you don't aggressively attack it and very very high inflation
[00:41:24] for an extended period of time is not good for stocks not good for bonds not good for consumers
[00:41:31] and so you know that's the those are the types of economic environments you you know hopefully
[00:41:37] we don't experience in the future although you know there's going to be periods of time
[00:41:42] and we don't know when when inflation could come back and roar you know and and really be damaging
[00:41:48] but let's just talk through the implications from an investing standpoint yes so
[00:41:53] thinking about this we basically just spent 40 minutes going through all these numbers and now we're
[00:41:56] gonna tell you why you probably shouldn't even care about any of the numbers um but that is the
[00:42:00] reality is like if you think about it and Matt can talk about on the planning side but if you think
[00:42:04] about it on the investing side like what am I going to do with my portfolio because of inflation
[00:42:08] you almost have to have the decision made in advance you can be one of these people it says stocks
[00:42:12] and bonds are enough you can be one of these people to say stocks and bonds are not enough
[00:42:16] I need other stuff in here but you don't want to be the person who's switching between those two camps
[00:42:20] you don't want to be the person who's looking at these numbers and being like oh inflation is 4%
[00:42:23] or 2% or whatever it is so let's think about making some changes because not only is in future
[00:42:29] inflation very hard to predict but how the reaction to future inflation is also very hard to predict
[00:42:35] so trying to buy anything you know obviously if I thought I could predict inflation and it was
[00:42:39] going to spike you know to 8% I've probably got a pretty good chance of buying commodities and
[00:42:44] doing pretty well like commodities track inflation pretty well but like how am I supposed to know if
[00:42:47] inflation is going to track back to 8% I mean it seems like it's unlikely going to do that so
[00:42:52] that's the challenge on the investing side as you almost have to have you you want to have your long
[00:42:56] term portfolio and you can be a believer all I need is stocks and bonds you can be a believer I need
[00:43:00] other stuff but you've got to stick with that and you've got to avoid the trap of inflation spiking
[00:43:05] so let's buy this and you know now it's back down so let's sell the commodities because that's
[00:43:09] a losing battle so now that jack said inflation's hard to predict I'm going to make some predictions
[00:43:15] here you are the Justin predictions are coming in no just a couple just some things that you know I'm
[00:43:20] thinking about like you know obviously technology is very dyslationary and with AI and I think the
[00:43:30] impact that it's going to have you wonder if that combined with the baby boomer generation retiring
[00:43:40] and sort of you know spending less you wonder if like those deflationary forces are going to be
[00:43:47] so strong that and that's kind of like where it's going to be like an anchor to pull us back
[00:43:53] to this lower than average historical inflationary environment um
[00:44:00] you know the the and who knows it's just you know thinking about what's happening with technology
[00:44:07] what's happening with the world then the flip side of it you could say like de globalization
[00:44:11] it is more inflationary so as we bring more stuff back here and create it in the United States
[00:44:16] which is more expensive to produce you know maybe that's going to put upward pressure on inflation so
[00:44:21] you kind of have these global things that can have you know these pretty big impacts when you
[00:44:29] kind of try to think about them from a from a high level I think yeah and you to your point like
[00:44:34] there's been three drivers of deflation of low inflation over time not deflation but lower
[00:44:38] inflation you have technology you have demographics and you've had globalization so now we're in a
[00:44:43] situation where two of those are still likely deflationary but the other one is not anymore or
[00:44:48] disinflationary um that the globalization one has kind of gone the other direction and that's why
[00:44:52] this is so hard to predict is we just don't know like you've got two different things with inflation
[00:44:56] you've got sickle inflation you've got structural inflation and so the big quiz inflation is going
[00:45:01] to bounce up and down even if we're in like a 1970s which I don't think we are but even if we are
[00:45:05] the 1970s had big moves down in inflation as well so your sickle inflation is going to be all over
[00:45:09] the place no matter what what you're getting to is the idea of structural inflation and that's
[00:45:13] the big question right now you know it also like populism in general is kind of a driver of this too
[00:45:18] if we're going to take money from corporations and we're going to give it to people that's inflationary
[00:45:22] so the big question is the structural inflation and those major forces like once we get through the
[00:45:27] cyclable parts of this are those major forces going to drive a new like more permanent higher
[00:45:32] inflation level and you know it's above my pay grade to figure that out I mean that that's why
