Perspectives on Investing

A Little Respite

noreply@blogger.com (Under A Buttonwood Tree) — Mon, 30 Jul 2007 20:13:00 +0000

Today's gain of almost 100 points in the Dow Jones Industrial Average provides a least a short respite for investors after two terrible days in the stock market last week. The decline occurred despite the strong economic news released on Friday coupling strong GDP growth with fairly stable inflation and falling interest rates. The 10-year Treasury yield fell below 5% which we believe is an important bell weather for the market.

The bottom line? We'd hang in there with equity positions as this market looks inexpensive to us on an earnings basis - particularly when compared to the 10-year Treasury as we think this should set the stage for further gains to the upside.

Back to Blogging on the Markets

noreply@blogger.com (Under A Buttonwood Tree) — Wed, 25 Jul 2007 18:08:00 +0000

It has been some time since my last post - the result of a busy work schedule and a bit of indifference thanks to the rising stock market.

I think most of us spend too much time on the minutiae - the daily economic reports, earnings results, interest rate spreads, etc. - and too little time on the big picture. Putting events into their proper context is an important component to successful investing.

It is interesting to note, therefore, that despite $3 gas, rising mortgage delinquencies, terror attacks, slowing economic growth, the market has made a significant advance with the Dow Jones Industrial Average crossing 14,000 for the first time in history!

Now, of course, we have started to experience some choppiness in the past several days including a couple of triple digit declines. And all of sudden, market participants have come to the conclusion that the sub-prime market woes will spread to the rest of the economy. Bill Gross, the famous bond manager from PIMCO, was on CNBC yesterday talking about a five to ten percent correction thanks to a widening spread between high quality and "junk" bonds. We'll he's right - spreads have widened but no more than back in 2005. Lending is not going to come to a halt, and the economy will continue to move ahead.

So put let's put the past few days in context. The market has done fine so far this year - indeed more than fine and a little correction is probably a good thing. The economy is growing, earnings are rising and interest rates have stabilized (at least for good credits!). So relax, don't listen to all the noise, and perhaps look for some bargains.

Four home runs in a row . . .

noreply@blogger.com (Under A Buttonwood Tree) — Mon, 23 Apr 2007 15:07:00 +0000

Last night, the Boston Red Sox, hit four consecutive home runs. At the time the Sox were trailing the hated New York Yankees by three runs. The four home run outburst powered the Sox past the Yanks and to ultimate victory.

Using last night's performance as an analogy for the stock market may be a bit of a reach but I'll try! And, since it's been a while since my last post, I'll be able to cover a lot of ground with it. Here goes:

Home run #1: The Economy. Without a doubt, the economy's growth rate has slowed from last year's levels. However, the final revision of the 2006 was upward to 2.6% from 2.0% so we ended the year with a bit of momentum. We'll find out how much in just a few days as the Q1:2007 GDP preliminary report is out on the 27th. We're betting that it will be a "decent" report (say 2% give or take) albeit slowing somewhat given the rocky housing numbers and some unexpectedly poor weather - particularly in March. Remember that employment has remained strong and the unemployment rate is still low. So people are working and spending money and growing the economy.

Home run #2: Inflation/Interest Rates. Despite spikes in some commodity costs (have you bought any gas recently!) core inflation rates remain relatively subdued. While they may be a "smidge" above the Fed's comfort level, they are not spiraling out of control. We think that given somewhat slower GDP growth, continuing concerns over the subprime mortage market (and its impact on housing overall), the Fed can and will stand pat for some time to come. Stable interest rates are good for the economy and the stock market.

Home run #3: Corporate Earnings: Earnings reports are starting to flood in and, so far, companies are meeting forecasts at a rate surpassing most investors expectations. In fact, it appeared to us that last month, investors were bracing for some major disappointments. And while there have been some high profile misses, such as Yahoo! and AMD, strong reports from the likes of Google, Caterpillar, and even Intel have driven the market to new highs.

