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Outlook Promising for Stock Prices

Prof. Peter Morici - 2/21/2007

Today, the Labor Department reported that the Consumer Price Index rose 0.2 percent in January, despite falling energy prices.

Energy prices fell 1.5 percent in January, after rising 4.2 percent in December. Gasoline prices fell 3.0 percent, fuel oil prices were down 4.4 percent, and natural gas prices rose 0.5 percent. Colder weather in February is pushing up fuel prices; however, energy prices should not spike too high as long as oil prices do not go much above $60 a barrel.

Food prices were up 0.7 percent, after not changing in December. Pressures from international grain markets and from the diversion of grains to bio fuels are pushing up prices from flour to bakery goods, meats and poultry, and these pressures will likely continue in the months ahead.

In January, the core CPI—consumer prices less energy and food—rose 0.3 percent, after rising 0.1 percent the previous three months. A one month surge should not be viewed with alarm, as monthly data contains a lot of noise.

Food and energy prices are quite erratic from month to month, and are much less affected by U.S. economic conditions and Federal Reserve interest rate policy than other segments of the economy. Consequently, Federal Reserve policymakers pay close attention to movements in the core index.

Since January 2006, core consumer prices have risen 2.5 percent, and the compound annual rate of change for the three months ending in January was 1.8 percent.

The January surge core inflation may cause investors to fear rising interest rates but the outlook for inflation and a steady course at the Fed remains good. The stock market should continue rising, perhaps after a hiccup today.

No Change Likely in Federal Reserve Interest Rate Policies

Core consumer price inflation remains above Ben Bernanke’s target range of one to two percent, and the Federal Reserve will continue its cautious posture toward inflation.

The hawks at the Federal Reserve will remain vocal. However, inflation should continue to moderate in the months ahead, and wholesale price data released in recent months indicate Federal Reserve interest rate policies cannot much affect remaining inflationary pressures on consumer prices.

Moderate economic growth, falling housing prices and lower energy prices should relieve pressures on both the broader consumer price index and core consumer prices.

Aggressive actions by OPEC, and shortages of U.S. refinery capacity, bio fuels strategies, prospective taxes on oil companies, and other regulatory constraints pose more immediate threats to price stability than the moderate recovery in U.S. growth expected in 2007. Barring a crisis in energy markets, caused by a natural disaster or some seismic event, inflation should decline to comfortable levels through the spring.

With the housing and automobile sectors slow, raising interest rates further would serve no useful purpose. The Federal Reserve should not change interest rate policy before summer.

Outlook for Growth and Stock Prices

Growth should be about 2.5 by the first half of next year.

Moderate inflation and growth, and stable interest rates, will further strengthen corporate profits and investor confidence. Corporate profits will outperform the U.S. economy, because many large U.S. companies earn considerable profits in booming foreign economies.

Prices for new and existing homes have moderated, not collapsed, and overall these have risen about 56 percent over the last five years. Recent adjustments in existing and new home prices should be viewed as healthy, reining in speculation in land and new homes. Once completed, the housing adjustment should promote healthier growth and moderate inflation less dependent on consumer borrowing.

Ordinary investors will be less inclined to buy larger homes than they need and put more cash into stocks. Also, a lower dollar against the euro and concerns about a bubble in Chinese stocks should spark interest in U.S. equities.
Moderate inflation, rising profits, and stronger demand from ordinary investors and from abroad should push up stocks.

The January surge in core inflation may give the market a hiccup today but the outlook for stocks remains strong.