May 18, 2006
APRIL SHOWERS FERTILIZE INFLATIONARY FLOWERS
When Mr. Market speaks, investors may or may not listen. But when he shouts, almost everyone pays attention.
Mr. Market was definitely shouting yesterday. The S&P 500, every institutional investor's favorite equity benchmark, collapsed on Wednesday, losing nearly 1.7%. That's the biggest one-day percentage retreat in recent memory. The proximate cause was yesterday's April report on consumer prices. Suffice to say, the report was received with less than enthusiasm on Wall Street.
And for good reason. As we wrote yesterday, there's more than enough reason to worry that inflationary pressures are building a head of steam. Until yesterday, there was widespread agreement that the inflation has been "contained," to use one of the Fed's favorite words for communicating recently to the masses that there's everything's under control on the matter of price trends.
Perhaps it's time to rethink that assumption, to judge by the April's CPI numbers. To recap the news that convinced traders to dump stocks and bonds (the 10-year Treasury yield rose to 5.15% yesterday, the highest in four years), the core CPI pace of change jumped to a higher level, running at 0.3% in April, the second month at that level. Meanwhile, top-line CPI is rising at an even faster rate. With both core and top-line CPIs signaling trouble ahead, it's getting easier to favor cash if only because expectations are growing that higher interest rates are still the path of least resistance.
To be sure, it remains to be seen if April proves to be a turning point on the inflation front. There have been scares about pricing pressures before, only to watch the threat evaporate in the optimism of a renewed bull market in stocks and bonds. Will it be different this time? In search of an answer, we took a closer look at yesterday's CPI numbers. If this is in fact the turning point, it's time to acquaint ourselves with the particulars of the transition. As usual, energy was the leading source of upward pricing pressure last month, rising by five times as much compared with consumer prices overall, as the chart below reveals.
For perspective, we also ran the numbers on a trend basis, and once again found energy to be the big weasel in the statistical henhouse of late, as you can see below.
It's all about inflation again, and so it promises to be a long, anxious wait until next month's CPI update confirms or denies April's warning.
Posted by jp at May 18, 2006 9:27 AM
Of course, aside from energy in the henhouse, eventually, the higher rates themselves will be in the henhouse, affecting costs.
Also, I think a gloabl mental turning point is at hand, wherein foreign capital dodges the chance to continue investing in t-bills in a depreciating currency. The answer to continue the inflows is, of course, higher rates.
Rates, rates, rates: it's all about them rates. Higher and higher, eventually, eventually, driving the market lower and lower.
As always, when is the big Q. Soon, I think, very soon.
The Confused Capitalist
Posted by: Jay Walker at May 18, 2006 6:31 PM