Robert Genetski: price rises slow, interest rates down, stocks up, amid emerging signs monetary restraint is finally slowing economy.
by Robert Genetski
The Week That Was
April CPI reports show annualized inflation remains in the 3½ percent vicinity. This was consistent with the year-over-year rate and slightly below the core inflation rate of 4 percent in the latest three- and six-month trends.
However, April retail sales data remained weak. Year-over-year sales were up only 3 percent, while the six-month annualized increase was a weak 1 percent. The numbers show the retail part of the economy has been in a recession for the past six months. Unfortunately, retail sales data are notoriously unreliable and often extensively revised. As a result, its difficult to place much faith in these reports.
With wages rising much faster than retail sales, there is always the potential that sales figures understated the actual gains.
The Homebuilders’ Index for May fell to 45 in response to elevated 7 percent mortgage rates. The sharp decline from 51 in March and April shows how sensitive the new home market is to rate changes. If the recent decline in interest rates continues, the Index should be back to breakeven in June.
Things to Come
Most of the economic news next week will include reports on April housing activity. The Homebuilders’ Index for May is more important and more current than housing reports for April. The Index for May signaled potential problems based on higher mortgage rates. With mortgage rates falling to 6½ percent, the Index will likely improve in June.
On Thursday data for April new orders for durable goods will be released. New orders for durable goods (as well as total new orders) have been essentially unchanged for the past year and down after allowing for inflation. The April release for new orders will show if this trend continued.
Market Forces
Stocks are on a six-week run up. For the week, the major indexes rose 1.3 percent (Dow) to 4 percent (IWM, IJR). The S&P500 rose by 1.7 percent.
Once again, investors chose to view all economic news as good news. The April core CPI report showed inflation at a 3.6 percent annual rate. This was good news because it came under the Atlanta Fed’s 5 percent prediction and because the year-over-year rate was also 3.6 percent, down from 3.8 percent.
Our model shows fundamental inflation is moving lower, with an estimate of 3.4 percent for the third quarter and 2.4 percent by year-end. There also are emerging signs monetary restraint is finally slowing the economy.
While the economy continues to face major risks, these are gradually receding. Inflation is coming down, albeit slowly. It will continue declining as the slowdown or downturn in the economy becomes more apparent. Once the economy shows signs of a downturn, the Fed will quickly shift from restraint to stimulus.
Stocks tend to look three to six months ahead. So far, instead of faltering from monetary restraint, the economy and corporate profits held up better than we expected
The stock market correctly anticipated the economy and profits would hold up well despite the Fed’s tightening. Although the surge in federal spending and regulations provide the appearance of strength, living standards have declined. When living standards decline, people opt for change.
Current polling raises the odds of a major change in policies after the November elections. This change would restore free-market classical economic policies and reverse the current decline in living standards.
This combination of a positive shift in technical indicators and the potential for more sensible policies, increases the odds of further gains in stock prices.
Outlook
Economic Fundamentals: positive
Stock Valuation: S&P 500 overvalued by 32 percent
Monetary Policy: restrictive
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