Home run #4: Buyouts galore: It seems that we start every day with at least one, multi-billion dollar buyout. While many of the buyers are private equity firms and hedge funds, we're also seeing some significant corporate buyout activity as well - witness today's by of Medimmune by AstraZeneca. The result of all this activity is a meaningful reduction in the amount of publicly traded stock. The simple law of supply and demand continues to provide uplift to our stock markets.

Bottom line? A month ago it looked like game over for the stock market. However, thanks to the four "home runs" listed above, we're once again making new highs in the Dow Jones Industrials. Time will tell if the bull market will keep its lead over the bears - but I wouldn't leave the park just yet.

A Wake Up Call?

noreply@blogger.com (Under A Buttonwood Tree) — Wed, 28 Feb 2007 13:45:00 +0000

Yesterday's dramatic decline in stock markets globally is an important reminder of the risk of complacency. Since late Summer 2006, the market has risen steadily with only very minor reversals. We were once again reminded don't go up forever without at least a "technical" adjustment from time to time. And these adjustments can be swift and painful. However, investors with well diversified portfolios that kept their heads yesterday are still in great shape - no need to panic.

The big decline was perhaps sparked by the Chinese sell-off. However we think there may be more to it. The economy has slowed - GDP was revised downward to just up 2.2 and the Chicago PMI was below 50 again (above 50 is good, below not so good), the mortgage markets are jumpy, new housing starts are still falling fairly rapidly, the Democrats in control of Congress are looking to increase their share of your wallet and oil has bounced of its recent lows. All this uncertainty and and a stock market that has risen sharply off its lows seems ripe for a correction. It may have started yesterday. We don't think it will be too bad or too long and it should be a good environment for bargain hunters. So make a list of the stock you wish you had bought last summer and look for opportunities to build a position.

Focus on Expectations

noreply@blogger.com (Under A Buttonwood Tree) — Mon, 26 Feb 2007 13:22:00 +0000

A day after our post on using the market as a forecaster, the Wall Street Journal has an interesting article on a change in the way the Fed looks at employment and inflation. The Fed is becoming less concerned that in the short run high levels of employment or unemployment have a meaningful impact on inflation. Now, this doesn't mean changes in the level of employment will be totally ignored by the Fed, but it does seem less likely that the Fed will alter rates on employment changes. This is good news for interest rates in the current high employment environment.

The Fed has heightened its focus on inflationary expectations and changes therein. Review our prior post on the spread between 10yr TIPS and 10yr Treasuries. It is market based measure of inflation expectations. And today it shows expectations at a low ebb. Our bet, the Fed stands pat.

Markets as forecasters

noreply@blogger.com (Under A Buttonwood Tree) — Sun, 25 Feb 2007 15:58:00 +0000

We often talk about inflation in our posts. Why? The level and direction of inflation has a very important impact on interest rates. And interest rates are a key input for valuing the stock market. Last week's dip in the market is evidence of that linkage - the CPI was worse than expected and investors sold stocks.

Thus it makes sense that if there was a way to forecast inflation with some degree of accuracy, we could make better investment decisions. Where can we find such a forecast? The usual suspects, economists, government experts, the Fed, have a spotty forecasting record which could result in some nasty surprises. So we look to the market for help. Here is a chart of the spread between 10yr US Treasury TIPS (inflation protected bonds) and traditional 10yr US Treasury bonds.

The spread provides important insights into inflation expectations. When it is rising, the market fears accelerating inflation. When it falls, the market is expecting stable to falling inflation. Notice that this spread has remained in a narrow band for about three years. And at the moment it looks like the market is not expecting a worsening inflation situation. That's good news for stocks!

Why Earnings Growth Matters

noreply@blogger.com (Under A Buttonwood Tree) — Wed, 21 Feb 2007 15:35:00 +0000

In many of our posts, we report on the corporate earnings environment. It doesn't take a rocket scientist to understand the linkage between economic/business conditions and a corporation's ability to grow profits. Positive GDP growth, modest inflation, stable (falling) interest rates and benign government interference (e.g. taxes, regulation, etc.) should allow corporations to grow sales and profits. Negative GDP growth, rising taxes and regulation, unstable inflation/interest rates make growing profits very difficult indeed.

Why does this matter to investors in stocks?

