Stocks dipped lower at the open as economic data on inflation in the form of April producer prices showed a 0.7% gain, which was above economists' forecast of 0.3% and March's 0.5% gain.
In some circles, the data suggested too much inflation, while some economists noted the rise, but by no means thought it harmful to the economic recovery.
Market Snapshot / Internals - 05/13/04 Close
It was a choppy trade that finished fractionally lower for the major equity indices, while Treasuries found further selling from not only the 0.7% increase in April producer prices, but $15 billion worth of new supply brought to market by the Treasury in its 10-year note auction.
I was a bit surprised that the S&P Banks Index (BIX.X) 333.81 +0.39%, which faded into the close managed to trade as high as 337.31 considering the further rise in Treasuries. The BIX.X came within fractions of testing its WEEKLY R1 before gravitating back towards its weekly pivot by the close.
As noted in today's intra-day updates, the major indices seemed to find a late-morning bid after the Continuous CRB (cr00y) saw brief trade below my closely watched 269 level.
In tonight's wrap, I will try and give an overview of the CRB, tie it in with current PPI data, and try and give some insight as to why commodity prices have become a key topic of late as "the indicator" to be watching in regards to inflation.
Pivot Analysis Matrix -
There was some range to today's session, and while the Dow Industrials (INDU) continues to show some relative lag in relation to its peers, or other major indices, intra-day trade showed the indices tracking each other pretty closely.
10-year YIELD Chart - Daily Intervals
Treasuries saw selling again today as the Treasury Department successfully auctioned off $15 billion in the 10-year note at coupon interest rate of 4.75%, where the bid-to-cover of 2.78 showed strong demand for the government's debt. In the prior auction on March 11, the 10-year auction fetched 3.752%. Today's auction rate of 4.75% was the highest rate since the 10-year notes sold for 5.17% on May 8, 2002.
How high will the YIELD on the 10-year go? One can never be certain, but the point and figure chart of this bond's YIELD suggests a longer-term YIELD objective of 6.55%. In January of 2000, the 10-year YIELD reached a peak of 6.823%, then declined to a YIELD low of 3.07% in June of 2003.
Continuous CRB - Monthly Intervals
I don't want to continue to focus too much on commodities, as many of us aren't really trading them from the Index Wrap, but I've received a lot of email and questions regarding inflation and commodity prices.
Let's face it. With the thought of Fed tightening due to continued signs of economic growth, but the higher prices of goods that come with that growth, traders and investors should have some type of grasp, or knowledge base of what everyone seems to be talking about as it relates to impact on the economy, equities and bonds.
This is a complex topic, and there are BIG books on the subject, but lets look at it from a factual, but also a technical basis.
I've broken down the recent 5 months PPI reports into finished goods PPI, which one can think of as the "final product ready to ship" PPI. Then I show the Crude Materials component, which in its basic form would be the raw materials used to eventually make up the finished goods.
What the Continuous CRB hopes to depict is more of the crude materials components. The prices of the raw commodities.
Now, the MAIN reason I've started following the CRB more closely, is due to concern that commodity prices, which some say have risen more than 50% suggests the Fed is too loose with rates and hyperinflation may be at hand, if not obviously present.
I show on the CRB chart where the 10-year YIELD reached its peak YIELD at 6.67% in January of 2000, then roughly 2 months later (March 2000) the SPX reached its peak, and obviously the CRB continued higher.
Most of us are familiar with the economy, stock and bond markets from 2000 to 2002. Stocks fell and bond rose (YIELD fell).
Have commodity prices risen more than 50% from their lows of 2001? Certainly they have.
But what is disagreed upon is if this is a sign of damaging commodity price inflation, which would eventually work its way through to consumers.
What is being debated, or I think is confusing the market participants is where commodity price inflation started, and has the Fed missed an important signal regarding inflation, and if so, would then have the Fed having to raise rates rapidly.
Remember, it is the Feds primary purpose to provide a monetary policy, that will help provide an healthy economy, where one of the BIGGEST risks to economic growth is inflation.
I (Jeff Bailey) and perhaps others would argue that just because commodity prices rose from 185.00 to 250.00 (35% rise) that the Fed probably didn't need to raise interest rates in February of 2003, when looking back, many economists now say the U.S. economy didn't come out of its recession until March of that year.
What is being decided, each day of trade, is just where commodity price "inflation" really began.
I (Jeff Bailey) would say that a point of reference would be the CRB 230 level, if using the CRB as an indicator of raw commodity prices.
I don't have the time this evening to have answered all the questions I've received in regards to the CRB, and I'll try and tackle that in this weekend's Ask the Analyst column, but the reason I think we as traders and investors need some underlying knowledge of commodities at this point, is that while gold prices suggest NO INFLATION and accurate Fed policy, there is the camp, or group of market participants that says commodity prices are all that matters.
Now, to further build on why I (Jeff Bailey) begin to think the CRB is more of a technical benchmark to be thinking of commodity price inflation from is this.
Some call it too simplistic "economic theory," but put yourself in the shoes of a business, or person that makes a living by selling raw commodities.
What is the usual reaction when business slows, and prices of what your are selling also falls? You aren't making much money are you? What usually happens during that type of cycle?
Usually we find that some proprietors go out of business, while only the strong survive, and are able to last out the hardship. However, production of the raw commodities usually shuts down.
My thinking is this is what happened from CRB 185 to CRB 230 if not at least CRB 250.
Now, what usually happens when an economic upturn is found? Demand builds, but it takes TIME for production to return. Especially when commodity prices are back at what had been a "peak" cycle.
My thoughts are this.
Yes, the economic upturn in the U.S. and global basis has been strong and has probably fueled demand for raw commodities.
And it is perhaps this reason why commodity prices are being closely watched at this time.
In the CRB chart, where I broke down the Finished Goods PPPI and the Crude Materials components, the basic difference between the two percentage increases can be greatly accounted for with the rising rates of productivity that the Fed will often discuss.
Productivity will also be closely monitored in further economic reports.
But MARKET fears of inflation still weigh in the balance, where the price action in the CRB could become THE CRITICAL KEY to stock market direction in the weeks and months ahead.
The recent "bearish scenario" we discussed and currently have tests for certainly seem to be in play, but it may be commodity prices that weigh in the balance.
Remember some of the comments regarding "asset inflation?" YOU and I hopefully recognize this. I recognize it in the various bullish % indicators we report on each day.
Certainly when the bullish % were above 70% and some reaching as high as 85% (I had not seen those level even during the late 1990s!) that there was asset inflation!
The MARKET has always had a tendency to remove such risk from a market, and this in a way, is what Treasury YIELDS are doing at this point.
The main preface to grasp hold of is when you and I hear that raw material prices are soaring, we must try and conceptualize "from where, and in what context?"
Keep and eye on the CRB as it would be my analysis that we're probably going to start seeing some production begin to pick up with demand. This usually happens in any part of business. When prices are high, suppliers usually grow to try and capture the higher prices to make money.
However, one of the key components that will also be watched is the pace, or rate of productivity with the crude commodities themselves.