Today’s producer price index (PPI) update for March reflects the ongoing economic complexities we face. Depending on your perspective, this latest inflation metric could either bring a welcome sigh of relief or reinforce growing concerns.
On a positive note, wholesale prices experienced a 1% increase last month, a slight decrease from February’s higher 1.3%. Furthermore, core PPI—excluding volatile food and energy prices—remained stable in March, well below the expected 0.2% rise.
However, the year-over-year PPI has surged by 3.1% through March, signaling continued inflationary pressures that complicate the Federal Reserve’s focus on fostering economic growth. “This certainly doesn’t absolve the Fed from attention,” cautioned Gina Martin, an economist at Wachovia Corp., in her comments to Bloomberg News. She noted that while inflation has not escalated, it also shows no signs of improvement, remaining “stubbornly high.”
Yesterday, the Federal Reserve released the minutes from its March 20-21 FOMC meeting, confirming a widely suspected issue: inflation remains a significant concern.
Anyone who regularly reviews government-released economic data understands the potential for interest rates to rise again in response to ongoing inflationary threats. Notably, the core CPI (which excludes food and energy) shows little sign of moderation.
The Federal Reserve closely monitors the core CPI, and this inflation gauge likely influences the direction of future interest rates. Over the twelve months leading up to February, core CPI increased by 2.7%, a rate that exceeds the Fed’s comfort threshold. “On a twelve-month-change basis,” the Fed minutes stated, “core CPI inflation in February was considerably higher than the pace from a year earlier, primarily due to a notable rise in shelter rents over the past year.”
The S&P 500 may face corrections periodically, but they do not last, as recent trends indicate. The index closed yesterday at just under 1% below its post-2000 peak. Currently, the S&P 500 is up 2.6% year to date and has risen 13.9% over the past year. This performance suggests that optimism remains strong in the equity markets.
How do we reconcile this trend with the news of slowing earnings growth? As reported by The New York Times over the weekend, S&P 500 earnings are no longer experiencing double-digit growth as they did in prior years. According to Thomson Financial, earnings for the index are projected to rise by only 3.3% in the first quarter of 2007, a significant decrease from an initial expectation of 8.7% growth at the year’s start.
Achieving a new high for the post-2000 era could signify a noteworthy trend, though skepticism about its immediacy remains. “Everyone is awaiting the earnings season,” said Tim Hartzell, chief investment officer at Kanaly Trust Co., in an interview with AP. “Many are poised to see how the numbers play out.”
If these numbers fail to impress as they once did, it may alter market expectations. “Investors have somewhat adjusted their outlook for first-quarter earnings, making it easier for stocks to outperform,” commented Christopher Johnson, chief investment strategist at Johnson Research Group, in his discussion with Bloomberg News. “The incoming figures have not been significantly worse than those from last quarter. Bright spots could emerge.”
While rebalancing alone cannot resolve global economic challenges, it might provide a path to salvation for long-term portfolios. Historical evidence supports this approach.
By tactically selling overperforming asset classes and acquiring those that have underperformed, a disciplined rebalancing strategy for a well-diversified portfolio may yield favorable outcomes. As Charlie Ellis famously advised, consistently avoiding losses is crucial for long-term success.
Given this context, what current opportunities exist for those interested in rebalancing? As indicated in the table below, options appear limited based on recent trends. Investors assessing year-to-date performance through April 6 will notice that the top performer is the MSCI EAFE index, represented by the iShares ETF. This ETF has gained 6.2% year to date, but whether this increase justifies the expenses associated with trimming this position and reallocating elsewhere is debatable.
When an employment report is released, its significance remains in question.
Today’s report on job creation for March arrives amidst a quieter Wall Street scene due to Good Friday holidays. The U.S. stock market is closed, leaving government bond trading only partially active. The Labor Department revealed that nonfarm payrolls increased by 180,000. Meanwhile, unemployment decreased to 4.4%, its lowest level since last October.
