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By New_Deal_democrat November 6, 2017 11:06 am
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Rising producer prices are flashing a caution signal
In addition to my long leading/ short leading/ coincident paradigm for forecasting expansions and recessions, I have a couple of fundamentals based alternative approaches that tell me how confident I should be.

One alternative method is to look at the health of consumers: are real wages increasing?  If not, are interest rates on mortgages and other loans falling in a way that allows refinancing? If not, are widely held asset classes like housing and stock prices rising?  Nothing has changed on that front recently: real wages are treading water and interest rates have not fallen to new lows. but asset prices are rising. 

Another alternative method looks at the production side: are producer prices outpacing consumer prices? Is it happening after the expansion has become established (as opposed to just coming out of a recession)?  If so, producers generally aren't able to pass on price increases to consumers, and that means they will be looking to make cuts. 

To look at this second alternative method, here are two graphs covering the entire post-WW2 time period.  The blue line is PPI minus CPI. If the value is above zero, that means the YoY PPI is higher than YoY CPI.  The red line is YoY PPI by itself. Usually but not always before a recession (and before each of the last 3 recessions), PPI is running "hotter" than CPI, and PPI itself is accelerating or at least steady:

 

Of course, the most important point for our purposes is the far right of the second graph, which is the present.

And there, the fundamental analysis is flashing a warning. For the last year, producer prices have accelerated, and they are running hotter than consumer prices. This condition has gone on long enough that I would expect to see producers begin to engage in cost-cutting measures.

This is essentially another way to look at what is probably happening with corporate profits, a known long leading indicator. Here's a look at how this shakes out on a quarterly basis:

Producer price increases outpacing consumer prices has typically (although not always) coincided with a pause or downturn in YoY corporate profits.  But since producer vs. consumer inflation are reported monthly with only a slight lag, they create a much more frequent and timely signal.

All of this cycles back generally to housing. Since last winter, most housing sales metrics have been flat to slightly negative. If that persists, and *if* house prices follow suit, that would trigger a warning in the consumer based fundamental analysis, and would probably be decisive in tipping the general direction of the long leading indicators to negative as well.

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