Next Week the 800 Pound Gorilla Speaks

Includes: DIA, IEF, QQQ, SPY
by: Scott Snively, CFA

The Bulls managed to clear extraordinarily weak March retail sales reports with little trouble on Thursday, only to be sucker punched by GE's Q1 EPS miss. Making matters even worse, the Univ of Mich/Reuters Consumer Confidence Index fell to 63.2 from 69.5, its lowest level since March 1982. This sets up the return next week, of the 800lb gorilla from 1982, Stagflation.

Why stagflation? The next hurdle for this tentative market could well be the March PPI (Tues) and CPI (Wed). The next round of inflation numbers will show the effects of rapid money supply growth, tight commodity supplies, a persistent trade deficit and a declining dollar. The inflation inputs actually started to roll in yesterday.

Money Supply: Nobel prize winning economist Milton Friedman said, "Inflation is primarily a monetary phenomenon, produced by a more rapid rise increase in the quantity of money than in output." Last night the Fed reported the seasonal adjusted annualized growth rate in M2 for the three months ending in March soared to 12.5% from the 2007 rate of 5.2%. Compare this to the output (GDP) which could be zero in Q1. The M3 money supply, which the Fed no longer bothers to publish, is estimated to be up 17% by

March Import Prices: Import prices rose 2.8% in March adding some heft to the 800lb gorilla in the room. Excluding a 9.1% jump in petroleum prices, import prices were still up 1.1%. The prices of goods made in the U.S. are soaring as well. Export prices jumped 1.5% last month, thanks largely to a 4.1% increase in ag prices.

Today: The Univ of Michigan reported 1-year consumer inflation expectations have moved to the highest level since 1982, to 4.8% from 4.3%.

Next week: Tuesday's headline PPI and Wednesday's headline CPI could easily top consensus expectations. That is because commodity prices soared from late Feb through early March, the time period sampled. The May RBOB gasoline contract jumped 7.6% in the month ending Mar 11, the typical PPI sample date. The Powershares Commodity ETF (NYSEARCA:DBA) rose 11.5% over the same period. The DOE reports average gasoline prices rose 8.0% in the 4 weeks ending March 17. In February, both the January PPI at 1.0% and CPI at 0.4%, shocked the market on similar commodity price advances.

(Note: PPI inputs are normally reported "for the Tuesday of the week containing the 13th of each month" according to the BLS. That works out to the month ended March 11. For the CPI, prices are sampled throughout the month.)

The NY Fed's Empire State Manufacturing Survey (Tues) also has an inflation component. Its prices paid index, at 51.69, set a 21-month high in March. Expectations for prices 6 months hence, at 59.55, are near the 1-year high set in November.

-- Apr 15: PPI (Mar) 0.4% expected, 0.3% prior
-- Apr 15: Core PPI (Mar) 0.2% expected, 0.5% prior
-- Apr 15: Empire State Mfg Price Index (Apr)
-- Apr 16: CPI (Mar) 0.3% expected, 0% prior
-- Apr 16: CPI Core (Mar) 0.2% expected, 0% prior

Importing inflation: China's consumer inflation was up 8.7% in the year ending in February, a 13-year high. China's M2 money supply grew at a 16.3% Y/Y rate, but this the slowest M2 growth in more than a year.
-- Japan's wholesale inflation rate rose 3.9% for the year ending in March, a 27-year high.
-- India's inflation rose 7.4% at the wholesale level for the year ended March 29, the fastest pace in more than 3 years according to Bloomberg News.

More Earnings Tests
This week two blue chippers, Alcoa (NYSE:AA) and General Electric (NYSE:GE), reported per share earnings that fell short of expectations by double digit percentages. The GE report was especially damaging to investor confidence, because it broke a seemingly endless record of in-line quarterly earnings.

GE CEO Jeffery Immelt noted, "financial services businesses were challenged by a slowing U.S. economy and difficult capital markets." He also noted the company saw slowing U.S. consumer demand. Retail sales, unemployment rates and company guidance all point to a slowing U.S. economy. What receives less attention is the inflation storm brewing just out of view of the typical pundit.

Next week, the bulls will be looking for some positive news from the likes of MDR (Mon); CSX, INTC, JNJ & WM (Tues); IBM, KO & WFC (Wed); GOOG, LUV, MER, NUE, PFE & SNDK (Thurs) and C, CAT, HON, SLB & WB (Fri). Today's Q1 results and guidance from GE point to challenges in the financial and consumer discretionary names, while energy and infrastructure should be relative outperformers.

Inflation pressure, earnings uncertainty and an economic slowdown; this market is treacherous with one big monkey leaving banana peels everywhere.

Disclosure: None