Government agencies are systematically misrepresenting the level of US consumer price inflation by understating it, according to Devonshire Research Group. The New York-based research affiliate of Devonshire Capital Funds comes to this conclusion based on input from three inflation analyzing sources that hold a contrarian view – the Chapwood Index, the Shadowstats Alternate Inflation Indices, and Now and Future’s Consumer Purchasing Power Index. These contrarians believe that Consumer Price Index-based inflation is actually closer to about 8%, rather than about 3%.
As Devonshire sees it, “A wide range of inflation indices and concepts are intimately commingled, leading to a widening divergence between reality, published government statistics, and the assumptions used for investment decisions. Notably, a ‘consensus of contrarians’ is emerging, one that is shared across several independent critics and supported by concerns among many that official statistics paint an overly optimistic picture of the economy.”
The contrarians base their arguments on factors such as:
- The Consumer Price Index’s inability to measure a “simple basket of goods” that consumers tend to buy out-of-pocket
- The shift in weights in the official baskets over time in a way that tends to subdue the impact of more pricey products
- Price increases tied to quality improvements that are subjective and overstated
- The incentives for government agencies to underplay inflation so as to reduce cost-of-living payments, reduce their borrowing costs and raise the level of real economic growth
All of this has implications for the US economy and investors. For instance, Devonshire contends that the current real economic growth may be overstated, and the economy may be in an extended state of recession, having never recovered following the dotcom bust of 2001. And returns on fixed investments may be even less appealing after factoring in real interest rates. Also, investors may be accepting a return on their investments that is too low, based on a too low cost of capital.
Institutional investors could be using incorrect assumptions on inflation in their asset allocation models and their investment choices. For instance, “capital preservation strategies may be compromised, portfolio allocations may be distorted, and return performance is likely broadly overstated.”
Devonshire also sees a deep impact on capital markets as a result of this inflation misrepresentation, which could lead to a “black-swan” event.