The direction of earnings is perhaps one of the most critical factors to overall stock market health. A study by FTN Midwest Securities shows a very high degree of correlation (r=.83) between the direction of earnings and the market (in this case measured by the S&P 500). Simply put, when earnings go up the market tends to go up.

Surprisingly the same study shows that the pace of earnings growth is not correlated to the level of the market. So today's level of angst about slowing earnings growth may be over done.

Bottom line: Earnings growth matters. As long as the environment allows corporations to grow their earnings, even at a modest pace, the market should retain a positive bias. So while looking for slower earnings growth this year, we're still looking for a market advance.

CPI Runs Hot

noreply@blogger.com (Under A Buttonwood Tree) — Wed, 21 Feb 2007 15:03:00 +0000

After all the positive news over the past several weeks, today's report on the CPI was just a bit disappointing. Both the "headline" number of +0.2% and the "core" gain of +0.3% were above expectations and the prior three months levels. Of note, healthcare costs took a big jump - +0.8% - in January.

While not we're not happy with these numbers, we're not really concerned as one month does not make a trend break. We still believe inflationary pressures remain relatively mild and at a level the Fed can tolerate. Indeed it seems to us that we've entered a period of interest rate stability across the yield curve which should provide a favorable backdrop for the stockmarket.

Under Promise, Over Deliver

noreply@blogger.com (Under A Buttonwood Tree) — Mon, 12 Feb 2007 15:20:00 +0000

While bullish last Fall we were nonetheless surprised by the scope and magnitude of the market’s advance in the fourth quarterof 2006. This occurred despite a significant decline in residential housing, the ongoing turmoil in the Middle East, and a significant shift in the make-up of the Congress.

We believe the market rally was fueled by unexpectedly strong earnings gains, attractive valuations (thanks to stable interest rates), falling energy prices, a significant amount of M&A activity, and thankfully, a lack of natural or manmade disasters during the quarter. Recent reports released by the Departments of Commerce and Labor have increased our confidence that the US economy can sustain reasonable levels of growth in 2007 without a meaningful risk of accelerating inflation. As a result, we believe that 2007 offers promise for investors in equity markets globally and particularly here at home.

We also adhere to the view that larger cap stocks are likely to out-perform small/mid cap stocks in 2007 after years lagging behind.

At this point in the market cycle, we believe small cap valuations have become stretched beyond their normal ranges. Investor expectations for smaller companies seem elevated as well, leaving little room for disappointments. And disappointmentscan lead to sharp corrections in small cap stock prices.

On the other hand, we feel many large cap stocks are selling at much more appealing valuation levels. Investor expectations remain subdued and many analysts are expecting slowing growth. This sets up the favorable scenario of larger companies exceeding expectations as they report year end results and offer forecasts for 2007. For investors, it's almost always better for companies to under promise and over deliver.

The choppiness of the market in the opening weeks of the new year is a sign of investor nervousness and uncertainty as they try to position their portfolios for 2007. While we believe the current environment looks favorable, we remain concerned about the potential impact of geopolitical events, uncertainty resulting from the change in Congressional leadership, and the potential for an adverse policy shift by the Fed.

Nevertheless, as it stands today, it looks as if 2007 will be another positive year for stocks.

Good News on Inflation and Growth

noreply@blogger.com (Under A Buttonwood Tree) — Thu, 08 Feb 2007 00:40:00 +0000

Recent reports out of the Departments of Commerce and Labor are encouraging for the market. Last week's GDP report and today's report on labor costs and productivity should be construed as good news for the prospects for economic growth and controlled inflation in 2007 in our view. The 3.5% rise in GDP provides a positive backdrop for business while improved productivity may ease concerns about falling profit margins and inflationary pressures - at least for the near term.

Despite some hawkish Fed comments, we don't expect significant changes in interest rates. And, the strong economic growth evident in recent reports will help support solid earnings growth in the corporate sector. Solid earnings growth and stable interest rates are usually a recipe for rising equity prices.

So, for now we're looking for stock market gains for 2007.

