Sunday, December 2, 2007

Are your lights on upstairs?

We're talking inflation this week. It's a much bandied about subject around here. I believe it is significantly higher than the 2-3% the BoC likes to claim. Apparently I'm not alone:
Good investors check things out for themselves as Ronald Reagan recommended when he dealt with the Soviets: "Trust, but verify."

To take a concrete example: What do you think is the level of inflation? This is critically important, both if you invest, and if you plan for your retirement. In the case of investing, the rule of thumb is that the proper market price-to-earnings multiple is 20 less the inflation rate. So if inflation is 3 per cent, a PE of 17 times is reasonable. On the other hand, if inflation is 10 per cent, as it was in the late '70s and early '80s, then even a PE of 11 or 12 would be too high. As for retirement, no need to elaborate on the need to figure just how far your dollars would go in your golden years.

So, you may ask, what's wrong with taking Statscan's consumer price index figure? That number usually ranges between 2 per cent and 3.5 per cent. But is this the real inflation figure? No it isn't. In fact, the government says so specifically - although in very small print: The CPI is merely a measure for indexing civil service employees' pensions.

Seymour Schulich, in his wonderful book Get Smarter: Life and Business Lessons, says that in his experience, money loses 90 per cent of its value every 30 years. For example, a La-Z-Boy chair for the TV that costs today $2,000, had cost $200 about 30 years ago. A house that had cost $50,000 30 years ago, would cost today $500,000, and so on. A growth of 10 times in 30 years comes out to about 8 per cent a year.

Therefore, the best indicator for food inflation I have found is the price of yogurt. Yes, that simple, plain food item that - unless you buy it flavoured - is about the same everywhere. Since I have a good memory for prices, I know that eight years ago my family paid 29 cents for one of those little plastic containers of yogurt. Today we pay 79 cents. (You'd probably pay $1.29, but I am a value buyer.) This comes to 2.7 times the price in eight years, or a growth rate of 13.2 per cent a year!

How high is real inflation today? It is certainly not 3 per cent a year. Even if it is "only" 6 per cent, the market's PE is too high. But if inflation is really 8 to 10 per cent a year, then the market next year may see some reckoning, because its PE is way too high.

So why does everyone figure on inflation of 3 per cent a year, 3.5 per cent, tops? Because, as you probably realize by now, few people bother to check things out for themselves. Most rely on printed numbers and stats, instead of opening their eyes to physical reality. If you, on the other hand, start checking things for yourself, very soon you might know what no one else does - and could take advantage of it by acting on what few others see.
Kind of reminds me of when I talk RE with my peers. They keep saying the market has no where to go but up. They keep saying all the Realtors keep telling them so. And CMHC. And VREB. And the TV. And the Newspapers. Funny that.

VREB numbers should be out tomorrow. I'm thinking that the October numbers will prove to be a downward blip. I think, just from watching the low-end that prices will be up from October, but still below September's high. Sales will be the highest seen in November.

As an aside. I read that Schulich book two weeks ago. It's a great read. No chapter is longer than 5-6 pages. Well written, good thinking, plain lessons.


Anonymous said...

Thanks HHV, will look for that book for a stocking stuffer for hubby. He's a H.Dent convert, anyone else have some good book recommendations? I was looking at some to do with the rise of India and China for him. He's read all of Kiyosaki. He liked "when it's raining in brazil, buy starbucks". Hit me with the reading list, I'd love to get him another "Dent" like bible.
Also I have a young child so I miss most 6 pm news. My Dad says there was a piece on ? Global or Chek this past weekend that had to do with falling home prices and warning buyers off buying for a few months, credit crunch etc. Did any of you catch that and do you know where I can find the print version? Just curious to see how far MSM waded into bubble theory.

Anonymous said...

It seems that some "prices" are rising while others are dropping, but a credit crunch leads to deflation, does it not?

Anonymous said...

more bad news:;jsessionid=4QOSCUYZZ3EXJQFIQMGCFF4AVCBQUIV0?xml=/money/2007/12/03/cnrates103.xml


Prairieboy said...

I also think inflation is higher than Statscan states, but I don't know how much higher. I was actually talking to my dad about it yesterday. He was laughing about how much they paid for things in the 70s. His first colour TV, a 20" model from the local Co-op store, was $400 in 1975. Also, buying me toys for Christmas was a big deal - a FisherPrice toy was $25 in the 70s, a time when he was making $5/hour. Yes, some items have risen in price like crazy, but others, not.

Anonymous said...

I'm waitin' and waitin' and waitin'...eventually, we're going to buy...
My wife and I left Vancouver in September and moved to Victoria. We didn't own in Vancouver, but did buy waterfront on Pender Island a few years ago. That purchase sorta 'gets us in the game', as it were.
We're basically house sitting until March, but will have to find somewhere to live by April.
I guess my question is this: Will prices continue to reduce through to March, or will they hover and then drop later in the Spring? Or are we better off giving up buying in the next 6 months and just renting something? Any input would be appreciated..

vg said...

I would expect them to hover around here til spring when the reality of the coming US recession hits home then the declines will start once the volume begins to increase and the reductions we have seen lately is much more common, the days of bidding on a house are getting fewer and farther between in my opinion.

Another article in the Globe today on the misconception of the Canada/US "decoupling" theory that just isn't going to happen once the US starts slowing down big time,we will not be immune,it will be too large a slowdown with the subprime still causing Canadian financial institutions grief trying to calculate their real value.

Economic train wreck in the U.S.

As much as we would like to think otherwise, the Canadian economy remains deeply intertwined with the United States. Americans buy more than three-quarters of what we export, accounting for nearly a quarter of gross domestic product. And the United States is now perilously close to recession. The risk is now near 50 per cent or better, according to many forecasters.

Even the credit crunch, which many believed was quarantined in the U.S. subprime lending industry, has proven remarkably virus-like. The crisis in the Canadian short-term commercial debt market suggests there isn't much that happens in the United States that doesn't eventually affect Canada.