Keystone's Inflation-Deflation Indicator Signals DISINFLATION

The markets and economy were mired in Disinflation for much of 2012 despite the higher food and gasoline prices that folks see daily. In May 2012, Keystone's indicator dropped into Deflation. The stock market rally from June into the October top boosted the indicator back up thru Disinflation and into the Neutral zone (3-4), only to see it fall again during the November market selloff, dropping down to 2.9-ish on the verge of deflation. The indicator recovered in December to print on either side of 3 but end the year at 2.99, a hair on the Disinflation side. The 10-year yield (now 1.76%) moves in the same direction as the equity markets since money moves from stocks into bonds and from bonds to stocks depending on risk-off, or risk-on, respectively. Higher yields = higher stocks = a move towards inflation. Lower yields = lower stocks = a move towards deflation.

The note price is used for the denominator of Keystone's equation. The 10-year yield is 1.76% with a price at 98.8047. The CRB (Commodities Index) languished at 270-ish on the cliff edge during June-July 2012 but recovered when Draghi said he would support the euro by all means necessary.  The CRB is weak closing the year out at 295.01 under the 300 level indicating a weak global economic environment.  Taking a look at the numbers;

CRB/10-Year Price = 295.01/98.8047 = 2.99

Over 4 = Inflation
Between 3 and 4 = Neutral; inflationists and deflationists fight it out
Between 2.9 and 3.0 = Disinflation
Under 2.9 = Deflation

Chairman Bernanke announced QE1 in 2009 and QE2 in 2010 as the country became mired in deflation with Keystone's indicator in the 2.5-2.6 range each time. The indicator dipped into this area in May 2012 but then recovered when the central banksters started talking stimulus from 7/26/12 forward (Draghi's proclamation). The oddity was that the ECB's OMT Bond-Buying program and the Fed's QE3 announcements in early September, and even QE4 announced in December, occurred when the stock market was already elevated.

The prior stimulus measures (QE1, QE2, Operation Twist, LTRO 1 and 2) all occurred when the markets slipped into deflation (under 2.9) so that expected trend was broken for the latest stimulus measures.  It smacks of desperation, a 'throw the kitchen sink at it' approach. The SPX actually dropped under the levels where QE was announced in early September by both the Fed and ECB.  Bernanke fears deflation since he is a student and scholar of the The Great Depression.  Bernanke says the Fed did not act quickly and forcefully enough in the 1930's.  Hence, he has the nickname Helicopter Ben since he said in a speech a few years back that money should be dropped from helicopters to stop a deflationary spiral.  Japan's deflationary spiral is now in its second decade. But Bernanke's economic experiment may hit a road block in 2013 since the velocity of money is not increasing and now all the major countries are in a race to debase their currencies.

Keystone's indicator is now signaling Disinflation. The pundits and analysts that say Inflation and even Hyperinflation are at the doorstep are likely premature.  Inflation will likely not appear until two, three, or even more years down the road to line up with the 18-year stock cycle of 1964 (bear), 1982 (bull), 2000 (bear), and 2018 (bull). That will be a new and intense problem, especially hyperinflation, but for now, the disinflationary and deflationary scenario's are far more important. Look at Japan's funk for the last twenty years; deflation can be nasty and will surely change all our lives.  Large-scale layoffs are now occurring in the U.S. with more frequency. The current stagnant wage growth screams of deflation.  Technology, computers and the Internet are huge deflationary machines.  Robots continue to replace human's on the job.

Watch Keystone's formula above, you can crunch the numbers to check on the indicator every few days. Markets are in trouble when the indicator drops under 3.00 into Disinflation.  Equity markets are going over the falls if 2.90 fails since it indicates a deflationary spiral is occurring and the U.S. is headed straight for a Japan scenario. As long as the indicator stays above 3.0, in the Neutral territory and higher, the equity market bulls are happy.