2006 - A Quick Review

noreply@blogger.com (Under A Buttonwood Tree) — Thu, 04 Jan 2007 14:22:00 +0000

The new market year got underway yesterday with some interesting stock market action. More on 2007 in a later post. For now, let's step back for a brief review of 2006's market action.

Here are the latest twelve month returns (thru 12/29/06) for various asset classes:

S&P 500: 15.80%
3-Month T-Bill: 4.85%
LT Treas. Bonds: 1.40%
Gold (US$): 23.92%
CPI (1 Month lag): 1.97%

A couple of comments:

Most market participants were not expecting a double digit gain in the stock market at the start of 2006. But thanks to several key factors including better than expected corporate earnings, the end of Fed rate hikes, stable long term interest rates, the impact of private equity players, and perhaps the better than expected news on weather, oil, etc. Oh, by the way, the residential real estate bubble was finally pricked in 2006. Housing related equities suffered unsurprisingly, however, the economy and the rest of the stock market took the real estate troubles in stride.

Long term treasury bonds were up slightly for the year leaving long term interest rates essentially unchanged for the year. And interestingly, the CPI is running right around 2%, hardly a level for serious concern.

All-in-all, 2006 was a great year for the stock market. But that's history. We're looking forward to 2007.

Slow Growth in 2007

noreply@blogger.com (Under A Buttonwood Tree) — Thu, 21 Dec 2006 14:27:00 +0000

Over the past ten days we've seen some interesting economic reports. Last week's report on the CPI was surprisingly good - almost unbelievable. This good news was offset earlier this week by the PPI report which was much worse than expected. Today, the final report on third quarter GDP was released. It was down from the last revision to 2.0% vs 2.2% but up from the initially reported 1.7%. And also today, the Conference Board released its Leading Economic Indicators index for November, showing a gain of 0.1% - the third increase in a row - pointing to further growth in the economy.

What should we make of all these mixed reports? Simple. The economy has slowed but is still growing. Inflation is not accelerating out of control. We think that the Fed can stand pat on short term interest rates, perhaps cutting in 2007.

We're expecting more of the same economic action in 2007. That is slow GDP growth, controlled inflation, stable interest rates and rising corporate profits and cash flows. We believe that this will be a favorable environment for stocks and bonds (although our preference is for stocks) and we would tend to focus on companies with solid top line growth, stable/rising margins, and positive free cash flow generation. We expect more M&A activity across a number of sectors of the economy. And, at the risk of sounding like lemmings, our bet is that larger cap stocks will be the better play in 2007.

The risks to our scenario are the same ones we faced this year and include energy supply disruptions, terrorism, a worsening Middle East situation, N. Korea, storms etc. The new unknown is the impact of a Democrat controlled Congress. Watch taxes, particularly the talk on dividends and cap gains - as the impact would be certainly negative for stocks.

All-in-all, we think being cautiously optimistic on the economy and market in 2007 is the correct stance for now. So, don't worry, be happy and have a very. . .

Merry Christmas!

Some better news!

noreply@blogger.com (Under A Buttonwood Tree) — Tue, 05 Dec 2006 15:14:00 +0000

Maybe there will be more than just coal in investors' stockings after some fairly positive news on the economic front today.

Labor Department data released today provided some more evidence that inflation is not spiraling out of control. Unit-labor costs were revised much lower in both the second (from +5.4% to -2.4%) and third quarter (+3.8% to +2.3%). As a result, instead of rising at a 5.3% rate over the last twelve months, unit-labor costs were revised down to a reasonable 2.9% annual gain.

Productivity figures were also revised upward to 0.2% from flat in the third quarter as initially reported. While this result was disappointing to some, we would note that the sharp slump in residential construction may be putting undue pressure on the productivity figure given that home builders either can't or won't reduce employment as fast as the decline in construction activity. We suspect that once homebuilding "normalizes" the solid productivity gains in other sectors of the economy will become more of a positive factor.

This is an important and positive report on inflation which significantly reduces the risk of further Fed rate hikes for the foreseeable future in our view. And stable rates should at least be neutral for the stock market.

On another front, the ISM services index rose to 58.9% from 57.1% in October surprising most economists - who had been expecting the index to slip to 55.8%. This is counter to the fall below 50 for last month's manufacturing figure and should assuage some fears that the economy will fall into recession next year.

