With the U.S. Federal Reserve’s (Fed) money machine working overtime, the upward pressure on pricers of stocks and consumer goods and services continues.
The Week That Was
The explosive increases in consumer prices for May brought year-over-year inflation up to 5 percent for the total index and 4 percent after eliminating food and energy prices. This was the highest yearly inflation in over a decade.
Some of the inflation represents shortages attributable to the explosive rise in spending from government payments. Inflation rates will ease a bit this summer and fall as markets adjust to the shortages.
Even so, the seeds for the next inflationary cycle have been planted. With the recent sharp increases in wages, the underlying inflation rate is likely to be at least 3 percent to 4 percent by the end of this year.
Labor markets continue to show some improvement. Weekly initial claims for unemployment moved slightly lower in the first week of June, to 376,000. The average
mumber of claims in May was 426,000. The number of people receiving unemployment payments has changed little in the past three months.
Things to Come
Most of the economic news this week will arrive tomorrow, notably retail sales and
manufacturing output for May and the Homebuilders’ Survey for early June.
Retail sales numbers in April were 18 percent above their pre-Covid peak. This is far above personal income and real disposable income, which were roughly 10 percent above their pre-Covid peaks. With sales well ahead of income, it’s reasonable to expect a few months of subdued retail sales until sales are more aligned with incomes.
Manufacturing production in April remained 1 percent below its pre-Covid peak. Business surveys for May suggest manufacturing will move at least 1 percent higher, to new all-time highs.
Wednesday’s Fed meeting could be interesting. The Fed has clearly underestimated the strength of both the economy and inflation. It will be interesting to see if the Fed governors begin hedging their statements about money and interest rates in light of the latest data. Although I hope they would recognize the obvious, my guess is they are not ready to change their tune.
Stocks were mostly higher this past week. The S&P 500 gained 1 percent, moving to a new all-time high. The Nasdaq and QQQs rose by 3 percent, reaching close to their all-time highs. The Dow was down slightly, and small caps were mixed.
Overall, stocks continue to show strong upward momentum. At 4239, the S&P500 is 27 percent above its fundamental value. Stocks clearly are overvalued.
In spite of this overvaluation, the outlook for the market remains positive. After a bit of tapering in March and April, the Fed purchased $125 billion in securities in May. The Fed’s policy last year has led to double-digit increases in spending and wages during the first half of this year.
As the Fed pumps a significant amount of money into the economy, the impact on financial markets is immediate. In spite of the market’s overvaluation, the odds still favor higher rather than lower stock prices.
The flood of new money into the economy has also depressed interest rates. Although the Fed’s target rate remains 0 percent, U.S. interest rates are higher than those of Europe and Japan. Foreign investors are ignoring U.S. inflation and seeking out higher relative interest rates. This provides still another force driving interest rates temporarily lower.
As a result, rates for longer-term bonds have moved sharply lower. The Fed is settling up both the economy and financial markets for a dramatic and damaging correction.
For now, with the Fed insisting on refilling a punch bowl that is already overflowing, all we can do is—Party on!
Economic Fundamentals: positive
Stock Valuation: S&P500 overvalued by 27 percent
Monetary Policy: highly expansive