[00:45:35] we have you here yes it's clearly within my pay grade to now tell you the the very true
[00:45:43] inflation number so it's fascinating to me how these things both stack up and can be measured
[00:45:52] it's fascinating to me how you have to think and until like the deflationary point okay AI
[00:45:57] is going to take all these things and drive costs down to which then you also have to go well if we
[00:46:02] have AI then we need all these servers and then there's less globalization then what are we going
[00:46:06] to plug it into or is all the energy going to come from it isn't that part inflationary and over
[00:46:11] and over again I go back to this and I believe we covered this in another episode but it's this
[00:46:17] concept when when I'm explaining stocks may or may not be a great inflation hedge maybe they're
[00:46:24] correlated maybe they're not we know something goes into the input cost decisions if we think about
[00:46:29] just a McDonald's and we just literally think that any any store any operation that has to be in
[00:46:35] business has to figure out their input costs has to figure out how much it turns up to turn the
[00:46:40] lights on every morning how much it costs to get their inventory pay their workers all these types
[00:46:45] of things we're always trying to think at least a day or a quarter or a year into the future and
[00:46:51] figure out how do we basically charge more than it costs to continue to run this business
[00:46:58] and that's true for your household that's true for the stock that you buy that's true for in an
[00:47:04] abstract way even the governments of the world and so when we think about inflation and we think
[00:47:10] about all the things we're not going to know about what it is or where it's going we have to at
[00:47:15] least inventory the stuff that we know we have to pay out as an expense and we have to kind of set
[00:47:22] prices accordingly to what lets us play the game another day that's a hard thing to think about
[00:47:31] but you can't not sorry double negative you can't not think about that stock you got to make
[00:47:37] the list of all the stuff you're going to pay for and make sure you have a justifiable reason
[00:47:41] you're going to survive to fight that next day so whether it's financial planning or thinking about
[00:47:45] it in the investing landscape we're relying on companies when we invest in them when we're
[00:47:50] loaning money we're relying on some of the assumptions that are in that loan for the money that
[00:47:54] we're going to get back at the end that that's going to make sense that is a foundational building
[00:47:59] block of finance that's why this stuff is so infinitely interesting even if it's not
[00:48:05] true in the two plus two cents it's true in the sense that this is reality we have to deal with it
[00:48:12] since yeah one of these you and I talked about offline and I thought it was a really good point
[00:48:17] you made is this idea about thinking about inflation more like directionally than exactly
[00:48:22] like the idea is you know Matt hasn't prepared a financial plan for me you know I've got 3.5%
[00:48:27] in there it's 3.7 now let's let's like get that thing in the fireplace and let's start over but
[00:48:32] like it's almost like I have to think about this in terms of the major moving parts
[00:48:35] the versus the exact numbers because people get trapped in this you know we see these exact numbers
[00:48:38] all the time every time there's a CPI report we see these exact numbers and it's like oh do I
[00:48:43] need to change something because I saw these exact numbers and I thought that was a good point
[00:48:46] about like thinking about it directionally and I want to take it back Justin you made the point
[00:48:51] about you said like before 2020 or whatever you didn't have to think about inflation most people
[00:48:57] did not anybody let me tell you who had college age or near college age kids was really thinking about
[00:49:03] inflation they might not have been thinking about whole price inflation they might not have been
[00:49:08] thinking about prices at the pub but they were thinking how much of these tuition payments gonna cost
[00:49:14] being directionally aware of what prices you have in that big checklist so being aware of
[00:49:20] what those things are in your checklist if things are going to have to expense and then being
[00:49:23] directly aware of which direction they're headed in that's kind of the best any of us can do
[00:49:29] at the individual level to understand this stuff because if I'm a retiree I might only be thinking
[00:49:36] about my health care costs and you know whatever else if I have kids going into college I might be
[00:49:42] over over indexing to how much are those tuition payments are gonna be and if all my young person
[00:49:48] who doesn't own a house yet or you're thinking about having a kid and buying or whatever else
[00:49:52] you might want to over index to those things I have to my wife and I have to buy a house in the next
[00:49:58] you know couple years or we think we'd like to we're renting right now inside of that decision
[00:50:03] we're carrying it I care more about real estate prices right now than I've cared about
[00:50:08] in a hot minute and that's just because that's a future expense to me that directional awareness is
[00:50:15] that's such a huge point I think one thing that investors sometimes forget is that the returns if
