Jason Kelly's Week In Review

It was a mixed week as another rate hike became certain:

Dow +1.1%

Nasdaq -0.2%

S&P 500 -0.1%

The Fed continued its strong anti-inflation message. On Monday, Cleveland Fed President Sandra Pianalto said the core CPI has increased at an annualized rate of more than 3% during the past three months. She that if the level persisted, it would exceed her comfort level, but that the Fed's current stance is close to where it should be to keep inflation at bay.

Fed funds futures priced in a 90% chance of a 17th straight 0.25% rate hike at the end of this month. The Dow fell almost 1% and the Nasdaq dropped more than 2%.

Morgan Stanley changed its mind and decided that the Fed will raise rates on June 29. What's more, the firm thinks there's a good chance of another increase in August. Before this week, the firm thought the Fed would pause until September. While the firm believes the market has fully priced in a June rate increase, it's worried that it has not priced in an August increase.

Canada's esteemed BCA Research, however, said we're close to a bottom: The key takeaway is that the S&P 500 is closer to a bottom than many currently perceive because the upcoming slowdown in economic growth is rapidly being discounted. Nevertheless, our Profit Model is not signaling a contraction, only a growth slowdown. Equity valuations are attractive. The forward P/E for the S&P 500 is on a par with the bear market trough in 2002. Once the bond market relief valve kicks in as inflation fears subside, valuations are likely to expand from current levels.

The producer price index (PPI) for May came in Tuesday at 0.2% compared to expectations of 0.5%. The core rate, which doesn't include food or energy, rose 0.3%, higher than the 0.2% expected. The report confirmed the Fed's recent inflation concerns and further raised the odds of a June rate hike.

May's retail sales came in with a 0.1% increase. The expectation was for no increase. We have to dig a little deeper into the report, though, to find the real story. If we strip away gas station sales, retail sales for May actually dipped 0.1%, compared to a 0.3% rise in April. Thus, echoing the consensus view, it appears that the consumer is indeed slowing down.

This is no surprise and isn't hard to understand. Retail sales hit their high in January. Since then, as the Fed's concerns have highlighted, the percentage of income needed to pay for food, gas, medicine, and interest payments on loans has risen to new highs. At the same time, home prices have dropped and taken with them the wealth effect that sent a lot of people rich on paper out shopping.

The PPI and retail sales reports sent a shudder through the market again. The Dow fell 0.8% and the Nasdaq fell 0.9%. Gold, already down 30% in the last month, fell $40 to $569.

The biggest economic news of the week, May's consumer price index (CPI), was reported on Wednesday. It rose 0.4%, in-line with expectations. The core rate, which is the most important component, rose 0.3% for the third month in a row. The consensus had been for just 0.2%. The report put year-over-year core inflation at 2.4%, up from last month's 2.3%, and far above the Fed's well-advertised 1.5% preferred level and even higher than its 2% tolerable level. That makes it intolerable.

So, we're getting another rate hike this month.

With that settled, the stock market rallied. After falling for six weeks on inflation fears and increasing odds of a June rate hike, it was relieved to finally see the hike as a certainty instead of a possibility. The Dow gained 1% and the Nasdaq rose 0.7%.

The mood continued on Thursday. Talk of a bottom having been reached dominated the corridors of Wall Street. After all, went the refrain, the S&P 500 has a P/E of just 15.5 so perhaps this is a time to buy, not sell. The Dow rose 1.8%, the Nasdaq 2.8%, and the S&P Midcap 400 3.2%. Broad-based hardly describes the near total participation in the rally; 146 out of 147 S&P 500 industry groups rose for the day.

Even Fed Chairman Bernanke helped. He said that commodity prices have pushed core inflation higher, but that rising energy costs should be manageable and that the economy is resilient.

Friday was a new day, however, and the Fed returned to its recent role as wet-carpet thrower. St. Louis Fed President William Poole said that core inflation is over his comfort zone and that the Fed might need to take action. That sent the Dow fractionally lower and the Nasdaq down 0.7%.