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Prepare For Deflation In 2019

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Includes: BIL, DFVL, DFVS, DLBS, DTUL, DTUS, DTYL, DTYS, EDV, EGF, FIBR, GBIL, GOVT, GSY, HYDD, IEF, IEI, PLW, PST, RINF, RISE, SCHO, SCHR, SHV, SHY, SPTI, TAPR, TBF, TBT, TBX, TLH, TLT, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBT, UDN, USDU, UST, UUP, VGIT, VGLT, VGSH, VUSTX, ZROZ
by: Jason Tillberg
Summary

I think inflation is heading lower in 2019.

I think the Fed will be halting interest rate hikes and even lowering them in 2019.

Safe, longer dated bonds look attractive now.

This 20+ Year Treasury Bond EFT fits the bill.

I think we are headed for lower rates of inflation in 2019. In such a condition, the stock markets would be a place to avoid as capital leaves riskier assets and plows into what are perceived as less risky assets.

Higher yielding longer dated US treasury bonds should still be considered a safe place to put money. The ETF iShares 20+ Year Treasury (TLT) fits the bill for such a place to put money now. The risk however is that if interest rates rise, this EFT share price would fall. I would not suggest this ETF as a long term investment (2-5 years), but do like it for 2019 as lower inflation takes hold as I predict it will.

I'll start off my case stating that 2018 will prove to have been the year when the US had its best chances of creating real momentum in the economy.

Deregulations, tax cuts and a very pro-growth Federal Government agenda were all that the US needed to re-ignite the animal spirits of Main St. America.

My observations suggest that this was as good as it will get. The jump in GDP growth may well prove to have been a false move and the real trend of a long term declining economy will continue.

For this article, I want to point to two statistics in particular that in my judgement proved to be too weak vs. what should have happened.

The old saying, "you can lead a horse to water, but you can't make it drink."

You can create the conditions for a strong free market economy, but you can't make them work and/or borrow.

Work

Demand for labor certainly took off in 2018 as judging by the statistic of the number of job openings. The number of job openings has exceeded the number of people considered unemployed. That is, they are in the workforce looking for work but don't have a job.

U.S. Bureau of Labor Statistics, Unemployment Level [UNEMPLOY], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNEMPLOY, November 25, 2018.

This is quite a chart and goes to show the tremendous amount of work that is being asked to be done that is going undone solely due to there not being enough people wanting to work and make money.

It's this next chart that is the one that is the most telling of the state of the US worker. The labor force participation rate.

The best we can say for the US labor force participation rate is that it stopped falling. It bottomed in September of 2015 at 62.3%. With all the job openings, this should have been moving up. It didn't and that should concern anyone who wants to see growth.

I have two other thoughts about this worth noting. First is the relationship between the labor force participation rate of those aged 16-19 and those aged 55+.

A 60-year-old today was 16-19 years old back in the years 1974-1977. It was during roughly that time period when we had very high rates of labor force participation (when the 55+ were 16-19 years old) in our current 55+ age group.

The 16-19 year olds during the 1970's up until 2000 were far more likely to have been working than those aged 16-19 today.

The second thought is to compare our labor activity rate to that of Japan, the land of the rising sun. This statistic is called the Activity Rate. It measures both the employed and unemployed. Per wikipedia,

This figure is a measure of the degree of success of the economy in engaging the population in some form of production.

The percentage of Japanese people simply engaged in the workforce has shot up since about 2012 while it has stagnated in the US.

Throughout the 1980's and 1990's, the US has a fairly higher participation rate vs. Japan and it's only since about 2009 when Japan's exceeded ours.

What's worth noting is that during the 1980's and 1990's, Japanese workers tended to work far more hours per year than us here in the US.

Today, both the US and Japan have similar annual hours of work statistics.

The point of this thought it to point us that the US has a fairly substantial percent of her population that isn't engaging in the workforce or even trying to enter it. Untapped economic demand that has passed and gone with the wind.

Loan Growth

We'll be more likely to take out a loan to buy something or invest in something when we have confidence we can both pay it back and it will provide a reasonable rate of return.

The key factor is confidence. The private sector is where this happens especially.

Inflation does indeed come from new loan growth and it's the lack of new loan growth, even with the economy running as strong and tight as it is today, that raises concern for deflation or perhaps even a credit crunch.

I'm going to provide two charts that I believe speak volumes as to the state of demand for new loans.

This first chart is the net percentage of domestic banks reporting stronger demand for credit card loans.

Board of Governors of the Federal Reserve System (US), Net Percentage of Domestic Banks Reporting Stronger Demand for Credit Card Loans [DEMCC], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DEMCC, November 25, 2018.

Pretty much during the entire Trump Presidency, there has been a lack of demand for credit card loans as per this chart above. Even during 2018, credit card loan demand has continued to wane.

This next chart shows the net percentage of domestic banks reporting stronger demand for commercial real estate loans with construction and land development purposes vs. the previous 3 months.

Board of Governors of the Federal Reserve System (US), Net Percentage of Domestic Banks Reporting Stronger Demand for Commercial Real Estate Loans with Construction and Land Development Purposes [SUBLPDRCDC], retrieved from FRED, Federal Reserve Bank of St. Louis; Net Percentage of Domestic Banks Reporting Stronger Demand for Commercial Real Estate Loans with Construction and Land Development Purposes, November 25, 2018.

A net -17.9% of banks are reporting stronger demand for loans for commercial real estate construction vs. the previous 3 months.

In other words, out of 100 banks being asked if they are seeing stronger or weaker demand for loans vs. the previous quarter, 32 would have said stronger and 68 would have said weaker.

Conclusion

There can be a greater case made, an entire book written for that matter, for why I believe inflation is heading lower. I'll take it one article at a time, so please click the follow me button to hear my thoughts about inflation in the future.

This could become a very meaningful element to how the markets play out in 2019.

Inflation is a very dynamic animal and one that requires the forecaster to have a deep understanding of all the facets that contribute to how much the rate of inflation will be.

I'm becoming more and more convinced that we are headed toward lower inflation and that the Fed will be lowering interest rates in the not too distant future to try to stimulate loan demand again. Also, to reduce the debt service expense.

iShares 20+Year Treasury Bond EFT (TLT) offers investors both a decent yield of 2.86% at the current price of 115.14 per share, but also price appreciation potential in the event that interest rate decline.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.