Do Stocks Face a “Wile E. Coyote” Moment?

Among the most pleasant memories of my Baby Boomer childhood are the Warner Brothers cartoons that played on television every Saturday morning. Our TV set had rabbit-ear antennae and only three channels.

Particularly beloved was Wile E. Coyote. In frantic pursuit of the Road Runner, the hapless predator would run straight off a cliff and continue to pump his legs in midair … until he glanced around, gulped, and plummeted into the canyon.

Likewise, the overbought stock market has continued to defy gravity. But maybe not for long.

Today, the Dow Jones Industrial Average, S&P 500 and Nasdaq all posted sharp declines. Losses accelerated in the final minutes of trading. An even worse day of reckoning awaits, according to former Federal Reserve Chair Ben Bernanke.

Bernanke recently compared Wall Street to Looney Tunes. In remarks to the American Enterprise Institute last week, Bernanke said:

“What you’re getting is stimulus at the very wrong moment. It’s going to hit the economy in a big way this year and next. And then in 2020, Wile E. Coyote is going to go off the cliff and look down.”

Thanks to the Fed’s actions Wednesday, stocks took a tumble that perhaps presaged the eventual crash Bernanke envisions.

The Fed today announced a boost in the fed funds rate by a quarter of a percentage point to a range of between 1.75% and 2%. The Fed also signaled a total of four (not the originally planned three) rate hikes this year. Treasury yields jumped on the news, with the benchmark 10-year Treasury bond topping 2.97%. The U.S. dollar strengthened.

Rising inflation is the culprit. According to the U.S. Labor Department, the Consumer Price Index (CPI) rose 0.2% in May, following a similar gain in the CPI in April. In the 12 months through May, the CPI accelerated by 2.8%, the largest increase since February 2012, after rising 2.5% in April.

Excluding the volatile food and energy components, the so-called “core” CPI rose 0.2%, fueled by rising prices for motor vehicles and health care, after edging up 0.1% in April. That lifted the core CPI’s year-over-year increase to 2.2%, the largest rise since February 2017, from 2.1% in April.

The Fed’s preferred inflation measure, the personal consumption expenditures (PCE) price index excluding food and energy, rose 1.8% on a year-over-year basis in April, matching March’s increase. The Fed expects the core PCE in 2018 to exceed the central bank’s 2% target.

Manufacturers are reporting higher costs for raw materials this year. Trade tensions and growing uncertainty in the global supply chain are likely to exacerbate price pressures. Higher costs will eventually get passed along to consumers.

Meanwhile, the unemployment rate hovers at an 18-year low of 3.8%, which in turn boosts wage growth. Add stimulus in the form of massive tax cuts and a ballooning federal budget deficit, and you have a recipe for the Wile E. Coyote moment that Bernanke warned about.

The Labor Department also reported that gasoline prices increased 1.7% last month, after surging 3% in April. Wall Street has been encouraged by rising oil prices, seeing the trend as a sign that the economy remains strong. The broader stock market and energy prices have tended to move together. That may soon change.

Fanning the flames…

In a separate report Wednesday, the Labor Department said that wholesale costs in the U.S. surged in May, largely because of rising oil prices. The producer price index jumped 0.5% last month, prompting President Trump to complain about OPEC in a tweet today.

Over the past 12 months, as inventories decline, the price of crude has surged, climbing above $80 a barrel last month (see chart below, compiled with data from the U.S. Energy Information Administration).

OPEC and its partners have been curtailing supply since January 2017 to lift oil prices and reduce the glut in global inventories. Unlike production cut agreements in the past, this one has stuck and with little of the usual cheating.

Crude oil’s recovery since the price collapse of mid-2014 has been a relief for energy investors who were beaten-down by the protracted recession in the energy patch.

However, it’s delusional to think that rising oil prices won’t fan inflationary fires and eventually threaten economic growth.

West Texas Intermediate (WTI), the U.S. benchmark, today rose 0.51% to close at $66.70 per barrel. Brent North Sea crude, on which international oils are priced, rose 0.99% to close at $76.63/bbl.

An elevated oil price helps companies in the energy industry, but it hurts just about everyone else, particularly consumers. This unavoidable reality will soon catch up with Wall Street, the way gravity always catches up with Mr. Coyote.

Wednesday Market Wrap

  • DJIA: -0.47% or -119.53 points to close at 25,201.20
  • S&P 500: -0.40% or -11.22 points to close at 2,775.63
  • Nasdaq: -0.11% or -8.09 points to close at 7,695.70

Wednesday’s Big Gainers

  • Enphase Energy (NSDQ: ENPH) +32.89%

Energy tech firm to buy solar power entity.

  • Pivotal Software (NYSE: PVTL) +32.81%

Software firm excels in first post-IPO earnings report.

  • Korn/Ferry International (NYSE: KFY) +12.17%

Management consultant beats on earnings and sales.

Wednesday’s Big Decliners

  • Flex Pharma (NSDQ: FLKS) -75.12%

Biotech’s drug clinical trial flops.

  • scPharmaceuticals (NSDQ: SCPH) -22.08%

FDA rejects biotech’s new therapy.

  • China HGS Real Estate (NSDQ: HGSH) -8.77%

Developer whipsawed by volatile Chinese real estate market.

Letters to the Editor

“How worried should I be about inflation’s effect on stocks?” — Mike R.

Historical data show that inflation dampens the returns of equities. From 1928 to 2017, when inflation was below 3% in any given year, the S&P 500 generated a median return of 16%. However, when inflation exceeded 3%, the median return for stocks was only 6.5% a year.

Questions about inflation? Drop me a line:

John Persinos is the managing editor at Investing Daily.

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