Does the number of jobs created inspire confidence in the economy or raise inflationary fears? Perhaps both or neither. Regardless, this figure marks an improvement over February’s 113,000 jobs added and represents the largest monthly gain since December’s total of 226,000. Still, even the most optimistic perspectives must recognize that last month’s job growth is only modest compared to historical trends, as illustrated in the chart below.
When institutional investors were asked about their top concerns regarding the U.S. equity market, what do you think they would identify? Terrorism, a housing market collapse, or high consumer debt? Surprisingly, the greatest worry for pension funds and institutional investors is inflation.
According to a March survey by Frank Russell Co., 22% of the managers ranked inflation as their top concern for the equity market. This was followed closely by 20% who cited geopolitical instability and 15% who pointed to a weakening real estate market. Meanwhile, nearly two-thirds (64%) of the managers believed that domestic stocks were fairly valued, with 13% deeming them overvalued.
Money supply may not always be acknowledged, but it continues to reach new, albeit modest milestones in the 21st century.
The latest figures for the M2 money supply, released up to March 19, show a 6.1% increase compared to last year. This surpasses the previous 52-week high of 6.0% noted in January 2005, as illustrated in the chart below.
More importantly, the expansion rate of M2 is on the rise, having increased steadily from under 4% at the end of last year to over 6% recently. While whether this trend will persist remains uncertain, it is clear that the Federal Reserve is deliberately expanding M2.
Context is critical; at a nominal growth rate of 4.1% for the economy, as indicated by the annualized change in current-dollar GDP from last year’s fourth quarter according to the Bureau of Labor Statistics, the increase in money supply may indicate concerning inflationary prospects.
There are various interpretations for this uptick in money supply, some encouraging and others less so. Cautious observers, such as your editor, fear this increase could be a response to a faltering economy, potentially stoking inflation if continued unchecked.
Perhaps the pace of M2 will eventually decline, or the economy will accelerate. Perhaps the Fed will find the perfect balance between fostering growth and controlling inflation. However, for now, we remain cautiously skeptical.
Summarizing an $11 trillion economy is a daunting task, but it’s worth considering the latest numbers to gather insights into our economic trajectory.
Embracing that challenge, we examine current economic data for any trends that could indicate our future. Based on available statistics from February 2007, there are reasons to believe the economy may still experience growth. Notably, personal consumption expenditures saw robust gains in both February and over the past year. Although some have predicted a decline in consumer spending, current data does not support that view.
Nevertheless, we must acknowledge concerns regarding the housing market’s slowdown, as highlighted by decreased new home sales and housing starts. The rebound in construction starts in February, which rose by 9%, offers a glimmer of hope for potential unexpected positive developments.
Overall, our rough analysis indicates that economic reports from February showed a modest average increase of 0.2%, compared to a 12-month decline of 0.5%. The lingering question remains: Are we experiencing a temporary recovery or the onset of a stronger economic phase? Ultimately, future reports will help clarify this ongoing uncertainty.
In the current financial landscape, two significant threats loom large: inflation and taxes. One affects investment from the left, while the other emerges from the right. Ideally, enough remains after dealing with both to yield profitable investments; however, guarantees are elusive, especially within taxable accounts that encompass asset classes that may falter in performance irrespective of favorable circumstances.
Navigating the investment landscape presents numerous obstacles, not least of which is the human desire to outperform, beat the market, and generate discussions worthy of cocktail parties. Yet, unforeseen events often shift the most carefully crafted plans.
Consider recent moves by mutual fund companies detailed in the Wall Street Journal (subscription required), revealing that many are seeking shareholder approval for significant policy changes, including increased allocations to foreign stocks and real estate, just as those markets begin to struggle.
For active managers, especially those focused on relatively stable domestic equities, attractive opportunities are increasingly hard to find. The financial realities of expenses, trading costs, taxes, and unexpected developments can diminish the overall effectiveness of even the most sound strategies by the time they reach the individual investor. Although this challenge extends beyond U.S. stocks, it remains particularly pronounced in that sector.
