What a Week: Marginal Pressure

Major averages hold up well in the face of rising input costs. But how long can that last?
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Despite the volatility common to all commodities markets, the persistence of higher prices, most notably in energy, is going to sort out the winners and losers on Wall Street.

A drop in crude oil prices from near $70 per barrel in late January to the low $60s currently might signal easing cost -- and inflation -- pressures in the February numbers. But it's all relative, given that oil traded at $23 in 2003 and that $60-barrel oil is proving sticky.

As seen over the past week, oil can easily make a comeback -- absent supply and demand fundamentals -- amid rising geopolitical tensions. On Friday, crude oil shot up $2.37, or 3.9%, to $62.91 a barrel after a foiled bombing attack on a refinery in Saudi Arabia.

Oil's surge pressured stocks early Friday, although the market had recouped some of its losses by the close. The

Dow Jones Industrial Average

fell 7.37 points, or 0.07%, to 11,061.85, weighed down by a 3% drop in

General Motors

(GM) - Get Report

. Workers at

Delphi

, GM's bankrupt parts supplier, voted to authorize a strike at one of its plants.

The

S&P 500

rose 0.13% to 1289, and the

Nasdaq Composite

rose 0.32% to 2287.

Research In Motion

(RIMM)

jumped 6.5% after a court delayed a decision that would cut off the service of its popular BlackBerry communication service.

In a holiday shortened week, the Dow fell 0.5%, while both the S&P and the Nasdaq rose 0.2%.

The market seemed reassured Wednesday that core consumer prices rose in line with expectations in January. The consumer price index rose 0.7% in January, higher than expected, but rose 0.2% excluding food and energy.

Steep increases in energy costs had also driven the producer price index higher last month, although it's interesting to note that the PPI had increased less than the CPI. The headline PPI rose 0.3%, and it was up 0.4% excluding energy.

According to Lehman Brothers economist Ethan Harris, the two indices are rarely synchronized. Higher costs tend to appear almost immediately at the production levels, while many factors determine when, and whether, they show up at the consumer level. In January, for instance, gasoline prices tended to rise more than other energy costs.

However, Harris believes "we're at the early stages of the pass-through process, when costs are moving up to the intermediate levels of production

the production process moves from crude to intermediate to finished," and eventually to the consumer.

Consumers, of course, have already suffered from higher energy prices themselves. Among the inflationary implications is that workers will eventually demand higher wages, pressuring labor costs. In addition, when firms are able to pass on costs to others businesses or to consumers, overall prices rise, which is what the

Federal Reserve

has been nervous about for some time.

This should keep the Fed on inflation watch for some time, maybe longer than Wall Street currently expects.

In the meantime, the impact of rising costs on profits is likely to become more and more of a theme, according to Tom McManus, market strategist at Bank of America. His take: Stick to large-cap stocks, which can better absorb costs and pass them to consumers, and withstand higher interest rates, than small-cap stocks.

It should be noted, however, that small-caps continued to outperform the broad market this past week, as they have so far this year and over the past several years. The Russell 2000 index of small-caps gained 0.8% this week and is up 9% year to date.

Meanwhile, Wall Street has already started to sort out some of the winning and losing sectors of the rising cost story. The transportation services sector, for instance, has been notably good at passing on higher prices.

The Dow Jones Transportation Index rose 0.7% this week, even as crude oil gained ground. The index has shot up 8.4% since Jan. 17. The index's components are a mixed bag of airlines, such as American Airlines parent

AMR

(AMR)

and

JetBlue

(JBLU) - Get Report

, package delivery firms

FedEx

(FDX) - Get Report

and

UPS

(UPS) - Get Report

, and railroads, such as

CSX Corp

(CSX) - Get Report

and

Union Pacific

(UNP) - Get Report

.

Overall, 88% of transportation stocks have seen positive earnings revisions for 2006, the highest of any sector of the S&P 500, according to research by Thomson Financial and Morgan Stanley.

Henry McVey, market strategist at Morgan Stanley, includes transports in his list of "price makers," which he believes will be able to pass rising costs to others. He also includes hotels, capital goods and health care equipment makers, as well as the energy sector.

Among the "price takers," McVey includes the food and beverage industry, media, household products and commercial services suppliers, all of which are expected to see negative revenue growth in 2006.

But beyond sectors, it seems that a more careful stock selection is what will win the day.

Barrick Gold

(ABX)

, which should benefit from high gold prices and be a "price maker," dropped 2% this week. It posted strong earnings but warned that energy costs would weigh on profits this year.

Meanwhile, the likes of

General Mills

(GIS) - Get Report

and

Coca-Cola

(KO) - Get Report

, should theoretically be under pressure, as they face not only rising energy costs but also rising input costs, such as sugar.

But at conference in Arizona this week, General Mills and

Campbell Soup

(CPB) - Get Report

said they intended to continue lifting prices on their products to offset rising input costs, according to

Reuters

.

One safe bet, it would seem, is that the Fed will keep on lifting interest rates for a while longer.

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

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