The latest data points on US inflation trends reminds us once again that the much-anticipated road to rising interest rates is likely to not be anything resembling a predictable, linear trajectory. The July Producer Price Index, which measures price trends at the wholesale level, edged up 0.1% for a 1.2% year-on-year gain. The more closely watched Consumer Price Index came in at 0.2%, meeting consensus expectations and running at 2% year-on-year. As the Fed heads towards its first period of reckoning for the future of QE in September, the question of relatively low inflation hovers over the proceedings.
With regard to inflation and QE tapering, the concern is that if demand for credit is naturally soft – i.e. muted growth and modest price levels are keeping a lid on business and individual borrowing – then anything that has the effect of edging up interest rates could make a bad situation worse. There will be one more reading each of the PPI and CPI between now and the Fed’s September FOMC meeting when the world will be watching to see if the QE smoke is white or black. Arguably the September inflation readings will be the most influential in the year to date.
Meanwhile, At the Bull
Corporate earnings provide another aspect of the picture. The outlook as measured by analyst expectations has turned considerably less rosy. At the start of the year forecasts for 3Q and 4Q earnings growth for companies in the S&P 500 were 9.5% and 15.9% according to FactSet. With 2Q behind us those estimates have been pared back to 4.3% and 10.8% respectively. Meanwhile, the latest burst of the 2013 rally took prices on the S&P 500 to new record highs in early August. So…prices up, earnings down, and the result is higher P/E valuations. The current level of 16.1x (twelve trailing months) on the S&P 500 is not much above its most recent 10 year average annual rate of 15.8x, but the trend is moving higher.
Putting It All Together
Inflation and corporate earnings are both windows on growth, which continues to be the most vexing part of the equation. It is probably fair to say that the absence of a clear and compelling growth story is what makes the current stock market rally – which after all has been surging along practically unabated since the first trading day of 2012 – a sort of Rodney Dangerfield of bull markets, getting no respect. When you take financial companies out of the equation, earnings for the S&P 500 have actually declined through the second quarter. But that is still impressive compared to the even more growth-challenged rest of the world. Investors would seem, at this point, to be ready to trade their QE morphine for a compelling tale (with supporting data) of global growth. We’ll know more soon about how close we are to that trade.