Last Week in Review

Concerns over energy prices, weakening consumer confidence, a mixed inflation report and some increased activity in the merger-and-acquisition calendar caused U.S. stocks to experienced mixed performance for the week. The S&P500 Index was basically flat, falling one point to 1,360. After last week, the index was down just over 6.5% for the year. Large value stocks are the worst performing for the week and the year, down 7.8% year-to-date. Small and Mid Cap stocks are still out performing Large Caps.

Data last week pointed to continued weakness in consumer confidence, which acted as a drag on stock market performance. Historically, extremely low levels of consumer confidence have often presage market rallies. In fact, in the 12 months following the 10 lowest readings of consumer confidence over the last 30 years, stocks were up an average of 20%.

The big news last week was inflation. The CPI (Consumer Price Index) for May posted its largest monthly increase since last November, primarily due to energy prices. Core CPI inflation (which excludes energy and food prices) remained low. I do not believe that inflation is low even if you exclude food and energy. The government’s method of calculating inflation is flawed. It manipulates the calculation, substitute’s goods and then under estimates the price of improved goods. Inflation is a political hot potato and the incentive is to keep it low. The government has to increase social security benefits by the rte of inflation so low inflation equates to low benefit payout increases. Broad-based inflation in the U.S. is picking up and if our inflation is the same as most of the developed world then our inflation rate is around 7% which would mean we really are in a recession.

This leaves the Federal Reserve between a rock and a hard place. Deteriorating economic growth combined with the credit market issues has forced the Fed to keep dropping interest rates. On the other hand, the Fed is feeling pressure to increase rates due to rising inflation, the weak U.S. dollar and high oil prices. At this point, the Fed is talking tough (saying they plan to raise interest rates and that the dollar should strengthen) which is helping to bolster the equity markets. However, the Fed is unlikely to raise interest rates any time soon, given ongoing credit market problems. In fact it is entirely probable that the Fed may have to lower interest rates despite their hawkish rhetoric. The near term will continue to be bumpy in the equity and credit markets. The deteriorating economic climate here and abroad coupled with the worsening energy crisis will cause the markets to struggle for the next few months.