Bottom line, these results should offer some comfort and joy to investors.

A Lump of Coal!

noreply@blogger.com (Under A Buttonwood Tree) — Fri, 01 Dec 2006 16:10:00 +0000

Looks like investors received another lump of coal in their stockings with today's release of the Institute of Supply Management's monthly ISM index. This measure of manufacturing activity hit a 2006 high in the spring and has been drifting lower ever since. Today's report that November's number was 49.5 has particular significance for the market when you remember that a reading below 50 is indicative of contracting manufacturing activity.

Not surprisingly, the stock market has begun to slide on concerns that economic growth may slip further than expected and as a result, earnings may fall short of expectations next year.

Before you panic and sell everything, this is the first ISM index number below 50 in a couple of years. Since then the economy has grown strongly. And, this index reflects the manufacturing sector of the economy which is an increasingly less important factor in overall growth. So lets wait for perhaps another month or two of reports below 50 before we panic!

Oh, there's a silver lining to this report. Treasury bonds have strengthened today, pushing interest rates down a bit more. It's going to be tough for the Fed to raise in the face of evidence of a slowing economy and an inverted yield curve.

We believe next week's employment report may be of more help to investors' understanding of the current and future economic picture than to today's ISM.

Will Santa Bring Coal To Traders This Season?

noreply@blogger.com (Under A Buttonwood Tree) — Thu, 30 Nov 2006 16:47:00 +0000

It's been a while since our last post, so I'm not going to go into great detail about all the economic numbers reported since early November. Suffice it to say that the inflation reports released before Thanksgiving were better than most expected and certainly good news for inflation watchers. I've created a link to the releases for both the PPI and the CPI if you want detail.

Yesterday (11/29/06) we got the first revision of 3rd quarter GDP. (There's one more revision on the way. Imagine trying to tell your boss you needed three tries to get your work right and keeping your job!) GDP was revised up to +2.2% versus the initial report of +1.6%. While it's clearly an improvement, 2.2% still represents a deceleration from the prior quarter. There was some good news on inflation in the report as core personal-consumption expenditure index rose 2.2% (yr./yr.) - down significantly from last quarter's 2.7% rise. This inflation number may still be high for some but at least it's heading in the right direction. And there was some impressive results on the corporate profit front with the government's number showing a 30% gain versus last year. Here's the link if you need all the gory details: Q3 GDP

Of course, all these numbers are measures of historical performance. And as investors, we're more interested in what happens next. We've seen a few numbers (Chicago PMI, new unemployment claims, and some of the housing stats, for example) that make us think that economic growth will remain subdued going forward. It's probably not a great environment to sustain the high profit growth we've seen recently but it's a good bet interest rates stay in their current range. So right now we're looking for some appreciation in stocks next year - just nothing out of the ordinary.

And what about a Santa Claus rally this December? With some of the market averages already up double digits, we somewhat concerned that Santa will have coal in his bag.

Employment Results Startle Analysts

noreply@blogger.com (Under A Buttonwood Tree) — Mon, 06 Nov 2006 17:58:00 +0000

This past Friday's employment report from the Labor Department has been the subject of much discussion among pundits. Not because non-farm payrolls rose a less-than-expected 92,000 in October, but because the prior two months were revised upward by a total of 139,000 jobs. September's figure alone was revised up by 97,000. (Remember how surprisingly small September's gain was initially?)

The household survey reported an impressive job growth number for October of 437,000. This was a huge increase over September's household survey number of 271,000 new jobs. And, the headline unemployment rate fell to just 4.4%.

So what should we make of these numbers?

First off, it's tough to be overly pessimistic about the economy near term given these results. We suspect that holiday spending will be fine despite the problems with housing.
Second, strong employment gains often hurt productivity over the short run and may account for some of the recent disappointment on that front.
Third, there is a growing shortage of labor so wage inflation will be harder to keep in check, raising doubts about any Fed rate cut in the near future.