[00:50:23] they get have inflation in there and the reason I'm thinking of this Jack when we had you just
[00:50:31] interviewed Rob are not the other day and we were talking about his interactive asset allocation
[00:50:36] tool and I believe they give real and nominal returns I love that tool you can do real and nominal
[00:50:44] it's a beautiful looking tool I've just I just click on it and it makes me happy it's way it's way
[00:50:48] more uh I get a way better higher like dopamine hit from that tool then again from the true
[00:50:54] inflation tool I want to see if you have a sort of a match just plays with the research affiliates pool
[00:50:58] for now and that'll be our next episode because you have two quantitative financial planner
[00:51:03] not all superheroes should capricious nice let's do it um but no I think you know when he talks
[00:51:11] about returns he always talks about real real returns um and and you know but like you said
[00:51:18] you can do both on the website um so anyways that's just a point that I thought was worth bringing up
[00:51:23] yeah and when they're not that different like they have been for you know until 2019 they weren't
[00:51:27] that different it's not that big of a deal but like if you live in the 1970s the difference between
[00:51:31] real and nominal returns was a big difference um you know like with the stock market in some years
[00:51:36] was doing pretty well nominally but like when you started taking out those huge inflation rates
[00:51:40] it was a very different world than you know when you got into the real world do we want to end with
[00:51:46] sort of I guess two two other things with I guess well one investing and then um one planning
[00:51:51] um with the sort of inflation and sackers so you know what type of stocks might do well in different
[00:52:00] inflationary environments which I think might be a little bit more interest rate driven then those
[00:52:04] but interest rates and inflation kind of goes hand in hand um yeah well what's what what are we thinking
[00:52:10] what's interesting is that that's something in theory everybody thinks you know you want to buy
[00:52:13] the value stocks you know in high inflation and high interest rate environments and when you look at
[00:52:16] like from a discounted cash flow perspective that makes complete sense I mean value has more of its
[00:52:20] value in the present growth has more of its value in the future but that sort of breaks down with
[00:52:24] the data um it was interesting about inflation versus interest rates is it it's a little bit of a
[00:52:29] different conclusion like the the relationship for most people I've seen who have looked at it
[00:52:33] the idea that you want to buy value stocks in like higher rising interest rate environments it doesn't
[00:52:38] hold up um in the long term data it doesn't you really don't get any better return from it but
[00:52:44] you do a little bit in high inflation higher rising inflation so it's interesting there's actually
[00:52:49] a little differentiator there like you do typically get a little bit better return from value during
[00:52:54] periods where inflation is higher rising now having said that it goes back to my original point before
[00:52:59] like should you do anything with that no um like are you gonna time when the inflation is going to be
[00:53:03] high and you know add your exposure to value and then you're going to be wrong for three years so
[00:53:07] you're going to abandon it because it's not working like in the real world like trying to use these
[00:53:11] things to add exposure to factors doesn't make any sense but it is it was interesting to me at least
[00:53:16] that like at least that thing about interest rates that everybody says you know value stocks perform
[00:53:20] better in high-interested environments it doesn't hold up um in in the data you know you you would
[00:53:24] think in theory it makes a hundred percent sense um but in the data it doesn't hold up as well as
[00:53:28] you would think I think what fast states me about that and these points is this is one of those
[00:53:35] connected back to building and operating real businesses and by all means treat your stocks
[00:53:41] in your equity portfolio as ownership stakes in real businesses this is when it's actually useful
[00:53:45] exercise because if we reduce it just down to talking about it as the value factor and that
[00:53:52] might be well and appropriate for constructing the portfolio but also understand it as
[00:53:57] it's kind of like in 2008 when nobody can write a mortgage and everybody wants to sell real estate
[00:54:03] well it was a really good time to buy real estate like that holds true you want to hold that stuff
[00:54:11] for when nobody wants to own it and it's cheap that's what value investing is conversely on the flipside
[00:54:17] whether there's inflation and everything else and stuff is going up there's a time in a place when
[00:54:21] it makes sense to hold that tangible asset that you acquired when it's cheap and there also
[00:54:25] is a time to unload that thing connecting it back from not just what is the factor represent but what's
[00:54:32] the economic reality of the factor that you understand it and reducing it back to a real world
[00:54:37] business I think is a insanely useful exercise for thinking through this stuff too.
