Interesting take here.....
Inflation Has a History!
by Sy Harding on 2/20/2004 2:48:11 PM
More articles by Sy Harding
The news from the Labor Department on Friday was that inflation as measured by the Consumer Price Index surged an unexpected 0.5% in January.
That should raise suspicions about why the Labor Department did not release the Producer Price Index, which measures inflation at the producer level, on Thursday as it was scheduled to do. It’s the first time in my recollection that release of the monthly PPI data was postponed. Since it has had some increases lately that Washington down-played as temporary aberrations, I have to wonder, given the big rise in the CPI announced on Friday, whether the PPI numbers on Thursday were so high that they were taken back to the drawing board. All the Labor Department said was that the government was having “unexpected difficulties” in switching its PPI data to a new industrial classification system, and will release the data as soon as possible.
Inflation concerns have been rising over recent weeks anyway, as higher commodity and energy prices have finally caught Wall Street’s attention. It’s a situation investors need to watch closely.
Periods of low inflation have been very kind to investors, as we most recently saw in the bull market of the late 1990s. As inflation fell year after year, until it reached its lowest level in forty years, the stock market soared to its highest level ever.
In the opposite direction, periods of rising inflation have been downright cruel to investors.
For instance, in the decade of the 1950s, inflation rose just 25% over the 10-year period. The stock market gained 481%.
In the 1970s however, inflation rose 103% in eight years. The stock market gains amounted to only 77% during that period, and even those gains were almost entirely due to dividends. On a price basis alone, the Dow had no gain at all from 1965 to 1982. It was at 1000 in 1965, and didn’t break above 1000 until 1982. Even worse, during that 17 year period it suffered five bear markets in which the declines were as much as 42%. But then in the 1980s, under Fed Chairman Paul Volcker, inflation was brought under control again, rising just 64% in his 9 year tenure. And the stock market rose 405%.
In the 1990s, under Fed Chairman Greenspan, inflation declined even further, rising just 33% from 1987 through 1999. And the stock market rose another 433%.
So controlling inflation is not just important to the economy, and workers’ paychecks, but also to investors and the stock market.
The Federal Reserve controls inflation primarily by raising interest rates. The problem is that raising interest rates is risky business, as the stock market detests rising interest rates almost as much as it fears inflation. No one knows that better than Alan Greenspan. One of his first acts when he took over the Fed in 1987 was to hike interest rates to slow that overheated economy. Soon after, the stock market topped out into the bear market that culminated in the 1987 crash.
The Fed has an unenviable job at this particular point, given that the economic recovery from the 2001 recession remains anemic. Normally, an economic recovery is much more robust than the current one has been so far, and would be in position not only to handle a rise in interest rates, but might even need such a rate hike to prevent it from over-heating. But this time around, raising interest rates to ward off inflation any time soon might also bring the tepid economic recovery to a grinding halt. That is currently a larger fear for the Fed than the threat of inflation. In his semi-annual testimony before Congress last week, Greenspan clearly signaled his intention to keep priming the pump with low interest rates for as long as he dares. And the string of weaker than expected economic numbers of the last two weeks provide him with ample reason to do so.
But any further indications that inflation is getting out of the bottle while he waits, will add to pressure on the Fed to at least raise rates toward a neutral level from the current extremely accommodative level. Meanwhile, Washington and Wall Street immediately chimed in on the unexpected 0.5% rise in the Consumer Price Index, with the old spin that since the rise was due primarily to sharp increases in the cost of food and energy, inflation is still not threatening. After all, they said, the ‘core rate’ of inflation, that is with the increased cost of food and energy subtracted, only rose 0.2%.
What a relief. Now if only we can figure out how to maintain ourselves without food, energy, gasoline, and heating fuel, we and the economy should be okay – through the election anyway.
Sy Harding is president of Asset Management Research Corp., publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market!
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