No Productivity Gains in the Third Quarter

noreply@blogger.com (Under A Buttonwood Tree) — Thu, 02 Nov 2006 13:50:00 +0000

The Labor Department released productivity figures for the third quarter and they aren't very encouraging. In fact productivity for the quarter was unchanged and the prior quarter was adjusted downward significantly (read the release here). As we mentioned in a recent post, rising productivity offsets rising employment costs and helps to keep a lid on inflation. So right now, companies are not able to offset rising labor costs with productivity improvements and will either try to raise prices (bad news for inflation) or take a hit to their profit margins (bad news for earnings growth). Either way, this is not a positive for stocks.

For the optimists in the crowd, we observe that the productivity numbers can be a bit flaky as the measurement of output in some sectors is quite difficult. How does one measure the output of the financial sector for example? So wait to early December for the report on nonfinancial productivity before jumping out the window.

More Evidence of a Slowing Economy

noreply@blogger.com (Under A Buttonwood Tree) — Wed, 01 Nov 2006 15:18:00 +0000

Today the Institute for Supply Management (ISM) released the results of their October survey of purchasing managers - the Purchasing Managers Index (PMI). At 51.2, the index points to further growth in the economy. (Remember that any result above 50 indicates economic expansion, while below 50 indicates contraction.) However, this result was below the prior month as well as expectations, and can be construed as further evidence of a slowing economy.

A look behind the headline number provides for some interesting reading (you can access the press release here). In particular, the ISM survey on prices indicates that purchasing managers are seeing lower prices. I'm not sure how much of this relates to energy, but this has to be a hopeful sign for inflation. And, the numbers on new orders and inventories seem to indicate the potential for some further slowing in economic activity.

The ISM survey is an important indicator of the direction of economic activity. It does not help much with gauging the magnitude of the change in GDP. So based on today's release, it looks like the economy will continue to grow but we still lack clarity on the rate of growth over the next several months.

Employment Cost Index Up - Bad News for Inflation?

noreply@blogger.com (Under A Buttonwood Tree) — Tue, 31 Oct 2006 16:23:00 +0000

The Labor Department reported today that the Employment Cost Index rose 1% (or more than 4% annualized) in the third quarter and 3.3% for the latest twelve months.

Many, including myself, view the ECI as the "super core" inflation measure since employment is the predominant cost of doing business in our service-based economy. When the ECI runs above the CPI, as it is doing now, it has to raise concerns of further acceleration of the consumer price index as businesses raise prices to offset rising costs. The implications for Fed policy, interest rates and the stock market if the ECI continues to track above the CPI are not positive, in our view.

Before you panic, however, there is another key figure due out later this week - productivity. This measure of output per man-hour is a critical offset to the ECI. Simply put, if productivity grows at least as rapidly as the ECI, the chances of accelerating inflation are lessened and the pressure for the Fed to act is reduced.

Stay tuned!

Will the election matter to the market?

noreply@blogger.com (Under A Buttonwood Tree) — Fri, 27 Oct 2006 16:27:00 +0000

With the midterm elections less than two weeks away, investors are debating the impact of potential changes to the make-up of both the House of Representatives and the Senate. The direction of the economy, taxes, government spending, the war in Iraq, all have the potential to see major changes in 2007 and beyond. But for the stock market, does it really matter what happens on November 7th?

It seems not. According to the folks at FTN Midwest Securities, the stock market has risen an average of 19% in the year following midterm elections. And since 1959, every post midterm year has been positive, even with changes in control of the Congress.

So have fun debating politics - and (it seems) don't worry about your portfolio.

One caveat: Past performance is never a guarantee of future results.

GDP Growth Slows to 1.6%

noreply@blogger.com (Under A Buttonwood Tree) — Fri, 27 Oct 2006 15:46:00 +0000

The GDP report this morning surprised investors to the downside at only +1.6% versus expectations of more than 2% growth in the third quarter. The plunge in residential investment carved about 1% off the GDP result. On a positive note, the rate of inflation as measured by the personal consumption expenditure index slowed sequentially and consumer spending rose nicely.

What do these results mean to us?

