Inflation Striking First In Emerging Markets
Federal Reserve chairman Ben Bernanke was on Capitol Hill today testifying to the House Budget Committee. He was characteristically sanguine. While declines in the unemployment rate the last two months are “some grounds for optimism,” he cautioned that “with output growth likely to be moderate for a while and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level.”
Notice the “several years” part. Vague, yes, but Bernanke clearly does not expect significant improvement in the near future. This matters to traders because they want to know whether the Fed will keep pumping after the current QE2 program ends this summer. Bernanke admits it is a possibility – and that has people concerned about inflation.
Our view is that the inflation question is more complicated than most people want to make it. The U.S. is plagued with excess labor capacity, which means wage levels are generally flat and certainly not rising. It is hard for inflation to take hold in these conditions. The emerging markets do not have this problem, for the most part, so inflation is a bigger concern for them. This is why global demand for raw materials and energy is so strong. Since natural resource prices tend to rise and fall everywhere, we in the U.S. get double trouble. We get to pay more for commodities like gasoline at the time when we can least afford it. Bernanke is correct that resolving these imbalances can take a long time.
After moving higher the last few days, Treasury yields reversed sharply lower today. Gold and stock prices began pulling back at about the same time. This combination suggests that the immediate reaction to Bernanke’s comments was in support of his low U.S. inflation stance. The stock market rally that began in November is highly correlated to the Fed’s monetary stimulus. When and if traders grow convinced the stimulus is coming to an end, stock momentum could take a sharp dive. It isn’t happening yet, though.
Crude oil prices dipped, but Energy maintained its grip on the top sector ranking. Three other sectors are right behind, as they have been for a while now. Industrials, Technology, and Materials are all strong based on signs of increasing economic activity around the globe. This week Technology edged slightly ahead of Materials for third place. Semiconductor stocks have been very strong, and software/internet firms are also contributing. There was no change in the lower half of the table, with defensive sectors still on the bottom.
The Style rankings remained tightly packed, though all categories improved on an absolute basis in the last week. The lack of dispersion means we should probably not read too much into the relative positioning of each style. That said, Growth does seem to have a slight edge over Value at all capitalization levels. Size seems to be less relevant right now, with the segments actually quite jumbled. Small Growth is at #3, for instance, while Small Value is in last place at #11. The two extremes, Mega Cap and Micro Cap, are right next to each other near the bottom of the list. If any capitalization size has an advantage, it is probably Mid Caps which occupy three of the top four positions.
Europe again held the top global ranking, but there is a large cluster forming just beneath. The U.S. and Canada are tied for second place, with Japan and the U.K. close on their heels. All these categories are separated by only a few points, so we could easily see some rearrangement by next week. Latin America has slipped into a downtrend, joining China on the bottom of the list. China raised interest rates in an attempt to reduce inflation risk. In fact, inflation is turning into a common theme across the emerging markets. So far it does not seem to be getting out of control.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“Monetization would involve a permanent increase in the money supply to basically pay government bills through money creation…What we are doing here is a temporary measure.”
Ben Bernanke, testimony before the House Budget Committee on February 9, 2011
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