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[TTHQ Staff]

BEING STREET SMART
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By Sy Harding

INVESTORS UNIMPRESSED BY STRONG ECONOMY. June 4, 2004.

Investors continue to hang back from the stock market, a nervousness that has been in place since the major indexes topped out in January. Wall Street has been providing various excuses along the way. A few months ago it was supposedly concern over 1st quarter corporate earnings, an obstacle that would be cleared away if those earnings came in strong. But when 1st quarter earnings surprised significantly with their strength, investors paid no attention. Trading volume remained low and money continued to pile up in money market funds.

Wall Street’s explanation was that although earnings were strong, the employment picture remained dismal. But if we could get decent jobs numbers the last impediment for the market would be removed.

However, when surprisingly strong jobs numbers obediently came in for March, and the previously released January and February jobs numbers were even revised sharply higher, the market also shrugged off that news. The problem we were told was that the stronger economy implied by the jobs numbers meant the Fed would start raising interest rates aggressively to ward off inflation. If only the Fed would say something to calm down worries about rate hikes. The Fed accommodated that wish with statements that it was not worried about inflation, and if it did begin raising interest rates, it would do so very gradually, not aggressively as the markets worried. Rather than encouraging investors, the Fed’s remarks raised a new worry, that maybe it is reluctant to raise rates because it believes the better economic numbers are only temporary.

So, for the last few weeks Wall Street has been saying that if the monthly jobs numbers for May also come in strong, that would finally and definitely indicate the economy is on a long-term growth track and provide the needed road map for stock market direction. And so the wait for those numbers began.

Released Friday morning, the jobs report showed there were 248,000 new jobs created in May, and previously released numbers for March and April were revised upward by a total of 74,000 jobs as well.

Yet once again market reaction was muted. There was a rally of some degree on Friday after the numbers came out, but on very low volume that indicated it was mostly short-term traders, with still no interest by institutions or investors.

So, what was the problem? Wall Street says now that we need a clearer picture of inflation. The Fed says inflation is benign, and according to Friday’s jobs report, wages are rising at a non-inflationary 2.2% annual rate. But we all see the sharply higher oil and commodity prices. It’s probably a good idea to watch the price of gold, traditionally a harbinger of inflation. Wall Street firms say gold’s value as an inflation indicator is no longer valid. But it’s in their own self-interest to say that now. That is not what they say when the price of gold is falling, and thus predicting low inflation.

After reaching double-digit levels in the early 1980s, inflation subsequently declined to a 40-year low just above 1% in 2001. As would be expected, gold was also in a serious decline for that period, falling all the way from $850 an ounce in the early 1980s to $255 an ounce in 2001. During those years, Wall Street, and even the Fed, frequently referred to the price of gold as a key indicator of inflation. Since gold prices were falling, the Fed had no inflation worries and so could continue to provide easy money by lowering interest rates whenever it wanted to provide stimulus and support for the economy.

It’s interesting that with gold now having risen from $253 an ounce in 2001 to its current level just under $400, the Fed no longer makes references to gold as a predictor of inflation, and Wall Street even ridicules the idea. Could it be because rising gold prices are not favorable to the Fed’s current desire to keep interest rates low in this, an election year?

Meanwhile, the increased pressure on the Fed to raise interest rates to ward off inflation, created by Friday’s strong jobs numbers, was probably offset in their minds by OPEC’s announcement this week that it will boost crude oil production to bring oil prices down. (In reaction to the OPEC announcement the price of crude oil declined from $42 a barrel to under $39 this week).

But keep an eye on gold. Higher gold prices since 2001 have been forecasting rising inflation, and gold does not seem to be buying either the thought that inflation is benign, or that the Fed will act aggressively to raise interest rates to ward off inflation. Although down for the week, and in spite of the decline in crude oil prices, gold rose $3 an ounce after the jobs numbers were announced.

However, some of that may also have been traders using gold as a safe haven as we approach another weekend, which coincides with my opinion that the main problems keeping investors on the sidelines has not been the changing list of worries expressed by Wall Street, but ‘event risk’, as international situations that threaten the U.S. do not show any signs of improving.

Sy Harding is president of Asset Management Research Corp., publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market.