[00:54:43] By the way Jack that data is a QR where is that coming from from a different place
[00:54:47] is we actually we had Mattias hand hour on the podcast he he put up a chart of that from Rebecca
[00:54:53] but yeah pretty much anybody like across the board they've kind of found that the relationship
[00:54:58] with that with value and interest rates and I'll try to go back and put one a chart in the podcast
[00:55:01] when we do it but it doesn't hold up as well as you would think it makes a ton of sense in
[00:55:05] theory it does not make as much sense in reality. Matt what about from just a planning standpoint how do
[00:55:12] you how do you work with clients when you're sort of looking at inflation or the directional side
[00:55:21] inflation or how does that how does this kind of flow into the planning process this is when the budget
[00:55:26] and all things for us go back to as I've said a million times on here it's what's the calendar
[00:55:33] what are the cash flows money in money out how they map over the calendar and then what's the balance
[00:55:38] sheet that results which is if the cash flow is a surplus what assets in my building if the
[00:55:42] cash flows are deficits what debt am I accruing or assets in my spending down and in financial
[00:55:49] planning the budget which takes it exists somewhere inside of that cash flow statement and it exists
[00:55:55] somewhere in not necessarily how much you spend on olive oil at the grocery store but what are the
[00:56:00] things that we expect to spend money on your basic stuff like if you're going to own a house and
[00:56:05] live there for 10 or 20 or 30 years we're not going to worry so much about the like there's no
[00:56:12] owners equivalent rent once you bought the house and your financial plan but there is a maintenance
[00:56:18] capital adjustment that will usually put on the value of a home will generally say the on the
[00:56:23] value of your home you know you're probably going to spend 3% on maintenance costs in a given year
[00:56:29] and if you don't spend it in one year expect to spend 6 and the other so we try to model stuff like
[00:56:33] that and again one of the most useful things where we I think modeling an inflation assumption is in
[00:56:40] places like college in places like health care places where a surprise of an above average rate of
[00:56:47] growth could really be a negative shock to your plan if you haven't set extra money aside to do it
[00:56:52] and those are cases where it's you might have with a retiring couple or something else you go
[00:56:58] how do we want to think about long-term care costs or something like increased health needs as we
[00:57:04] get on in life and you might want to actually break that out and apply a higher inflation rate to the
[00:57:08] expect the present present value of that number that's the places college I brought it up earlier
[00:57:15] you have kids going to college in a few years and this was certainly the case in like 2020
[00:57:20] where we would be saying yeah inflation is effectively zero you're not going to get any money on your
[00:57:25] cash but we still want to be making sure that college expense is going up by I forget what the number
[00:57:30] was but like 6 or 7% a year or something it was meaningfully higher than the regular inflation right but
[00:57:36] such was the tuition data for you know in state and out of state schools for most clients so on
[00:57:41] a financial planning perspective it's understanding on your cash flow statement what you have going out
[00:57:47] the door and if we need to index any of those where we really want to be cautiously aware of how much
[00:57:53] they can go up very very specific to the individual and very very specific jacks the point you made
[00:58:00] earlier of we just want to get this directionally right and probably air on the side of caution wherever
[00:58:05] we can yeah on the on the maintenance budget thing Matt I wish I had budget for a plumber instead
[00:58:10] of jack tries to change cartridge and kitchen faucet because we are currently on that project and I
[00:58:16] think the end result of that is going to be spend more money than flumber and jack does tons of
[00:58:20] works on kitchen faucet so I think I'll lose on both fronts there it's a stupid light item that we
[00:58:26] try to add to plans or what we talk through with people especially when they're going to be when
[00:58:29] they're not renting in their in a house for a long time is to actually think and again the key is say
[00:58:35] you use like 3% as the number on your house and there's there's background stuff on that I'm
[00:58:40] glassing over here but just say you use the 3% number the most important thing is to realize you
[00:58:46] might have a year when that cartridge doesn't go bad and man I had a kind of previously owned house
[00:58:52] at nightmare quit like a cartridge and like a shower thing and I thought I could fix for myself
[00:58:57] and man that was a that was a battle that ultimately I hope you don't find out it's not even the problem
