I got in last night from Cabo San Lucas, Mexico where I met the future leaders of America at the American Leadership Academy. I got a chance to speak and party with 160 college kids from 20 schools, and it was really a great experience. Big shout out to Phi Kappa Psi.
The market continues to grind higher, not propelled on news per se but maybe lack of news. Or should I say lack of bad news, as perceived by the general consensus. This morning is a prime example of positive perception bias. February PPI came in with a headline reading of -0.6% or twice as large a decline than was expected. On the surface that's good news, although those wailing about deflation wouldn't agree this is news that should be embraced. The core reading, however, was +1.0% and that was substantially hotter than anticipated. We are going to go into the numbers deeper (initial review below) but the savings grace for this morning's report was a decrease in energy costs of 2.9%. Yet, the core was sizzling. What happens when energy gets back on track, it is up 16.6% over the past year, after all.
I'll take the good news aspect of this but there are some yellow flags in the report.
A New Day, New Details
By: Brian Sozzi, Research Analyst
Investors enter today's trading knowing the following:
* The Federal Reserve will continue to maintain a cheap money policy.
* The Federal Reserve is likely to signal a change in its policy approach by first removing the "extended period" language. Potential extraction time for this language…April or June meeting.
* The Federal Reserve views the economy in a more positive manner, with the recovery continuing to build.
* The Federal Reserve is focused on fostering the "maximum employment" component of its dual mandate as opposed to "price stability." So goes the labor market, so goes inflation.
I posted a detailed breakdown of the FOMC statement on our website, www.wstreet.com, yesterday afternoon; it's quite helpful so I encourage all to take a look. With the Federal Reserve seemingly on hold when it comes to interest rates, and perhaps leaving the door open to additional balance sheet enlargement (aka "quantitative easing") should its exit from the mortgage market go awry in the form higher mortgage rates, what should investors do? Though inflation readings have been benign, the combination of cheap dollars and a pickup in labor activity heading into the warmer weather months (think more building activity, etc.) suggests the Federal Reserve is sowing the seeds for a modest return of inflation.
CPI core readings have ranged from -0.1% to +0.7% from July 2008 to January 2010. PPI core, during the same measurement period, has ranged from -0.5% to +0.6%. Coming off such a tame base of numbers and assuming greater activity in the labor market, investor attention should be placed on companies able to command higher prices for their products and that have the operating scale to contain operating costs/expenses. Such companies could be found in the heavy machinery sector or within the multinational category. These companies, on balance, have essential products that could be sold into a rebounding U.S. economic backdrop and in key growth markets overseas. Moreover, as long as the Fed leaves the money spigot open, the dollar will likely be under pressure (saw it sell-off yesterday on rate news) meaning favorable translation rates for multinationals.
I penned earlier in the week that the last thing the U.S. needs is a trade war with China at this delicate point in the economic recovery. A bill is making the rounds in the government that would impose tariffs on Chinese goods should the country be coined a currency "manipulator" (watch out for this report next month). Once again, those politicians with grandeur visions of connecting to unemployed workers should beware. I am all for America, but the fact is that U.S. companies have already shipped tons of jobs to China and other countries overseas. I have seen it firsthand in the furniture industry and of course among big box retailers. For example, Wal-Mart (NYSE:WMT) derives a greater benefit by having apparel made by a Chinese worker getting $0.40 an hour than having to pay an American Worker $15.00 in total compensation. I am not trying to be provocative, just stating something that has occurred. Think about this for a moment. A stronger Chinese currency would equate to higher costs for U.S. companies through imports. This would in turn have the following consequences:
* Force U.S. companies to lay off more workers.
* Force U.S. companies to shift more production overseas.
* Raise prices on products to counteract higher costs of doing business.
On the surface, the report supports the notion that inflation is not a pressing concern. However, digging through the report there were increases that coincide with a potential for higher consumer prices further down the road. February PPI on the headline was -0.6% (consensus: -0.2%), paced by a -2.9% print in energy goods. Within energy, gasoline (-7.4%) and heating oil were the prime determinants. Elsewhere, food prices were +0.4%, positive for the fifth consecutive month. Items like fresh fruit and dry veggies, as well as eggs, registered single-digit percentage increases. It makes sense to see these increases given what we are hearing from the management teams of big box retailers. The CPI report later this week is next on the docket.