bulls vs bears

Investors looking for inflation clues
Bulls see possible rebound if data comes in weaker
E-mail | Print | | Disable live quotes By Alistair Barr, Market Watch
Last Update: 8:51 PM ET May 14, 2006


SAN FRANCISCO (Market Watch) -- Stock market bulls hope economic reports in coming days will show inflation concerns that have dented equities recently are overdone.
But bears fear the data could confirm growing worries that high energy costs and a falling dollar will lead to more inflation and interest-rate hikes, crimping corporate profits and consumer spending.
A Tuesday report on April producer prices and a consumer price reading on Wednesday will be closely watched, as will housing data and industrial production numbers, also on Tuesday.
"If these indicators counter the prevailing inflationary story, then the market can rally again," said Barry Hyman, equity market strategist at New York-based broker dealer Ehrenkrantz King Nussbaum. "If these data points corroborate inflationary concerns, then the correction continues."
On Thursday, stocks logged their biggest one-day decline since January, drubbed by worries that rising commodity prices will translate into higher inflation and prompt the Federal Reserve to raise interest rates again in June.
For the week, the Dow Jones Industrial Average (DJIA : Dow Jones Industrial Average
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4:30pm 05/12/2006

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DJIA11,380.99, -119.74, -1.0%) fell 0.5%, while the technology-heavy Nasdaq Composite Index (COMP : Nasdaq Composite Index
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12:19am 05/15/2006

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COMP2,243.78, -28.92, -1.3%) lost 3.4% and the broader Standard & Poor's 500 (SPX : S&P 500 Index
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1:07am 05/15/2006

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SPX1,291.24, -14.68, -1.1%) shed 1.6%. All three equity benchmarks remain in positive territory for the year, although the Nasdaq is up by only a fraction. See Friday's Market Snapshot
While the market has managed to recover from similar, short corrections this year, Hyman isn't optimistic this time. On Wednesday, his firm began advising clients to sell stocks into strength and jettison holdings that have performed well recently.
While crude prices have surged, other commodities such as copper and silver have also jumped to multi-decade, or record highs this month. Most companies have yet to really pass the extra costs onto consumers, but some, such as airlines and FedEx Corp. (FDX : fedex corp com
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4:15am 05/15/2006

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FDX115.06, -2.21, -1.9%) , have begun raising prices, Hyman said.
The effect of higher crude prices on consumers became evident on Friday when researchers at the University of Michigan reported that economic confidence slumped in early May at the fastest rate in at least 28 years. See economic report
"How long is the consumer able to hold up to this? If the economy slows and employment starts to wither, then these concerns will start to compound. That's how a bear market will start," Hyman said. "We're not optimistic for the second half of the year."
In a more defensive market, healthcare stocks could do well, he added.
The recent drop in the U.S. dollar isn't helping because a weaker currency will increase import prices, fueling inflation further, said Jim Awad, chairman of Awad Asset Management, which overseas $1.3 billion.
The dollar tumbled to one-year lows against European currencies and eight-month lows against the Japanese yen on Friday. Concerns about the twin U.S. trade deficit and government spending deficit have been magnified of late, amid debates about whether the Federal Reserve will pause its interest rates-tightening cycle at the same time that Europe and Japan signal rising rates. See full story.
"The market is concerned about higher inflation, higher interest rates and higher prices for energy and other commodities, all of which have the potential to hurt corporate profits as we work our way through the year," Awad said. "This is compounded by expectations of slower growth and higher inflation on the part of consumers, combined with a chronically weak dollar."
"All in all, it's an awful combination for stocks as we close the week," he added on Friday.
Inflation concerns could weigh on equities during an information vacuum before the next Federal Reserve interest-rate decision and the start of second-quarter earnings season in July, he explained.
Still, Awad remained confident about the stock market longer term, predicting that benchmark indexes could reach new highs before the end of 2006.
While higher energy prices are bothering consumers psychologically, the U.S. economy is creating lots of jobs and trends such as the Internet, Chinese production and outsourced Indian services should keep inflation at manageable levels, he said.
"All the inflationary forces that are currently ranged against us will peak at levels that won't be damaging to the economy, interest rates and markets," Awad concluded. "But the market won't realize that for a while."
Awad said his firm is increasing investments in "quality" small-cap companies, such at School Specialty Inc. (SCHS : school specialty inc com
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7:30am 05/15/2006

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SCHS35.85, 0.00, 0.0%) and EDO Corp. (EDO : EDO Corporation
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7:49am 05/15/2006

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These holdings anticipate a swing from the current momentum-style of investing that's been fueled by low global interest rates, to a new focus on value investing, he said.