Riddle Me This
"Inflation is dead and it's not coming back." In one form or another, this mantra has been commonly espoused by various
officials, Wall Street economists and strategists, and other seers in the past year.
In recent weeks, fixed-income participants have become far less concerned about inflation. Treasury yields at the long end of the curve have been falling steadily since mid-May, when the 30-year's yield peaked at 5.91% and the 10-year's peaked at 5.51%. Additionally, the spread between the 10-year Treasury and its inflation-index counterpart -- a measure of inflation expectations -- fell to its lowest level since mid-April today, according to BondTalk.com.
So why does the stock market continue to perform as if market participants expect strong economic growth and/or inflation to revive in the coming months?
Today, as major indices regurgitated some of
last week's big gains, the
Dow Jones Transportation Index
rose 0.7% and is now up 12% since June 25.
Of course, falling crude prices -- they slid another 2% today after falling 5.7% last week --have both aided transportation stocks and quelled inflation fears. But transportation's rise is not a new phenomenon; the sector has been the best performer in the
in the past 12-months, Douglas Cliggott, market strategist at J.P. Morgan Securities, noted in a report today.
"Year-to-date performance has been more thematic -- the economic recovery trade is on," the report continued. "Consumer cyclicals, basic materials and transports are the only three sectors showing positive absolute returns so far in 2001."
Basic materials stocks are extremely economically sensitive and the sector includes that time-honored inflation hedge, gold. The
Philadelphia Stock Exchange Gold & Silver Index
shed 1.6% today but is up 2.9% year to date. Additionally, precious metals funds are the best-performing group this year; up an average of 11.7% for 2001 through July 12, according to
Inflation is a hot-button issue for readers, and many take pleasure in emailing me when evidence that it is contained emerges. Given that I've often written about inflation's potential return in recent months, that's to be expected.
But it has paid to invest based on the potential for inflation's return so far this year, judging by the performance of economically and inflation-sensitive stocks as well as long-dated Treasury bonds, whose yields remain above Dec. 31 levels.
Clearly, there are myriad contributing factors and I'm aware that growth doesn't automatically mean inflation, which is a monetary phenomenon. But if inflation is really dead, how do you explain the performance of these inflation-sensitive vehicles? I ask sincerely, and will pass along readers' best theories.
But before you send that email, please note the theme I've
long expressed is that the
has planted the seeds for inflation to revive
when the economy rebounds
. Thus, it's not surprising inflation hasn't materialized in a dramatic way as yet.
Riddle Me This Redux
The latest fodder for the "no inflation" argument came Friday, when the
Producer Price Index
showed a 0.4% drop in June vs. estimates for a 0.1% dip. A 2.5% drop in energy prices -- highlighted by a 5.8% decline in natural gas prices -- accounted for much of the decline in overall PPI, the biggest decline in nearly 2.5 years.
The long end of the bond market rallied Friday in the wake of the PPI data and continued the advance today, despite a report showing business inventories flat in May while sales rose 1.1%. The price of the benchmark 10-year note rose 10/32 to 98 23/32, its yield falling to 5.18%. The price of the 30-year bond rose 15/32 to 97, its yield falling to 5.59%.
Bonds also benefited from expectations for a benign
Consumer Price Index
report and concerns about emerging markets, particularly Argentina.
Even some staunch inflation hawks concede the danger has receded. But they don't believe it has been eradicated.
"I think inflation is on vacation right now, without a doubt because energy prices have come down," said Paul Kasriel, chief U.S. economist at
in Chicago. "Until they stabilize, this is going to be a factor bringing down headline inflation numbers, which no one paid attention to when they were going up."
Indeed, little notice was given to the fact core PPI, which excludes food and energy prices, rose 0.1% last month. Perhaps it's because the rise was as expected, but it also seems the core rate takes precedence only when energy prices are rising (i.e. when it's convenient to the "no inflation" argument).
Kasriel, a foremost proponent of
inflation's potential return, believes energy prices will soon stabilize and start heading higher again as the U.S. economy rebounds in the second half of the year. He foresees economic growth averaging 3% in the second half.
The economist expects the June CPI to be flat overall, and up 0.2% in the core, which is actually less than the consensus estimate for gains of 0.1% overall and 0.4% in the core.
Outside of energy, most of the inflation that has emerged this year has been in the consumer services sector, Kasriel noted, "and there's been no real evidence that service sector inflation has slowed."
For the 12 months ended in May, the
median CPI had risen 3.5%, the CPI by 3.6%, and the core CPI by 2.6%.
Are you sure inflation is dead?
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.