Inflation comes nicely packaged

The Dow for example, fell from its 52 week high last Wednesday of 11709 to 11,099 by the time of writing, down 5.5% and giving back three quarters of the year to date gain in the index.

On a week by week basis, all three major US gauges were down for the week. The DOW lost 2.1%, its worst week in four months. The S and P 500 fell 1.9% and the NASDAQ was down 2.2%. A little light was visible though as gold, metal pricing and oil prices plunged as well.

The recent sell off was based on fears of inflation and the related need for rising interest rates, but we draw our readers attention to two important considerations.

Firstly, corporate earnings continue to be strong and have demonstrated an excellent resilience during the past five years to move forward though euphoric investment attitudes, terrorist acts, war, corporate malfeasance, for instance.

This recent drop in equity value has increased the value as determined by the P/E ratio, leaving the US big board index, the Dow Jones Industrial Average near 20 for a P/E ratio, and the broader S and P 500 index at a P/E ration of 17.6. This is good value. The only reason you wouldn’t be a buyer in this circumstance is if you didn’t believe the world was going to continue growing.

We believe this will not change, with China and India becoming bigger players, and so offer some discussion in our opinion segment this week.

The second point to consider is the world’s leading economy, the United States, is likely to slow in economic growth in the second half this year, but it is also likely inflation risks may prompt at least one more rate hike as the US Federal Reserve nears the end of a two-year tightening campaign.

With 16-quarter point hikes behind them in one of the most steady and aggressive campaigns on record, one should consider the effectiveness of the Federal Reserve at controlling inflation. That said, core consumer prices rose by only 0.3% in April, just over analyst projections of 0.2%.

In major news this week, crude oil for delivery fell 92 cents to $68.53 a barrel on the New York Mercantile Exchange last Friday, after slipping near a five-week low earlier in the day’s trading. The greenback soared, climbing against the yen and the euro, and COMEX Gold for June delivery tumbled $24.70 to $656.20 an ounce, off last week’s 26-year high of $730.

We take this opportunity to remind investors that $US losses often boost gold prices by making bullion cheaper for holders of other currencies. In treasury prices, things were pretty steady with the yield on the benchmark US 10-year note staying at 5.06%. There has been justified concern over inflation in recent times and we have discussed the impact higher inflation will have in several past articles. But this week, considering the recent hard correction seen in the equity markets, we have dedicated our opinion segment to understanding inflation and the risk it poses to investing.

To give some definition, central banks set the overnight rate, that is the interest rate which banks charge each other on overnight loans. When a central bank want to cool the economy or slow down the growth/expansion, it raises the over night rate which causes the interest rates charged to others to increase. With money costing more, people are more reluctants borrow funds to complete purchases and thus less products and services are purchased. The economy then slows.

When central banks want to stimulate an economy, it will lower the overnight interest rate to make money cheaper to borrow and spur spending/growth.

The recent shock that was seen in the stock market was the result of investors selling out of the market based on a fear that more rate increases are coming, slowing growth and thus hurting corporate earnings. For the record, we continue to forecast that inflation will not become severe enough to derail the world’s growing economies. We still maintain, as we did when oil first crossed through

$US 40.00 a BBL, that when considering the overall increased wealth and life style of citizens, they can afford the higher costs. True, the commodity price pressures are real, prices are going up, and inflation is increasing, necessitating interest rate hikes to control. For the most part income levels and life styles have been improving for some time and have built in, a discretionary cushion that will cover the price increases with little change in lifestyle.

The fact is you have the world’s leading economy, the USA, is growing at a solid 3.5%. The worlds other major economies are growing as well.