Wednesday, April 20, 2005

Did the Easter Bunny cause inflation?

No, but he may have caused the market to wrongfully be worried about strong inflation on the rise. Last week was horrible for the major averages. Just plain lousy. Over the weekend I heard many comparisons to the crash of 87`. I heard fear about a crash on Monday. The fear lingered in the air. Look at the P/E ratio of the SPX (the s&p 500) 18x earnings. We are not in an overvalued market here people!

What we are experiencing is a change of tides. A fulcrum point. A Rotation. This recent "rotation" has been due to the Federal Reserve's recent increase in the short rates to fight inflation and perhaps "cool" the housing market. Yesterday, the Producer Price Index (PPI) was released with a core increase of .01%. This was great news for the equity markets as this alluded to very minimal core inflation (ex food & energy as they traditionally are very volatile)

The more popular indicator of inflation, the Consumer Price Index (CPI) struck a nerve. This morning's release of the CPI was not as peachy. The CPI rose 0.6% in March, slightly higher than expectations. But the core index rose 0.4%, double expectations (The key metric the market is watching). The culprit behind the surprise increase in core prices was a 3.9% surge in lodging costs. Economist Mr. Shepherdson makes a great observation, "It is possible that the early Easter explains the March leap, hotels may have raised rates earlier than usual," says Shepherdson. "Either way, this is not a sign of impending stagflation." Ah ha!

The Easter Bunny's egg definitely skewed our perception of everyone's favorite inflation indicator. Although, I don't think the market is aware of this factor or at least the market doesn't think the Fed will realize inflation is not as big of an issue as it seems!

Another key problem causing the core CPI to rise was Airline ticket prices. They rose by 2.7 percent, the largest increase in nearly four years, reflecting efforts to deal with surging fuel costs. This is a serious cost to many travelers, this is more correlated with energy costs and I don't believe raising rates will lower our demand for energy. The strong marginal demand for energy I believe is in China/India keeping prices high.

Food prices were basically flat as, food costs rose by 0.2 percent in March, following a gain of 0.1 percent in February. Although, prices for pork and fresh fruit fell.

When all is said and done, some consumer prices are rising but the numbers really aren't as scary as they seem. I think there should have been more seasonal adjusting for the good ole Easter Bunny and perhaps investors wouldn't have been selling off like they did this afternoon.


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