Wind Still At Our Backs

Today’s buying strength brings stock indices close to their all-time highs. The S&P and Dow are pennies away while the NASDAQ has blow considerably past its seven year high. In all the indices dropped between 3 ½% and 4% starting on June 5th. On that day inflation fears rocketed long term interest rates to three-year highs. The good news today is that an important measure of consumer price inflation increased less than predicted. The index which excludes food and fuel rose only 0.1% last month following a 0.2% rise in April. The measure which includes gasoline was up .7% for the month. The good news so far is that rising energy prices have not been passed along by producers to consumers.

During the early days of June yields on US Treasuries maturing in 10 years increased from 4.9% on June 5th to a high of 5.3% on Wednesday. Helped by some bargain hunting yesterday and better inflation news today yields have pulled back to 5.18%. While yields may remain above 5% for some time as inflation fears remain, the recent volatility may subside. Economists project the economy will expand at only 2.1% this year, the slowest in five years. That rate is probably slow enough to keep inflation under control yet fast enough to maintain momentum and avoid recession. 

Foreign buying of US bonds was up a net of $84 billion in April, well above expectations. Some had worried that there would be an exodus as offshore buyers might seek higher yields elsewhere. While foreign purchases of US Treasuries did decline, purchases of stocks actually increased by $27.4 billion, the most since February 2000, according to the Wall Street Journal. These numbers imply strong global confidence in the US economic outlook.

The economy is actually showing vigor on several fronts. Consumer spending, as reported on Wednesday, remains robust as retail sales improved by the most in a year. The industrial side of the economy is also improving. Also on Wednesday the Federal Reserve provided a positive assessment of US regional economies in their ‘beige book’ report saying that manufacturing activity and hiring were healthy in many parts of the country.

The best performers from the market lows reached a few days ago are some Latin American countries with Brazil leading the way. Here at home, big gains have been made by energy service companies and technology companies. On the bond side, it is not surprising that the longer maturities were hurt the worst and are the slowest coming back.

At this point investors’ panic seems more focused on buying stocks while they are cheap rather than about inflation. After a brief shift, the wind remains at our backs and seems to have picked up rather substantially.