It wasn't that long ago that everyone was worried about deflation. Now, with soaring commodity prices, especially the ones that are visible to consumers, the pendulum has swung the other way. There is a mistaken assumption out there that commodity prices somehow influence the overall level of prices. A look at historical data, though, shows that it just isn't necessarily the case:
Yes, it is true that the spikes in oil in the 70s did lead to inflation, but it was A cause not necessarily THE cause. Clearly, our economy, which is so much more service-oriented than three decades ago, is less vulnerable to material costs. What's the big swing factor these days? The cost of labor, which isn't budging:
Wages were a big big problem in prior inflationary periods, but there are absolutely no signs of wage inflation. Don't believe me? Try this: Ask your boss for a pay hike, telling him or her that you need more money to pay for gasoline and food. Please let me know how that goes. Good luck with that.
There are several other things that encourage me on the inflation front. Gold prices, usually a harbinger of inflation, are quite behaved:
Recall that in the early 70s, gold was allowed to float on the free market after having been set at a fixed price of $35. Since peaking in March above $1000, gold has actually pulled back over 12%. The dollar? It has rallied sharply relative to the Yen and the Euro lately. The Treasury market? No signs of problems yet (4.5% 10yr would worry me):
When I was bearish earlier this year, I was concerned that the dollar would be the sacrificial lamb as the FED cut rates indefinitely. Bernanke et al appears to be signalling that easing is done, and the dollar has responded quite well (108 yen after touching 96 in March, .65 Euro after touching .625 in April).
Hey, it's easy to be concerned about inflation when certain components are so obvious, but a deeper consideration of the facts shows that there is much more to the picture than the price of oil. The dollar, interest rates and gold are all saying not to worry, and the real issue appears to be the potential for wage inflation (no sign at all for now). I believe that the concern about inflation in the market is creating an opportunity not only in stocks, but also bonds. I manage a foundation that is benchmarked against a blended index: 60% S&P 500 and 40% Lehman Aggregate Bond. I have maintained my minimum exposure to bonds all year (10%), though I am considering moving some of the 15% currently in cash back into the bond market.
Disclosure: None, though all of my holdings are posted to my website.
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