Weekly Market Commentary 5-23-2011
Weekly Market Commentary 5-23-11
Inflationary head fake?
Tim Phillips, CEO – Phillips and Company
Recently when I’ve been out learning how to see, there has been a lot of discussion on rapid inflation in the near future. Frankly, I agree with their concerns. However, the bond market doesn’t seem to agree. Bond prices continue to rise and continue to push yields lower. The bond market appears to be pricing in the exact opposite: low inflation in the near future.
Instead of arguing in the affirmative for higher and rapid inflation, I want to play devil’s advocate and see if I can build a case for low inflation.
Currently, wage growth is around 2% annually. Looking at the wage growth data from the last recession it could still be headed lower before it bottoms out. Unemployment is off the recessionary highs but still has a long way to go to get to pre-recessionary levels.
The housing market appeared to be stabilizing however, recent data from Case-Shiller and CoreLogic show potentially more downside. If housing is approximately 40% of the CPI then it could prove to be difficult to have runaway inflation with flat or lower housing numbers...
For the year, commodities have done well but recently we have seen a pullback in commodities across the board.
Low Inflation Means What?
If this devil’s advocate scenario of low inflation in the near future is playing out then we should see lower GDP growth. Wait a minute! We have already seen GDP forecasted for the year revised lower. If lower CPI leads to lower GDP growth, does that mean lower stock prices too? At first it makes good logical sense, but the data seems to suggest otherwise.
In 2004, Jay Ritter did an exhausting study entitled, “Economic Growth and Equity Returns” and concluded that there is no stable relationship between growth and equity returns. Goldman Sachs ran their own analysis (“Staying the Course” 01/2011) and found similar results: there is no statistical significance in the relationship between equity returns and pace of economic growth. Lastly, Vanguard also produced similar results when they did their own study (“Investing in Emerging Markets: …”) last year stating that, “Since 1900, the correlation between long-run economic growth and long-run stock returns across 16 major markets has been effectively zero.”
If other people are making the “logical assumption” that cooling GDP numbers means lower stock market returns, we could see some emotional selling and a rocky summer that could prove to be a nice buying opportunity for investors that actually looked at the historical correlation. This could be a good summer to look back and evaluate whether or not your investment managers are actually adding any value and beating benchmarks or if they fall for a potential head fake.
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Tim Phillips – CEO, Phillips and Company