Taming the Beast: Stocks Rise on Mild CPI Data

Inflation data released Thursday was cooler than expected, helping push the major stock indices higher. So has the inflation monster been tamed, for now at least? Wall Street seems to think so.

I’m less convinced. Here’s what the financial press won’t tell you: Fears about inflation are quickly becoming one of the most popular topics discussed on first-quarter earnings conference calls, according to the research firm FactSet. Many corporate managers are witnessing inflation in their respective operations. Businesses are paying more for labor, steel, oil and other raw materials.

The Institute for Supply Management recently reported that an index that tracks what manufacturers pay for supplies such as steel or lumber rose to the highest level in April in seven years. I guess Wall Street didn’t get the memo. Nonetheless, today’s ostensibly good news on inflation cheered investors.

The U.S. Labor Department reported Thursday that its headline Consumer Price Index (CPI) rose 0.2% in April. The “core” CPI, which excludes the volatile food and energy components, edged up only 0.1% in April, after two consecutive monthly increases of 0.2%. Both April numbers are lower than consensus expectations for the CPI to increase 0.3% and the core CPI to rebound 0.2%.

The following CPI chart, compiled with data from the Labor Department, tells the long-term story:

The Federal Reserve prefers a different inflation measure, which now hovers near the Fed’s 2% target. The Personal Consumption Expenditures (PCE) price index excluding food and energy accelerated to 1.9% year-over-year in March.

The consensus expectation is for the the core PCE price index, which had increased 1.6% in February, to exceed the Fed’s target in May.

The Labor Department reported today that gasoline prices increased 3.0% in April after falling 4.9% in March. You can expect gasoline prices to spike in the wake of President Trump’s announcement on Tuesday that the U.S. would walk away from the international nuclear deal with Iran. The president promised to impose new sanctions on Iran, which would constrain supply and boost oil prices.

Crude oil prices today leapt to 3-1/2-year highs. West Texas Intermediate rose 0.38% to close at $71.41 per barrel. Brent North Sea crude rose 0.39% to close at $77.51/bbl.

The Labor Department also reported Thursday that initial claims for state unemployment benefits were essentially unchanged at a seasonally adjusted 211,000 for the week ended May 5. Claims fell to 209,000 during the week ended April 21, which was the lowest level since December 1969. Expectations had pegged claims rising to 218,000 in the latest week. The latest labor statistics were a wash and did nothing to stoke inflation fears.

From China to Bangladesh…

Economists are generally puzzled as to why inflation has stayed muted for so long, but several contributing factors are clear. Greater price transparency, via the Internet and other technologies, makes it easier for consumers to seek the best bargains; global trade competition and the offshoring of jobs to the cheapest destinations have dampened the cost of goods; and an aging population tends to spend less, lowering demand.

Instead of making goods in China, where an expanding middle class is pushing up wages, a growing number of manufacturers are outsourcing to countries such as Vietnam and Bangladesh, where workers toil for even less.

Factors that constrain inflation are all around you in your daily life. Instead of gassing up the SUV to drive to a mall, you can buy nearly anything you want with the click of a mouse on Amazon (NSDQ: AMZN). Instead of paying 10 bucks for a CD with maybe 10 songs on it (with only one or two of those songs actually any good), you can pay $9.99 a month for access to millions of songs on the music streaming service Spotify (NYSE: SPOT).

But don’t get complacent. Despite today’s reassuring CPI readings, the days of low inflation are ending. Inflation continues its inexorable climb higher, albeit at a moderate pace.

In the U.S., the robust economy is getting a double-shot of stimulus: massive tax cuts combined with federal deficit spending. Falling unemployment is creating a tight job market in which workers gain more bargaining power to demand higher pay. As the global economy continues to expand, commodity and energy prices are rising, which in turn pushes up the cost of goods.

Investors have been sleep-walking past inflation data, ignoring recent indications that it again endangers their wealth.

Inflation shrinks the real rate of return on investments. If an investment earned 7% over a 12-month period and inflation averaged 1.5% over that time, the investment’s real rate of return would have been 5.5%.

You should devote at least 35% of your assets to hedges with intrinsic value, including precious metals, oil, natural gas, agricultural commodities, commercial real estate, and inflation-linked bonds. Despite today’s upbeat reports, the inflation beast still stalks your portfolio.

Thursday Market Wrap

  • DJIA: +0.80% or +196.99 points to close at 24,739.53
  • S&P 500: +0.94% or +25.28 points to close at 2,723.07
  • Nasdaq: +0.89% or +65.07 points to close at 7,404.97

Thursday’s Big Gainers

  • ARMO Biosciences (NSDQ: ARMO) +67%

Biotech targeted for buyout by Eli Lilly (NYSE: LLY).

  • Turtle Beach (NSDQ: HEAR) +64.55%

Audio gear maker’s earnings excel.

  • Ceco Environmental (NSDQ: CECE) +26.33%

Environmental engineering firm shines on earnings.

Thursday’s Big Decliners

  • Amira Nature Foods (NYSE: ANFI) -49.07%

Specialty rice maker suffers declining demand.

  • Quorum Health (NYSE: QHC) -17.49%

Hospital operator’s earnings disappoint.

  • Cutera (NSDQ: CUTR) -9.16%

Medical device maker posts weak earnings.

Letters to the Editor

“Conditions look dangerous. How can I protect my portfolio?” — Tim S.

In the context of today’s uncertainty, you can either flee to safety (and receive dismal returns), do nothing (and get slaughtered), or take decisive measures to simultaneously hedge your portfolio and profit.

In addition to the inflation hedges I mention above, it’s a good idea for investors to keep at least 20% cash in their portfolios and take partial gains from their biggest growth stock winners.

Got a question about portfolio protection? I’m here to help:

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.


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