Fears of Deflation are Yet to Reach Extreme Levels…

An update of the weekly ‘inflation vs deflation’ indicators for 14/6/11. As can be seen from the charts below, deflation fears are yet to reach extreme levels against inflation worries.

 

The following two charts use data from google insights (google’s tool for gauging patterns in search) to figure out the prevailing opinion in the inflation vs deflation debate. The idea is to show how searches for ‘inflation’ are competing with searches for ‘deflation’. When people are searching for ‘inflation’ with greater vigor than they are searching for ‘deflation’, it is assumed that inflation fears dominate. Conversely, when people are searching for ‘deflation’ with greater vigor than they are searching for ‘inflation’, it is assumed that deflation fears dominate. The contrarian investor can use these indicators to oppose each conviction at its extreme.

 

inflation vs deflation indicator chart

Click to enlarge. Source: Google Insights

inflation vs deflation indicator chart (relative - more volatile)

Click to enlarge. Source: Google Insights

 

[The first chart uses plain search volume indices from google insights, whereas the second chart uses the relative out-performance of those indices (compared to searches about ‘finance & investing’). I invert the ‘deflation’ parts (red) to show how the two search items are competing with each other. When the blue parts are high, people are searching for ‘inflation’. When the red parts are very negative, people are searching for ‘deflation’. The black line is the aggregate of these two. When it is rising, inflation fears dominate, and when it is falling, deflation fears dominate.]

 

Interpretation for Market Positioning:

 

We’re about one and a half months into a period of market stress. As can be seen from the chart below, the S&P 500 futures are around 7% off the May 1 high. Needless to say, people aren’t overly bullish on the short-term (aaii sentiment survey chart at pragcap). However, as can be seen from the charts above, deflation fears are not extended (relative to inflation worries). That is, people aren’t frantically searching for ‘deflation’ in google as they were during November 2008 and early-August 2010. Thus, we can conclude that this period of market stress has some way to go (at least by the interpretation of these indicators).

 

S&P 500 Chart

Markets have been in 'Risk-off' mode for around 1.5 months. Source: Finviz.com

 

As I have said in previous weeks, perhaps the contrarian asymmetry in the deflation trade has gone, but it is not overextended (yet!). As the weeks pass, we’ll probably see these indicators point strongly towards the ‘deflation’. At that time, we can seek to reverse our positions and insure against inflation.

See here for our collection of rare historical economic data.

Posted Jun 14, 2011