A persistent belief that inflation is under control sent stocks higher for a second consecutive week, even as oil roared back. By Friday, however, the rally looked as tired as the assumptions that underpin it.
Besides oil, a mixed batch of economic data confirming a dip in both consumer confidence and spending growth also ate into the end-of-week gains. Crude oil for July delivery rose 6% this week to finish at $51.85 a barrel on Nymex.
On Friday, the
Dow Jones Industrial Average
gained 4.95 points, or 0.05%, to 10,542.55, the
rose 1.16 points, or 0.1%, to 1198.78 and the
added 4.49 points, or 0.22%, to 2075.73.
For the week, the Dow added 0.6% and the S&P 500 rose 0.8%.
Tech shares continued to post the most impressive gains this week, with the Nasdaq rising 1.4%. Several Wall Street powerhouses have piled into the tech rally, upgrading everything from the software to the Internet and chip sector -- a red flag for contrarians, who interpret unanimity as a reason to take cover. Ultimately, nothing has changed in the sector's fundamentals.
The averages, including the Nasdaq, are still down for the year, and that gives bulls hope that March's highs will be revisited. Bulls have been cheered by a belief that this spring's stagflation fears were overblown. Strong April employment and retail sales, followed by a tame CPI, went a long way toward vanquishing those fears.
But the market soon will have to come to terms with the fact that monetary policy, even after the recent inflation news, remains a significant headwind.
Certainly, a "glass half-full" vision guided investors' perception of inflation in this week's economic data and in the messages from the
. Tuesday's release of the Federal Open Market Committee May 3 meeting minutes showed that the Fed viewed March economic weakness as transitory and remains more concerned about inflationary risks.
The minutes showed no sign of the Fed softening its resolve to continue raising interest rates, even if that's still at the current quarter-point "measured" pace. Traders might have viewed the minutes as dated, as they preceded the release of the tame April consumer price index. Still, Fed officials went on tour to hammer home the message that inflation is on the rise and that the Fed was not nearly finished.
Michael Moskow, president of the Chicago Fed, said Tuesday that rates need to move higher to prevent stronger energy and other asset prices from becoming "permanently embedded in the inflationary mentality of firms and households."
Similarly, investors cheered a "just-right" revision of first-quarter growth on Thursday. As expected, the GDP was revised upward to 3.5% from the 3.1% previously estimated by the Commerce Department. Meanwhile, the GDP's core personal expenditure price index, a key inflation gauge closely watched by the Fed, remained unchanged at 2.2%.
One part of the GDP that received little attention, however, points to what many economists are defining as "creeping inflationary pressures." The Commerce Department revised its estimates of employee compensation by 2 percentage points for both the fourth quarter of last year and for the first quarter of this year.
Much of that higher compensation, according to Lehman Brothers economist Joseph Abate, is linked to bonuses, stock options and real estate appreciation. While employment and wage growth have remained tepid, this could go a long way in explaining the consumer's resilience in the face of soaring gasoline prices.
Then, of course, the housing (bubble, bubbles, or froth -- take your pick) was again making headlines this week. Existing-home sales surged to a record 7.18 million in April, from 6.87 million in March, while the average price of homes soared 15.1% from last year -- the largest price appreciation in 25 years. New-home sales, meanwhile, while less than expected in April, rose at the highest rate on record. To emphasize the point, homebuilder
posted blowout earnings on Thursday.
Still, few economists expect the housing market to fizzle anytime soon. The housing frenzy remains fueled by the low yield of the 10-year Treasury bond, which is used to set mortgage rates. This week, the bond continued to gain and its yield fell to 4.07%, a 3 1/2-month low, from 4.12% last Friday.
The bullishness is explained by many as a combination of still-strong buying from foreign central banks, bets of an economic recession next year, and the tame inflationary outlook. This week, both Lehman Brothers and Merrill Lynch revised downward their forecasts of where the 10-year yield will be at year-end.
Merrill's rate strategist Jim Caron sees the 10-year yield at 3.8%. Lehman economist Ethan Harris now predicts that the yield will be at 4.7%, compared with his previous forecast at 5%.
But the bullish bond market mostly is a reminder of the extremely easy monetary policy of the past few years. The Fed's 200 basis-points tightening so far has done little to scare the market. As Lehman's Harris asks, "Fed, where is thy sting?"
"Since the Fed started to tighten last summer, the bond market has rallied, credit spreads -- outside of autos -- have narrowed, the dollar has weakened, the stock market has rallied, bank lending conditions have eased, corporate profits and cash balances have surged and, perhaps most important, home price inflation has accelerated," Harris wrote to clients.
In this environment, those betting that the Fed may be done sooner -- that Fed Chairman Alan Greenspan would take the chance of ending his term even slightly behind the curve on inflation -- are daydreaming.
To view Gregg Greenberg's video take on today's market, click here
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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