Wednesday, June 13, 2007

A Stock Market Warning?

Maybe you have noticed that the stock market as proxied by the Dow and S&P 500 have been trending downward recently.


What is causing this swoon? Inflation, inflation, inflation, at least the fear of inflation. Recently the yield on the 10-year U.S. Treasury bond reached a 5 year high. The primary reason that the yield has risen is that investors are pricing in higher inflation. That is, inflation erodes the value of future interest payments. Thus, investors demand higher rates to compensate for this erosion.

But the worst may not be over. Tomorrow and Friday, the U.S. Bureau of Labor Statistics releases its producer price index (also called the wholesale price index) and the consumer price index.

If these two reports show that the core rate of inflation (excludes prices changes in food and energy) is pointing to inflation rates over 2.8%, the market will continue to wilt in my estimation. So what is an investor to do? I am holding a lot more cash today to take advantage of potential bargains in stocks next week. As long as the U.S. Congress does not pass restrictive trade or immigration bills, inflation is likely to be tame in the long run.

Ernie Goss

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