[00:59:03] you think is the problem because you thought you can figure out the problem but the internet lied to
[00:59:07] you that's what happened to me it's like you know six other repairs later it ends with the
[00:59:11] flumber basically it ends with the yeah the arrival of a plumber and like a new heating unit and
[00:59:16] several other things but the reality is even when you have when you own a home as I have in the past
[00:59:22] like you go through you might have a year where nothing really goes wrong but then you have another
[00:59:27] year where everything goes wrong and the funny thing is like if you just say set aside 3% a year
[00:59:32] for maintenance costs on the house I'll just say they can go a long way even in a year when you
[00:59:36] don't use it it's getting sidecar bucketed somewhere you can be really happy when you go like we didn't
[00:59:42] spend the 10 grand last year or whatever it is with the 5 grand but like that 10 or 20 grand expense
[00:59:49] is coming it always is that's the joy of home ownership so we'll wrap it up in a second and this
[00:59:55] might be a good topic for you guys to explore with then over up breaking news but an article got my
[01:00:03] attention about grade inflation so inflation can happen outside of these financial the financial
[01:00:11] world and what they've found is this is worse than tooth fairy inflation but this is testing I saw
[01:00:16] this online this is staggering and especially with Jack and I know kids so they're finding that
[01:00:21] teachers are grading their students papers and work higher in order to just overall give better
[01:00:32] better grades and I don't know if the article pointed this out but it might and the other thing
[01:00:37] that was floating around too in the last week was like you know how test scores especially for the
[01:00:42] you know younger kids that with COVID and stuff they're finding that you know they're they're
[01:00:48] lower than they've been historically and so anyways the grade inflation might be a result of
[01:00:53] trying to make it make things look better than they actually are in the school system anyways that's
[01:00:59] the topics for maybe you guys to explore with with Ben Hunt on breaking news but kind of coming
[01:01:06] outside of the outside of the financial the financial arena yeah I thought I'd saw something at some
[01:01:12] point that like even like up through college like a lot of these Ivy Lee schools like you either get
[01:01:16] an A or they consider it like failure so they're like just giving out A's like almost everybody is
[01:01:20] getting A's these days because like it's a failure basically in the way you view it at least if you
[01:01:26] don't get an A this this is the stuff that's like a mess and as somebody with teachers in the family
[01:01:33] and whatever else can it test to this is one of those things where you have to be aware of what the
[01:01:37] layers of correct are in the people around you and who knows I mean for all the my generation
[01:01:45] often like was criticized for giving trophies to too many kids now I don't know maybe too many
[01:01:50] kids are getting A's in English class when they can't even send a text message with the proper
[01:01:54] your statement yeah that's true it's kind of a mess yeah um a non pop culture story although I was
[01:02:03] thinking earlier that like a good way to think about this too is you could think about like
[01:02:09] at the Super Bowl like who sings the national anthem and how often that changes over time
[01:02:13] that feels like inflation that feels like things that we can choose to like or choose to dislike
[01:02:18] but I'll agree upon as happening in the real world why does you know Whitney Houston say in 91
[01:02:24] and you know Garth Brooks in 93 and does anybody remember joules singing the national anthem in 1998
[01:02:29] I was looking this up earlier but I'm thinking about do you know about the the size of the cockpit for
[01:02:35] airport's air force pilots do you know the story no no like setting this this is perhaps as useful
[01:02:43] if not more useful than the planes getting shot down thing so they had this world were to
[01:02:50] later 40s so post world were to where all these pilots were crashing and they do this big internal
[01:02:55] study and it effectively said that the problem is in human or mechanical air but design of the planes
[01:03:01] itself as you can imagine post world were two there's a lot of these things so the standards for how
[01:03:07] built these planes and set the cockpit they all the way go back to 1926 when the government is
[01:03:13] trying to figure out how to build planes because of you know wars so in the 50s the military
[01:03:19] commissions of study they capture 140 dimensions of over 4,000 pilots jack your research to the
[01:03:26] inflation numbers do we have 140 dimensions of 4,000 different inflation indicators yet I think it
[01:03:33] is less than that okay so this junior researcher this guy I think it's lieutenant Gilbert Daniels