Inflation looks to be under control, allowing the Fed to stand pat on interest rates for the time being.
Growth in the economy, ex-housing, looks fine - consumer spending rose 3.1% for example. But we wonder how long the overall economy can continue to grow when such an important component, housing, is in freefall.
Slowing GDP growth will ultimately impact corporate earnings growth. We've enjoyed a string of double digit profit growth quarters - this can't continue forever (unfortunately) so stocks could be vulnerable after the strong gains since last summer.

The good news is that our economy is diverse enough to absorb the shock of a collapse in housing and still grow. As a result, we think the risk of a recession is fairly low. However, the likelihood of subpar growth for the next several quarters has increased and investors will need to get used to slower earnings growth as we head into the new year.

Oh, and don't forget, these numbers are subject to revision and may be better (or worse) than today's report!

Commodities Trend Break!

noreply@blogger.com (Under A Buttonwood Tree) — Wed, 18 Oct 2006 15:09:00 +0000

Take a look at this chart of the CRB index of commodity prices. After a period of steady increases, the CRB has recently experienced a noticeable (if not significant) break in that upward trend. Of course, oil is an important component of the CRB so much of the index's price erosion is due to the recent decline in energy prices.

Our take? Ultimately, commodity prices are driven by the forces of supply and demand. So perhaps the trend break reflects some slowing in economic activity. The good news, to the extent the CRB reflects inflationary pressures in the economy, its recent fall is further evidence that inflation has at the very least stabilized for the time being.

Inflation's Not So Scary After All

noreply@blogger.com (Under A Buttonwood Tree) — Wed, 18 Oct 2006 15:06:00 +0000

Yesterday, markets were startled by an unexpectedly high core PPI report (see our last post). So, we held our breath waiting for more bad news from the CPI report today.

It didn't happen. In fact, the CPI actually fell more than expected thanks to gas prices. And the core CPI (excluding gas and food) rose 0.2% as expected.

So, what do we make of these numbers? While the core rate is still above the Fed's "comfort level" it doesn't look to us like there is a big risk of acceleration of the core rate of inflation. And as a result, we suspect the Fed will stand pat for awhile longer - good news for equity investors.

Inflation Scare!!!

noreply@blogger.com (Under A Buttonwood Tree) — Tue, 17 Oct 2006 20:09:00 +0000

Halloween is just a few weeks away, so it seems appropriate that investors got a real inflation scare today.

First the good news. The Produce Price Index fell a whopping 1.3% last month. Needless to say, the collapse of gasoline prices caused much of the overall drop in producer prices.

Now for the scary part! Core PPI (excluding food and energy) rose 0.6% in September or about 3X what the economists were expecting. All of the increase was to be found in finished goods (autos for example). Both crude goods (ie. raw materials) and intermediate goods prices declined in September.

Bottom line? I'm not willing to read much into these numbers, as I am wondering if the finished goods increase reflects hikes in raw and intermediate goods in prior months.

But watch out - tomorrow is the CPI!

Bonds Better Than Stocks in 3rd Quarter

noreply@blogger.com (Under A Buttonwood Tree) — Fri, 13 Oct 2006 18:13:00 +0000

The third quarter was great for stocks with the S&P500 rising more than 5% between June 30, 2006, and September 30, 2006. But bonds did better! Look at the chart to the right. It compares the performance (price only) of the SPY, an S&P500 Index ETF and the TLT, a long bond ETF (click on the link for more info on ETF's). Long bonds rose in value over the period as interest rates fell, thanks to the end of Fed tightening, signs of a slowing economy, and lower energy prices. (Remember that there is an inverse relationship between interest rates and bond prices.)

Perhaps, the upward move in bonds (interest rates down) has had as much to do with a strong stock market as earnings reports, investor sentiment and the like. At the very least, falling interest rates (rising bonds) made stocks more competitive, particularly after their sharp correction from early May.

Please note the recent change in trend I have circled. The stock market continues to head higher while bonds have reversed trend and are falling in value. Interest rates have backed up a bit. While we don't believe this "trend-break" portends any serious problems for the stock market, it may raise the likelihood of a pause or short correction of the stock market's advance.

Since we're a bit bullish, we'd take advantage of any near term weakness in the market.