from a newsletter i subscribe to. I think there are many good points here.
Inflation is raising its head a bit and the stock markets are reacting with a vengeance both here and abroad. Bonds aren't having a good time of it either, but in our view this over-reaction is simply that, an over-reaction by traders made complacent by the notion that the Fed would be done raising interest rates and that we could have monstrously strong economic growth with little to no inflation forever.
Let's put this into simple terms. First, the economy is strong. If it wasn't we wouldn't need to see interest rates hiked in the first place. The economy is, by all accounts, continuing to grow.
Second, interest rates have been extremely low at the long end of the yield curve. Why? Because while the Fed controls where short rates are, investors, meaning the bond market, control long rates. And long rates typically move in relation to inflation expectations. Well, now that inflation has come back a bit bonds are selling off, raising their yields. This hurts bond prices and the prices of bond funds.....but bonds have been in a bull market for so long this was only a matter of when, not if. We haven't invested in long-term funds precisely because we believed it was only a matter of time. But as prices come down and yields rise these long-term funds begin to look more attractive. We aren't really there yet, but we're moving in that direction.
Third, higher interest rates are not going to upset the balance sheets of U.S. corporations. These companies have some of the strongest balance sheets that we've ever seen and record amounts of cash on hand. A little inflation is simply not going to change that equation. Remember, higher interest rates aren't going to hurt a company directly if the company doesn't need to borrow. And right now they don't need to borrow. As we said, balance sheets are quite strong.
So, where does that put us? Well, our opinion is that a correction in stock prices, catalyzed by a one-month step-up in consumer inflation (inflation actually advanced faster in January, but who's counting?), which itself has been caused almost exclusively by higher oil and gasoline prices (which have fallen so far in May), is not marking the end of the world as we know it. ..... As fast as this market has turned down, it can, and almost certainly will turn up in the next week, or next month. We can't mark the time. Don't forget that the stock market has gone up six months in a row. Maybe it's about time to see a down month when investors' optimism will be tempered a bit and real investors like us will benefit from our portfolio managers' ability to buy bargains they haven't seen in more than half a year.
In contrast to the worrisome CPI report, the Producer Price Index report came in quite tame. While the PPI overall was up 0.9%, the core rate, excluding energy, was up less than expected, or 0.1%.
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