Courtesy of Doug Short.
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The June Consumer Price Index (CPI) is up 2.1% from a year ago. The latest monthly rise was driven by the escalation of oil prices. However, this rate of increase is slower than what consumers are experiencing. This post has been updated from our post on May 15, 2014.
Continuing our research into using the Big Mac as a gauge of inflation, we build on past posts but use our own research to draw conclusions. In previous articles, we have relied solely on The Economist’s calculation of the Big Mac price. The Economist has been conducting the research sporadically since 1986. However, it was not until a few years ago that they began regular updates to their research in both January and July. Believing this span is too great, we have compiled our own look at the price of the Big Mac in the United States. Thanks to my assistant Geraldine Garcia, we have surveyed 30 McDonald’s restaurants throughout the nation to obtain the average price and compare that to the trend.
From our research, we have determined that the average price of a Big Mac is $4.57 (the range was $3.91 to $5.57), an increase of $0.12, or an increase in 2.7% from what we obtained in March. During the last 12 months, this represents an increase of 4.3% from 12 months ago when the price of a Big Mac was $4.38.
As stated in previous posts, I believe that the Big Mac provides a better indication of price movements than the government compiled CPI. Many of us can neither follow nor actually experience what the CPI means or how it moves. Conversely, the Big Mac is consumed constantly, and we shell out hard-earned dollars to purchase the sandwich. Thus, it is a real-time metric of our economy.
The Consumer Price Index (CPI) was reported to have increased 1.8% during the past 12 months. The Big Mac increased significantly more. This under-reporting of inflation impacts savers, investors, retirees, and those who receive Social Security, just to name a few
Placed Insights surveyed the eating habits of Americans to determine that individuals eat 17 Big Macs a second. This means Big Macs are eaten at a rate of 1,200 a minute, 61,200 an hour, 1,468,800 each day and 536,112,000 a year. At $4.57, the current average price of a Big Mac generated $2.4 billion in revenue for McDonald’s from Big Macs sold in the U.S. alone.
My point is that people experience the change in the price of the Big Mac daily. It is tangible. Consequently, it is a good way to view inflation.
While we have just observed why the Big Mac makes for a good inflation gauge, it also is important to relate it to the financial advisor profession, and how we communicate the impact of inflation to individual clients.
Bet on the Big Mac
Ed Easterling, the founder of Crestmont Research, believes that the level of inflation – to a great extent – drives the valuation of the stock market. Mild inflation (1-3%) is typical, and relates to the highest of valuations. However, when inflation is above 3% and the market multiplies, the amount that investors are willing to pay for each dollar of earnings declines. Market valuations also decline with inflation below 1% and even further when prices decline outright.
Easterling uses CPI to measure inflation, which might be the right tool. CPI has a longer history to track than the Big Mac. However, CPI has changed over time as the weighting for different components has shifted. So, essentially, the calculation for CPI has changed. That said, are we not better off using the Big Mac to measure inflation? The formula for the Big Mac hasn’t changed.
Implications for Financial Advisors
There are two main implications for financial advisors. First, realize that costs are increasing faster for clients than the government suggests. Therefore, individuals need more income to sustain the same level of consumption they have had in the past.
Second, Easterling believes that the value of the stock market is predicated on the level of inflation. However if inflation is higher, or lower, than what is reported, does that make valuations of the stock market unstable than they already are?
Easterling wrote in “Nightmare on Wall Street: This Secular Bear Has Only Just Begun”:
| “Now, finally, the stock market is fairly-valued for conditions of low inflation and low interest rates (assuming average long-term economic growth in the future). But what about the future? If inflation remains low and stable indefinitely, then this secular bear will remain in hibernation until the inflation rate runs away in either direction.” July 1, 2012 (Updated October 1, 2013) |
What if inflation is already above the level to support heightened valuations for the stock market? Does that mean that the stock market could lose its lofty stance quicker?
Certainly this is a possibility and further justifies ongoing tracking of the Big Mac as the inflation measure of choice for financial advisors to use with your clients.
Originally posted at AUM in a Box
© James Cornehlsen, CFA
Dunn Warren Investment Advisors, LLC
http://www.dunnwarren.com
The opinions expressed here are based on the author’s views and should not be construed as financial advice. Model results do not represent actual trading and may not reflect the impact that material economic and market factors might have on the advisor’s decision-making if the advisor were actually managing a client’s money. Past performance is no guarantee of future performance. There can be no assurance that a client’s investment objective will be achieved or that a client will not lose a portion or all of his or her investment. Please contact Dunn Warren directly for a list of the recommendations provided over the last year. Investing outside the United States involves additional risks, such as currency fluctuations, periods of illiquidity and price volatility. These risks may be heightened in connection with investments in developing countries.
