Inflation Watch

"I wasn't affected by inflation, I had nothing to inflate."

-- Gerald Barzan

The primary issue facing the market right now is whether inflation is a big enough problem that it will keep the Fed from cutting rates as the economy slows and the subprime mortgage problems play out. There is little doubt the economy is facing some issues and there is great uncertainty about what is going to happen in the real estate market in the months ahead if mortgage lending tightens, prices stay soft, and foreclosures grow.

It is very easy for the Fed to boost a stagnate economy in a noninflationary economy by cutting interest rates. In fact, it is so easy that it tends to be a secondary goal to keeping inflation under control because inflation is a much more insidious enemy. Once inflation works its way into the economy it is extremely hard to root out without slamming on the brakes. That is why the Fed will always err on the side of being hawkish even when it seems fairly obvious that the economy needs a boost.

Those who are looking for a quick rate cut because of the subprime issues are likely to be disappointed if we have any sign of inflation. That is why the CPI report this morning is so important. If prices are well contained that will free up the Fed to consider a rate cut sooner rather than later but by no means is it a sure thing.

Technically the charts of the major indices are telling us that there might be some slight worries about stagflation in the air. A slowing economy with inflationary pressure is a very poor environment for stocks and recent data seem to suggest that it may indeed be an issue.

After the market hit a high about a month ago we have had series of two lower lows. We have had a bounce over the last couple days but it is clear that the character of the market has shifted lately and that the thinking that we had a 'goldilocks' economy is no longer dominating.

The game plan at this point is to not be overly hopeful that the market is suddenly going to regain its composure. We have fundamental economic issues that are creating headwinds and we need to be defensive as this plays out. We will turn back up again but it will be very costly if you are overly anticipatory.

We have soft action in front of the CPI news as market players are obviously nervous about a 'hot' report. Overseas markets were soft. Oil and gold are trading up. Be careful out there.

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James "Rev Shark" De Porre is the founder and CEO of Shark Asset Management, an SEC-registered investment advisory firm. He also operates sharkinvesting.com, an interactive online community that serves and educates active investors. De Porre holds business and law degrees from the University of Michigan, is a member of the Michigan Bar Association and a former tax attorney and CPA. He lives in Anna Maria Island, Fla., with his wife and two children.Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Rev Shark appreciates your feedback; click here to send him an email.