Investors face a conundrum. While they attempt to gauge the economic condition and forecast stock market direction, they also have to contend with a rare phenomenon. In times of economic deterioration, pricing pressure typically eases as a natural consequence. However, while the broad market indexes are well off their October 2007 highs, commodity prices are breaking records.
Stagflation is the term for it, and signs of it emerged last week. The Philadelphia Federal Reserve Survey, which measures Philly area manufacturing, posted a reading of negative 24.0. Concerns intensified because manufacturers experienced input price increases while continuing to raise their own prices, despite product demand softness. Earlier in the week, the Consumer Price Index also showed prices increased more than expected in January.
The Federal Reserve is in the process of cutting interest rates with a goal to inspire economic expansion. However, rate cuts could be offset by inflation as globalization has reached a critical threshold, and economic decoupling has set forth.
Developed markets are still tightly tied to America, however, in the large emerging markets of India, China and others, domestic market demand has gained traction. Even as the United States stumbles, these important consuming populations are draining commodity resources.
We expect capital flows are exacerbating that impact. Capital finds profit you see, and with the availability of new exchange traded funds [ETF], more investors can now participate in commodity investment. We believe that ETF regulation must intensify, or the return of inflation could stymie the global economy.
The Week Ahead
This week offers key housing, consumer and producer data to swallow. Existing and new home sales reports are due. Investors have come to expect poor housing results, and do not generally penalize homebuilders or the broader market for weak information any longer. This sets the stage for upside surprise eventually, but it’s still early for that in our view.
The Producer Price Index for the month of January will hit the wires on Tuesday, and this news should simply reflect the pricing issues reported by regional Fed districts. January’s Durable Goods Orders Report is set for Wednesday release, and is likely to offer follow through on trend of weak ordering patterns.
Consumer confidence will be measured through two reports this week. However, the most important consumer information could be found in Friday’s Personal Income and Outlays Report for January. Based on the month’s chain-store sales patterns, personal outlays should prove weak. The PCE Deflator found in the report is the pricing gauge viewed most important by the Federal Reserve. The Fed targets a growth rate between 1-2%, so anything greater should hurt stocks.
On Thursday, adjusted fourth quarter GDP will compare against the initial report of 0.6% growth. A significant revision higher or lower would be important to the stock market.
Some of the week’s noteworthy earnings reports include: Monday - LDK Solar (NYSE: LDK), Lowe’s (NYSE: LOW), Nordstrom (NYSE: JWN); Tuesday – Foster Wheeler (Nasdaq: FWLT), Home Depot (NYSE: HD), Macy’s (NYSE: M), Target (NYSE: TGT); Wednesday – Noble Energy (NYSE: NBL), Toll Brothers (NYSE: TOL); Thursday – AIG (NYSE: AIG), BEA Systems (Nasdaq: BEAS), Del Monte (NYSE: DLM), Dell (Nasdaq: DELL), Freddie Mac (NYSE: FRE), Sears (Nasdaq: SHLD), Sprint Nextel (NYSE: S), XM Satellite Radio (Nasdaq: XMSR); Friday – Petrobras (NYSE: PZE), Service Corp. (NYSE: SCI) and others.