In the graph above I’ve marked the difference between disinflation and deflation. Disinflation happens as part of the normal cycle. I’ve noted 15 such examples in the past 70 years. Deflation, however, is rare. In fact, it has only occurred four times since the late 1940’s. The rate of change in inflation is one of two main causal factors to my asset allocation decision making.  So just to be crystal clear, it is 50% of what I look at to make asset allocation decisions. For me to get this wrong would be like a pizzeria forgetting to put cheese on the pizza. (For those inquiring minds, the other 50% is the rate of change in growth in the economy.) Since my focus this week is inflation, the quick take on economic growth is that it is going down and hard. Given that backdrop, can you tell me what two seasonal investment outcomes to look for? If you said Fall or Winter you’d be correct. Just narrowing it down to those two regimes will give us a big leg up in our investment decision making. 

There is only one point I want you to take away from this graph. The main point is that inflation is not a constant or a level. It changes. There is no “managing” the level of inflation. See, you are already smarter than most people at the Federal Reserve. Asset prices move (which is really the only thing you should care about) based on the rate of change in inflation. Inflation is a cycle. Sometimes it is a big cycle and sometimes it is not. Sometimes it is a short cycle, sometimes it is a longer cycle. The only question we really need to answer is what is the future outlook for the rate of change (ROC) in inflation. Whether it turns out to be long or short or big or small is impossible to know ahead of time. I don’t know and neither does anyone else.  All we know is that it is beginning to change. So we continue to monitor the change and adjust the portfolio accordingly.

The easiest example of what I mean by the rate of change is to think about hitting the most perfect drive on a long par 5. Based on a small amount physics, you can imagine that as you strike the golf ball with your driver, the impact launches the ball forward - remember this is your perfect drive not your usual drive! Somewhere out on the fairway this phenomenon called gravity and a few other things slows the ball down and begins to descend toward the ground. If you could measure all of the factors that began to overtake the upward thrust of the ball, you would see that somewhere, out there, the ball begins to decelerate and fall. This is basically the rate of change process that I go through. 

The short answer to all of this is that inflation is peaking (think of our golf ball mid-flight) or to get super fancy- most likely peaked in March. Because we invest in the future and not the past, knowing the mechanics (physics) of the slow-down could be advantageous. No? You’ll notice in the graph that peaks in inflation are not nice, rounded tops. They are sharp and jagged. This is the proverbial “you have to skate where the puck isn’t” in order to make any money at this. The brain mechanics of why this is difficult to do is called recency bias. We are wired to take what has happened in the most recent past and extend this out into the future. This is like hitting a golf ball and expecting it to never come down in the fairway. 

Just remember, inflation is cyclical and not a straight line. We need to anticipate these coming changes and position our assets BEFORE consensus. Being outside with the birds looking in is never fun, but a necessary part of the successful investing process.

Have a blessed day!

Paul Franklin, Jr., CEO

Franklin Trend Investment Management, LLC