You have heard of the madness of crowds… on Tuesday this week, we witnessed the madness of computers. A few years ago, we talked quite a bit about the phenomenon of computer-driven trading. We don’t think of it much anymore, but it is still there, and every once in a while it rears its ugly head.
Tuesday’s Consumer Price Index (CPI) report showed inflation at 8.3 percent – below the previous reading of 8.5 percent, but above the expectation of 8.1 percent. The core reading, adjusted for food and gas, came in at 6.3 percent, which was an increase. The driver on that increase was housing, and it is important to understand that the current methodology for calculating housing cost has an almost seven-month lag. Real-time data suggests that housing has peaked and is heading down in price.
Here is where the computers take charge: They were programed for “miss on inflation = sell.” Had inflation been lower than the published expectation, they likely would have bought. How do I know this? In truth I have no evidence, nor am I going to waste my time researching, as it really doesn’t matter. Logic and experience tell me that no thinking human being with even a modicum of financial sense is hitting the panic button over an inflation reading that is headed in the correct direction – only computers trade like that.
Economic forecasting is not an exact science; in fact, it can barely be called a science at all. The important factor in Tuesday’s number is not whether it is 8.1 vs 8.3. The important factor is that this is the second reading in a row that is heading down instead of up. Thus far inflation, as measured by CPI, has peaked at 9.1, and the next two readings have been 8.5 and now 8.3. That is good news, not bad.
The sudden selloff does reflect the mood. Pessimism is high right now – too high, in our opinion. Pessimistic short-term traders create opportunities for long-term investors. We don’t even need things to be good, we just need them to be not as bad as the pessimists believe. An inflation reading of 8.3 percent is certainly not a good thing, but it is better than 9.1 percent and better than 8.5 percent. Improvement is all we need. Keep it heading in the right direction.
I know it is frightening to many to see the stock market go down 4 percent is a single day. When it happens, it is important to remember that this does not reflect reality. Apple is not a different company today than it was on Monday. The Home Depot will not be shutting down anytime soon. Your Visa card will still be accepted when you need to use it tonight. The real world doesn’t change 4 percent in one day.
This is why prudent investing is done from the bottom-up. We are investors in companies not traders of stocks, and the companies we own, both directly and indirectly through funds, are doing well. To the extent that their business is hurt by inflation, that pain is a little lower this month than it was last. That is what Tuesday’s report says to a rational human being. The computers are frustrating, and can cause havoc in the short term, but in the long run it is still about the companies one owns. This too shall pass, and long-term owners will be rewarded.
Warm regards,
Chuck Osborne, CFA
Managing Director
