Thursday, 24 March 2005

Stocks spooked by inflation fears

In its report released yesterday, the Labor Department said that the consumer price index rose 0.4 percent in February. Excluding food and energy, the index rose 0.3 percent.

The figures confirm the view that inflation appears to be picking up, following the previous day's report that the producer price index had also risen 0.4 percent and the Federal Reserve's remark that "pressures on inflation have picked up in recent months and pricing power is more evident".

Stocks reacted negatively to the notion of rising inflation.

In Asia, every major market fell except for Malaysia and Taiwan, which were little changed. Japan's Nikkei 225 Stock Average lost 0.9 percent to 11,739.12, its biggest decline in two months. Singapore's Straits Times Index fell 1.4 percent, South Korea's Kospi index slid 1.4 percent and Hong Kong's Hang Seng Index declined 1.3 percent.

In Europe, the Dow Jones Stoxx 50 Index dropped 0.3 percent to 2,854.44. Germany's DAX Index slipped 0.1 percent and France's CAC 40 Index lost 0.4 percent. The UK's FTSE 100 Index tumbled 0.5 percent. In addition, Germany's Ifo institute yesterday reported that business confidence in Europe's largest economy unexpectedly fell to 94 in March, the lowest since September 2003, from a revised 95.4 in February.

The US market was the only exception to the worldwide losses. The Standard & Poor's 500 Index added 0.82, or 0.1 percent, to 1,172.53. The Nasdaq Composite Index rose 0.88 to 1,990.22. The Dow Jones Industrial Average, though, slipped 14.49 or 0.1 percent to 10,456.02. However, the S&P 500 had fallen to a seven-week low in the previous session.

The Straits Times reported the fall in stocks with the headline "Asian markets overreact to Fed interest rate hike". It quoted UOB's head of treasury research, Jimmy Koh, as saying: "The Asian equity markets, which have been quite directionless for a few weeks, simply latched on to this piece of news and got carried away." He pointed out that the Fed did not mention "a runaway sort of inflation" and that the word "measured" was still in the Fed statement.

Koh may be sanguine, but rising interest rates have, more often than not, been followed by substantial falls in the stock markets. And yet, the level of interest rates counts.

The Capital Chronicle recently made the point that despite its recent narrowing, the spread between US 10-year Treasuries and 3-month T-bills "is not small enough" to suggest that a recession is imminent. And other indicators, like the Chicago Fed National Activity Index, tell "a similar story".

As for me, I always like to look at investor sentiment. I recently mentioned that Mark Hulbert has found sentiment among US investors to be relatively bearish. At the same time, however, fund managers tend to be more bullish on Asian and European stocks.

So if you believe in contrarianism, stay invested in the US but consider cutting back on Asia and Europe. I'm not sure how this suggestion sits with the ambivalent Capital Chronicle but I suspect Jimmy Koh may not agree.

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