Lack Of Inflation A Good Thing


Helped by solid economic data and a well-received speech from President Trump, the major averages rallied to fresh all-time highs. The Dow Theory is squarely in the bullish camp, and our buy lists have 94% to 97% in stocks.

Utility stocks shine

Economic news in the U.S. and abroad has been mostly encouraging, extending a run of stronger-than-expected data. Several Federal Reserve officials have commented on the robust reports, indicating that an interest-rate hike could come as soon as this month. Futures prices now imply a more than 70% probability of an increase after the March 15 Fed meeting, up from less than 20% in mid-February.

Predictably, banking stocks have benefited from expectations of higher interest rates. Cyclical groups have rallied on hopes for a stronger global economy, helping the consumer-discretionary, industrials, materials, and technology sectors reach all-time highs.

Interestingly, interest-rate-sensitive utility stocks have also rallied sharply since early February, pushing the S&P 1500 Utility Sector Index within 3% of the highs reached in July. Before the recent comments from Fed officials, yields on 10-year Treasury bonds had reached nearly three-month lows. Even now, with the Fed's preferred inflation gauge at four-year highs and near its 2% target, 10-year Treasury yields remain below their mid-December high.

Bears say the bond-market action is a reason to question the stock market's rally. Bond investors often pick up on economic shifts before equity investors, goes this argument, so their reluctance to embrace the "reflation trade" seen since Election Day is worrisome.

Bulls argue that the dip in bond yields simply reflects investors' strong desire for income in a low-return environment, that lower bond yields make stocks more attractive in comparison. After all, as legendary investor Warren Buffett said Feb. 27, "Measured against interest rates, stocks are actually on the cheap side compared to historic valuations."


Equity investors are right to worry whether expectations for stimulus from Washington are too high, but rooting for higher inflation makes little sense.

The stock market wants stronger economic growth that lifts corporate earnings without fueling an inflationary spiral, which would boost bond yields and likely result in lower price/earnings ratios on stocks. So far, economic data and market action since Election Day has been consistent with that scenario.

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