Tech Inflates on Benign Data - TheStreet

Tech Inflates on Benign Data

Cisco's earnings and Fed-friendly productivity news boost the Nasdaq.
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Cisco's

(CSCO) - Get Report

at the disco and Ben Bernanke's feeling groovy. But this isn't a 1970s flashback.

Between Cisco's earnings and the latest data to fall in line with the

Fed's

paradigm shift about core inflation moderating, the market's mood lifted Wednesday.

It turns out that despite last summer's record-high oil prices, there is no repeat of the 1970s inflation fiasco, a notion that Wednesday's data on unit labor costs helped confirm.

Oil has come back down, and consumer prices never spiked along the way. Core inflation, as measured by the core personal consumption expenditures index, now runs at a 2.1% year-over-year rate, down from 2.4% through October of last year.

And even though the labor market has been unflinchingly strong throughout a housing recession and growth slowdown in the middle of 2006, it is not nearly as stretched as it could be. Wage inflation is not yet a problem.

Investors took today's benign inflation data to reinforce their belief that the Fed is on the sidelines. This is just where Chairman Bernanke wants investors to be.

In the fourth quarter, productivity increased by 3%, much more than analysts' expectations for a 2% jump, and a sharp rebound from the third quarter's 0.1% decline (revised from a previously reported 0.2% gain). Hourly compensation accelerated to a 4.8% gain in the fourth quarter, but due to the strong 3% productivity, unit labor costs rose only 1.7%, less than the 2.1% rise analysts expected.

That means from the same period last year, labor costs rose 2.8%. Unit labor costs peaked at 3.6% annual rate in the first quarter of 2006, and have since been trending lower, writes Gary Bigg, economist at Bank of America.

And, most take the latest round of data to mean Bernanke will stick to his knitting in his semiannual testimony to Congress next week. In other words, expect him to highlight strong economic growth but remain vigilant on inflation, and he'll probably talk a whole bunch about communication methods.

Indeed, the message sent by Bernanke last summer in his July testimony was that slower growth would dampen inflation. Even though growth, by various Fed speakers' own admission, didn't weaken as much as expected, inflation has softened. How did the seemingly impossible happen?

Record-high oil prices that peaked at around $78 per barrel didn't spill over into consumer prices they way high oil prices did in the 1970s, for three main reasons, says Nariman Behravesh, chief economist at Global Insight.

  • First, globalization has gone a long way to support cheaper cost structures for manufacturing companies, he says.
  • Second, the scope of competition has increased due to deregulation. His favorite case in point is the airline industry, which has had trouble raising ticket prices despite the high cost of its fuel.
  • Third, Behravesh notes that the Fed and other central banks have done well at keeping inflation expectations under control.

Part of keeping inflation expectations down is the constant jawboning about vigilance against the threat, notes Behravesh. Philadelphia Fed President Charles Plosser is a perfect case in point. With all this benign inflation data piling up, Plosser came out strong on inflation Wednesday, even warning "there is some risk that we may not see a return to price stability unless monetary conditions are further tightened."

The markets and the economy are certainly in a sweet spot, but the risk remains that inflation could rear again. It is only because of high productivity that unit labor costs are lower. Otherwise, compensation is running at its highest level in six years, notes Michael Darda, chief economist at MKM Partners.

"Wage inflation could be a problem later in the year," says John Lonski, chief economist at Moody's Investors Service. Wednesday's data show that "there is still slack in the labor market," he says. If there weren't, companies would be complaining of scraping the bottom of the barrel for workers, and having to pay them higher wages for less or less-quality work.

The sweet spot is just fine for the stock market, which seem ever more bullish by the day.

"We're in this environment of inconsequential complacency," says Woody Dorsey, president of Market Semiotics, a research firm that specializes in behavioral economics. "The market can just push up and push up."

On Wednesday, the

Dow Jones Industrial Average

was pressured by weakness in

Exxon Mobil

(XOM) - Get Report

as oil prices fell 2% to $57.73 per barrel.

Alcoa

(AA) - Get Report

was likewise weaker Wednesday, down 2.1%. Overall, the Dow ended the day flat at 12,666.87 after trading above 12,700 intraday. The

S&P 500

ended the day up 0.1% to close at 1450.02.

With the good vibes about the economy, the volatile

Nasdaq Composite

soaked up the market's optimism, finishing up 0.8% to 2490.50.

Cisco's shares surged 3.3% Wednesday, while the Philadelphia Semiconductor Sector Index added 1.6%. Components such as

Infineon Tech

(IFX)

and

Broadcom

(BRCM)

jumped 10.5% and 4.7%, respectively. Infineon inked a deal with

Nokia

(NOK) - Get Report

, and Morgan Stanley upped its recommendation to overweight on Broadcom.

After the closing bell, earnings announcements were strong.

Disney

(DIS) - Get Report

beat expectations, and its shares were up 1.6% in after-hours trading.

Electronic Data Systems

(EDS)

doubled its profits, sending shares up 4.8% in postclose trading.

So as the markets move into the heart of February, the DJ may be playing a remix of some old '70s classics, but inflation is nowhere near the turntable.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

here

to send her an email.