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2006-08-15 :: Lower Than Expected Inflation Report

There’s joy in the streets this morning as the Producer Price Index reported much lower than expected.  The PPi came in at a 0.1% increase, below the 0.4% concensus projection and teh core rate actually fell 0.3% compared to a projected 0.2% increase.

Traders are taking this as a sign that the Fed is closer than ever to being finished with higher interest rates.

We’ll likely see consumer and economically sensitive stocks rally this morning.  If we see follow through until the end of trading today, that will be a good sign for the struggling markets.  If, like yesterday, we have an early rally that fizzles out by the end of the day then the struggle will continue for the forseeable future.

The big test is tomorrow when the Consumer Price Index is released.  If we see a similarly friendly CPI number, the consumer and cyclical stocks should react positively.

What to watch for:  since the following news items that should have caused rallies fizzled – the Low Employment Number Rally, The Fed Pauses Rally, the  Israel-Hezbollah Cease Fire Rally – we need the Inflation Numbers Rally to take hold and sustain.

As an aside:  the defensive stocks are way overvalued at this point.  Proctor and Gamble is sporting a near 25 P/E with earnings growth projected in the low teens.  Why own this other than because its a rule of thumb to own it as we move out of a Fed tightening phase?  The last time the defensives out performed was in 2001, and it lasted for nine months.  Since then, the cyclicals tied to the US economy more than quadrupled the performance of the defensives.  Stick with earnings growth and low P/E’s for long-term outperformance; just ride out the current lemmings-following-the-rule-of-thumb market and all will be well.

More later!