[01:03:39] this I'm an old cultist creative post on this I'm not remembering this off top man but he recognized
[01:03:44] the flaw in the approach and the takeaway was or one of the takeaways is he's like inculating the
[01:03:49] average hand they ended up with a theoretical hand that no person actually had so the 4,000 pilots
[01:03:56] the 8,000 hands not a single person actually fit the hand that was being used in the model for
[01:04:04] the cockpit design and that's kind of a profound thing and that's kind of like what's happening with
[01:04:10] these inflation numbers so if Daniels goes further to actually show that not even one pilot was
[01:04:17] average on his fewest 10 of the dimensions and he actually produced thing and were reduced only
[01:04:23] three dimensions about 4% of the population was actually a fit because there simply was no such thing
[01:04:28] as an average pilot they had tried to make a cockpit for everyone and instead designed a cockpit
[01:04:34] cockpit for precisely no one and this turned out to be the source of the crash problem
[01:04:41] with inflation and all this stuff it's just we're agreeing on average and we're agreeing on something
[01:04:45] we're going to measure average by but the reality is nobody experiences it this way you
[01:04:50] experience it one of the many flavors of ways you invest in a portfolio that's an exposure to
[01:04:55] many of these flavor ways just be aware of it like the Air Force pilots this is a mess to calculate
[01:05:03] and play it for this stuff and sometimes the answer is just aren't as clear as they seem jack I'm so
[01:05:07] happy you dove into all this data because I am consistently overwhelmed with the number of ways
[01:05:13] you can measure inflation and by the way my favorite nationally anthem of all time for Stapleton
[01:05:18] I don't know if you know why that was a great one wait I think we don't remember some of the
[01:05:22] older ones without it was outstanding Whitney Houston I think is my top of all time it's a weird
[01:05:28] thing the end of her national anthem it's one of those things I think I hear in my head automatically
[01:05:32] and remeasure everyone else nationally at the month forever but okay do you have a favorite
[01:05:38] uh you have a favorite national anthem Justin I mean I like I thought Jack kind of I may maybe
[01:05:43] maybe it's um recent Z bias Stapleton Stapleton was right um what what what are some of the others
[01:05:49] just real quick Matt oh man uh hold up or no yeah yeah no I have and it's also interesting that they
[01:05:54] didn't always sing the national anthem it was a star single I didn't realize jewel in 98 was like
[01:05:59] that big of an artist I mean we'll save your soul and sing the national anthem except there you
[01:06:06] huh yeah and there's lots of weird ones too like um I mean some of the highlights he had
[01:06:10] Barry Manelow in 1984 I thought that was a good one her Balber played it just on a trumpet 1988
[01:06:17] that was a fun one uh we got Backstreet Boys in 2001 yeah um it's also really interesting to look at
[01:06:22] like who bookends the different people like we had uh like Kelly Clarkson in 2012 and then Alicia
[01:06:28] Keys in 2013 okay Adina Menzel that's the frozen lady I think right she did 2014 uh pink in 2018
[01:06:38] I actually remember that being gladest night killed it in 2019 I remember being excited by that
[01:06:43] remember being confused about Demi Lovato in 2000
[01:06:46] he's not cheating the back there's the here's the real one though predict the future do you know
[01:06:51] who's singing it in 2024 I know they told me this I forgot and then Wikipedia retold me oh wait
[01:06:55] hold on I don't I don't I think we'll just do anything is it the um is he kind of like uh
[01:07:01] is it jelly roll or that would be awesome I mean maybe they've changed it with
[01:07:05] Wikipedia's update what was the throwback I wasn't ready for this one uh Reba McIntyre apparently
[01:07:11] oh cool Reba who in age inflation still looks the same for the less like 20 something years
[01:07:18] yeah we'll sing your next though I'm sure she's saying it she's saying it this year correct 2024 right
[01:07:27] yeah it's the boy Wikipedia my memory it is it
[01:07:31] that's right so I still have the chance to get that right
[01:07:33] do you think it's being so that's probably not the right jelly roll for 2025 that's our vote
[01:07:40] all right guys thank you guys for listening we'll see you next time
[01:07:44] hi guys this is Justin again thanks so much for tuning into this episode
[01:07:49] you can follow Jack on Twitter at at practical quant you can follow me on twitter at jj carbono
[01:07:55] and follow me on twitter at cultish creative if you found this discussion interesting and valuable
[01:08:00] please subscribe and either iTunes or on youtube or leave a review or a comment also if you have
[01:08:06] any ideas for topics you'd like us to cover in the future please email us at access returns pod
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[01:08:17] you