LITTLE ROCK — A year ago, three Stephens Inc. executives predicted that the country would soon experience an outbreak of inflation, contradicting the opinions of most economists.
Bill Tedford, Alan Tedford and Brian Bush, vice presidents and portfolio managers with Stephens Capital Management, projected in October 2009 that inflation would rise by early 2010 - and possibly hit 5 percent or 6 percent by early or mid-2011.
A year ago, the Consumer Price Index was deflationary - at minus 1.3 percent. It rose to about 2.5 percent early this year, but it has leveled off to about 1 percent since then.
Still, the Stephens team has not wavered from its basic premise of last year. Bush and the Tedfords project that inflation could reach about 3 percent by late summer 2011, less than the 5 percent inflation they predicted but still higher than the markets are anticipating.
“Our model is still saying that the inflation we talked about [last year] is still out there in front of us,” Bill Tedford said in his office at the Stephens Building in downtown Little Rock. “We’re still expecting a fairly important increase in inflation between now and next summer.”
The three base their opinion on the flood of money the central bank haspumped into the country’s economy - more than $1 trillion through the purchase of mortgage-backed securities in a 12-month period from fall 2008 to fall 2009, Tedford said. Typically, the government’s infusionof capital into the monetary system leads to inflation about 20 to 24 months later, Tedford said.
Stephens tries to determine the direction of inflation and not necessarily how high or low it gets, Tedford said.
“The Fed says it is worried about deflation, that the risk is on the downside,” he said. “We say, ‘No, it’s not.’ We disagree. We think the risk is to the upside.”
The Stephens group’s opinion on inflation still has little support among economists in the country.
In order to pull the national economy out of a recession, the Federal Reserve Board dramatically increased the money supply by buying the mortgage-backed securities - the first round of “quantitativeeasing” - to provide financial institutions with capital and prevent credit from drying up.
But while energizing the economy, there is the risk of awakening inflation.
Kathy Deck, director ofthe Center for Business and Economic Research at the University of Arkansas at Fayetteville, said she doesn’t expect inflation to increase significantly in the next year or so.
“What we’ve seen in our society is that the optimal condition for economic growth is low, stable inflation, in the 2 to 3 percent range,” Deck said.
“The reason we have not seen inflation ... is that the money is not circulating in the economy,” Deck said. “It’s getting holed up on banks’ balance sheets. It’s not that banks don’t want to lend out the money, there just aren’t as many credit worthy great opportunities as you’d want to see.”
A president of one of the 12 Federal Reserve branches has alluded to the possibility of high inflation.
Thomas Hoenig, president of the Kansas City, Mo., branch of the Federal Reserve, said this month that inflation in the 4 percent to 5 percent range could be possible based on how the country might react to a second round of quantitative easing- such as the Fed buying U.S. Treasury bills- to stimulate the economy.
With such a move, inflation might systematically rise to 2 percent or 3 percent in time, Hoenig said.
“[But] we have no idea at what level inflation might settle,” Hoenig said. “It could remain where it is or inflation expectations could become unanchored and perhaps increase to 4 or 5 percent.”
Some causes of inflation are beyond the control of the Fed and its monetary policies.
A bill pending in Congress - and already approved by the House - would authorize the Commerce Department to impose tariffs to offset what it determines to be foreign imports that are undervalued because of an unfair currency exchange rate. A tariffs war could lead to inflation in the
United States,
some argue.
If such a
battle were to
arise, world
trade would
shrink and
“everybody
loses,” Ted
ford said.
“The general feeling isthat would be detrimental to the world economy,” said Tedford, who cautioned that currency issues are not his specialty.
The Federal Reserve speculated in its Sept. 21 meeting about a strategy to promote spending by persuading consumers that prices could increase in the near future.
“The Federal Reserve would like to increase the expectation that there is some inflation out there,” Bush said. “What they’ve done is injected all this money into the system, but it’s not getting out there in the economy.”
But managing inflation expectations can be a “very tricky issue,” said Michael Pakko, chief economist and state economic forecaster for the Institute for Economic Advancement at the University of Arkansas at Little Rock.
“Eventually, we could have the classic formula for inflation, which is too much money chasing too few goods, with the emphasis on too much money,” said Pakko, who also doesn’t expect inflation to increase much in the near future. “There is so much money out there now in circulation, not finding its way into bank loans but just sitting idle.”
Pakko speculated that there may not be significant inflation in the country for four or five years.
Stephens doesn’t expect the economy to go back into recession, but it will not be red hot either, Tedford said.
“There are just too many people who have too much debt,” Tedford said. “It’s just going to take a long, long time for us to get back to the economy that we’ve been used to in the last decade or so.”
To hedge against the expected rise in inflation, for the past year Stephens has advised its customers to invest about 10 percent of their portfolios in a commodity fund, which has been profitable.
The firm also is advising investors to buy shorter-term bonds as a protection against a rise in interest rates, Tedford said.
“Rising interest rates cause the price of bonds to fall,” Alan Tedford said. “As such, the longer the maturity the more the prices get hurt. Therefore, an investor is better off to ‘play defense’ and buy shorter-maturity bonds in order to avoid getting hurt as badly.”
“And this may sound strange, but we think the stock market is really, really cheap now, so we’ve been increasing our exposure to the stock market,” Bill Tedford said. “Mathematically, stocks are the cheapest I’ve ever seen them.”
The earnings of the Standard & Poor’s 500 index companies equaled $13 a share at this time a year ago, Tedford said. Now those companies are earning $70 a share, hesaid.
“Stock prices have not risen nearly enough to account for that,” Tedford said. He advises buying broad indexes of stocks instead of individual stocks, he said.
Business, Pages 77 on 10/24/2010