Summary
Expectations of inflation play an integral role in establishing prices for financial assets. That’s why a focus on underlying price behavior is important to investment strategy.
Through a combination of policy tools and cyclical economic influences, inflation in the U.S. has been quite modest. That has not been the case in economies like Brazil, China and the UK. In Brazil, for example, the Consumer Price Index rose 5.9% in 2010. This compares to a 1.5% gain in the U.S.
We expect constrained increases in the rate of inflation domestically, reinforcing our favorable view of common stocks and high-yield bonds.
Highlights
Ø Capacity utilization, a measure of the level of output the manufacturing sector is currently attaining relative to its potential, is only 76% in the U.S. Although up from 72% one year ago, it is materially below past inflationary thresholds.
· This excess in capacity is a global phenomenon.
Ø Excluding volatile food and energy, the “core” rate of consumer inflation is well behaved, increasing at less than a 0.5% annual rate in recent months. This, with other indicators, keeps the risk of deflation alive.
· “Core" producer prices – items like motor vehicles, computers and civilian aircraft – have been running near 1% -- hardly a “cost-push” pressure on consumer prices.
Ø We do expect that other measures of inflation will show acceleration. Commodity prices, including food, have risen sharply. The U.S. import price index also picked up recently.
o We are monitoring developments in the Arab world for a possible impact on energy prices as well as other geo-political ramifications
Ø However, financial markets ultimately are driven more by core prices, taking shifts in volatile energy and food with a grain of salt.
The opinions in this newsletter are for general information only and are not intended to give specific recommendations or advice. Certain information contained herein has been compiled from independent third party sources believed to be reliable. Hamilton Capital Management makes no representation about the accuracy, completeness or timeliness of the information contained herein or its appropriateness from any given situation.