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5 stocks ready for inflation's return
The Fed hinted that its interest-rate hikes are nearing an end, and the market soared. But the rally doesn't mean inflation is a thing of the past.
By Jim Jubak
Inflation expectations drive the financial markets.
Or, more exactly, reversals of inflation expectations drive the financial markets.
That's exactly what happened Tuesday, when the release of minutes from the Federal Reserve's March meeting convinced stock and bond investors that the Federal Reserve was less rather than more worried about inflation.
Coming after a report that showed the core Producer Price Index, the Fed's favorite measure of inflation, up less than expected, the Fed minutes powered a rally that finished with the Dow Jones Industrial Average ($INDU, news, msgs) up 195 points, 1.8%, and the NASDAQ Composite ($COMPX, news, msgs) up 45 points, 1.9%. Investors seized on passages in the minutes that indicated that the housing market was slowing, that consumer spending stayed robust, and that inflation was under control. All that added up, the financial markets decided, to an early end to the Federal Reserve's program of interest rate hikes.
Inflation exasperation
But stocks wouldn't have moved nearly this much if the news out of the oil, gold, and other commodity markets hadn't raised inflation fears so high in the days leading up to the rally. Oil broke above $70 a barrel on Monday, and gold, the traditional inflation hedge, soared $18 an ounce.
It sure looked like a double-barreled inflation blast: Oil prices would produce the inflation and investor fears of inflation would drive up the price of inflation havens. On Apr. 18, investors who had swung to an extreme of worry about inflation rebounded with relief.
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Don't think this rally, however, signals an end to inflation worries. The data are just too ambivalent for that.
For example, take a look at the Federal Reserve's favorite inflation measure, the core Producer Price Index. In March, the numbers reported on Apr. 18 show, core inflation was running at an annual rate of just 1.7%. That's well within the Fed's no worry zone. And a huge decline from July 2005, when core inflation hit an annualized 2.8%, a ten-year high.
So everything is hunky-dory on the inflation front, right? Wrong. Remember what the core inflation numbers leave out: energy costs. And that's exactly where the big price increases are coming from. According to the Producer Price Index, gasoline prices rose 9% in March -- even though those prices don't get factored into the core PPI -- and now stand 22% higher than a year ago.
From one worry to another
I'm afraid that investors are stuck with data that will support either position on inflation. Look at the core: no inflation. Look at energy prices: inflation. The likelihood is that expectations about future inflation will continue to swing from one extreme to another, driven by over-interpretation of genuinely ambiguous or indeed meaningless short-term data. And if circumstances seem to build on each other, then expectations are likely to move to an extreme. Such was the case in the days before the Apr. 18 rebound: Worries about a confrontation with Iran were followed by worries that a civil war in Nigeria would cut oil supplies, and those were followed by worries that Chad would cut its oil exports. Such thinking sets up the possibility of a big bounce in the other direction.
I don't think stocks and bonds will stop swinging like a pendulum as investors worry about the Fed's next move until the Fed announces an end to its interest rate increases.
That, of course, will just set the markets swinging between a new set of expectations. Investors will vacillate between the idea that the Fed got it just right and fears that the U.S. central bank had overshot its goals and sent the economy into a slowdown.
That debate, in turn, won't be resolved until a slowdown actually shows up. (And maybe not even then, as economic measures are notorious for recognizing a recession only after the recession is over.)
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