22 Apr 2005 Inflation a Problem?
Will higher oil prices finally cause inflation in the U.S. economy? Will the Federal Reserve be forced to raise their benchmark rates faster and risk stalling the economy? These are the questions on the minds of investors and traders of stocks and bonds alike. Recent indicators released by the government this week had opposite and dramatic effects on the markets. The Producer Price Index released Tuesday showed that prices held steady for the month of March at the manufacturer’s level. The S&P 500 index was up .6% and the bond markets rallied substantially as well.
Wednesday brought the dark side of the story as the Consumer Price Index signaled inflation might be greater than expected at the consumer level. The S&P fell 1.3% to for a new low for the year and below the psychologically important 200 day moving average that had not been breached since October 13, 2004.
Interestingly though, bond prices continued their rally on Wednesday in spite of the consumer inflation news as investors speculated the economy was slowing and inflation would not be severe enough to stir the Federal Reserve to raise rates faster than at their comfortable ‘measured pace.’ Equity investors were clearly worried as indicated by the S&P 500 index that had given up 4.2% of its value in the last six trading days.
But yesterday, investors came back with gusto believing that the economy wasn’t in such bad shape after all. Supporting their claims were a bevy of blowout earnings surprises from the likes of Bank of America, Intel, Motorola, Dell, Nokia, Google, eBay, Caterpillar, General Dynamics, Kinder Morgan, and Johnson & Johnson. Bonds gave up all their gains for the week as bond investors concurred with the growth story.
According to an article in the Wall Street Journal following the CPI release, many economists found reasons not to worry that inflation was becoming a problem. First, the reported core rate of 0.4% was due to rounding; the precise number was 0.351%. And a big chunk of the gain came from a spike in hotel prices, which were skewed by seasonal factors, including an early Easter, the NCAA basketball tournament, and Spring Break. Remove those effects and trim a little from a bizarre surge in clothing prices, probably another echo of the early Easter and, voila, you get a 0.2% gain in core CPI, matching forecasts. The article goes on to point out that the Federal Reserve’s preferred inflation measure, the Commerce Department’s personal-spending price index, which doesn’t lean so heavily on hotel prices, will probably be friendlier.
Of the roughly 1,600 companies in the Dow Jones U.S. Total Market Index, a quarter of the companies in the index have reported earnings so far. They are averaging 14% ahead of last year’s earnings. Some analysts expect average earnings for the S&P 500 companies to be up more than 10% this year, while the average estimate is 7.5%. Based on results so far this year, it would seem we will be at the higher end of earnings projections, meaning stock prices are too low, although it may take a while longer for investors to regain their confidence.