Inflation destroys stock market fantasy

Wall Street suffers as higher energy prices nix dreams of more stimulus.

By Anthony Mirhaydari Apr 4, 2012 12:11PM

The delicate balance holding the stock market aloft has been broken. Central bankers, the providers of the cheap money that has sustained the uptrend, could no longer deny rising inflationary pressures. They also had to mention signs of economic strengthening, even if they're based on unsustainable things like unseasonably warm weather and a drop in the savings rate. 


By acknowledging the troubles of higher prices, they have destroyed Wall Street's hopes of hundreds of billions' worth of new monetary policy easing later this month. The stock market's cheap-money addiction has been laid bare. And it ain't pretty.


Stocks dropped dramatically after the latest meeting minutes from the Federal Reserve threw icy cold water all over the idea of a third round of quantitative easing being unveiled at its April policy meeting. The problem is higher gas and oil prices have pushed inflation above the 2% target. The sell-off continued Wednesday as the European Central Bank joined in, too.


In this environment, with the markets dependent on central bank largess to justify their otherworldly, no-volatility, low-volume uptrend in the context of deteriorating economic fundamentals, having the Fed and the ECB talk about inflation is like someone yelling "fire" in a crowded theater. It sent the meek scattering for the exits, unleashing the wave of selling pressure.


But rest assured, QE3 is coming. And it's coming soon. Most likely at the June meeting. Which means officials will start teasing it in about a month. Between now and then, the market will likely be pulled lower on weaker and weaker economic data, as was seen by pitiful manufacturing activity data earlier this week.



The Fed meetings pretty much outlined this scenario. Members of the policymaking committee saw no need to ease further unless economic conditions worsen. Only a "couple of members" discussed the potential need for more stimulus if inflation or growth weakens -- a downgrade from the "other members" who discussed this at the January meeting. They also noted the substantial increase in oil and gas prices.  


I'm not the only one with this outlook. As soon as news of the Fed minutes hit the wires, research note after research note from the big investment banks hit my inbox all saying the same thing: QE3 in June.


Societe Generale economist Aneta Markowska wrote that the minutes were "not as dovish as we expected" and were notable for their lack of discussion of further easing options "whether outright QE or some kind of sterilized version." The latter has been hinted at recently as a more inflation-neutral option for any QE3 initiative. (Essentially, the Fed would target mortgage rates while removing the excess cash it's using to do so out of the system.)


Merrill Lynch economists paid attention to the Fed's mention of warmer-than-normal winter weather and the effect it has had on seasonal adjustments to economic data -- acting as an artificial boost to the results that has made the economy look stronger than it really is. This is something I've mentioned before.


As for the ECB, bank president Mario Draghi noted Wednesday that upside risks to inflation prevail and that the annual inflation rate is likely to remain above the bank's 2% target this year. He added that all tools to address increases in inflation remain on the table.


All of this is a big disappointment for bulls looking for central bank largess to send stocks and other risky assets higher, regardless of the negative impact it would have on inflation, consumer spending and the real economy. The selling pressure that was unleashed should continue for at least a few weeks.


In response, I recommend conservative investors cash out and reduce stock market exposure for now. For nimble traders, there is a growing list of attractive short ideas. Until now, they have been relegated to energy and emerging-market issues. Now semiconductor stocks are joining the list of sectors demonstrating relative weakness against the overall market. European stocks are also turning lower in a big way after a poor Spanish debt auction early Wednesday. 



I am adding a new short position in Vishay Intertech (VSH) and a long position in the Direxion Daily Semiconductor Bear 3x Shares (SOXS) to my Edge Letter Sample Portfolio. Current positions include a short in the National Bank of Greece (NBG) -- up 33% since Feb. 22 -- and a long in the Direxion 3x Daily Emerging Market Bear (EDZ) -- up 11.1% since Mar. 15.


The SOXS is a triple-leveraged inverse ETF, so it's appropriate only for the risk takers out there. Milder versions of the same idea include the ProShares UltraShort Semiconductor (SSG), which I recommended to my newsletter subscribers earlier this week, or a short position in the Market Vectors Semiconductor Holders (SMH).


I found VSH and SOXS with the help of technical screens developed with Fidelity's Wealth Lab Pro back-testing tools, which you can find here. (Fidelity sponsors the Investor Pro section on MSN Money.)


Disclosure: Anthony has recommended SSG to his newsletter subscribers.


Check out Anthony's investment advisory service The Edge. A two-week free trial has been extended to MSN Money readers. Click here to sign up. Contact Anthony at anthony@edgeletter.c​om and follow him on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.


Apr 4, 2012 2:07PM

The Foes,


Inflation is far worse then deflation for the middle class. Deflation is a boom for anyone on a fixed income, savers, and those wishing to purchase goods or services. The only "good" for inflation is if you are in debt, then you can repay in inflated dollars, this is why the government is pushing inflation because they are the biggest debtor in the world, the banksters are number 2. Inflation pushes the pain onto the middle class while deflation pushes the pain on the government and banksters.

Apr 4, 2012 2:32PM
Unemployment is over twice the figure they throw out there.
Apr 4, 2012 2:21PM
Stop the QE madness! I'm going to repeat myself. It's a fact that you can't keep a leaky ship afloat forever with pumps. Sooner or later something goes wrong and down goes the ship. At a certain point in time you just have to decide to fix it properly or scrap it, either one of which is preferable to the chaos and tragedy of a sinking. No more money for wall street billionaires!!!
Apr 4, 2012 2:39PM
What we need is consumer demand to spur the economy. How can you stimulate demand when rising prices decrease consumer purchasing  power.
Apr 4, 2012 12:25PM
The market is addicted to cheap money.  It will get its next fix in June, but when will it end.  Europe seems to indicate that it does not.  It only makes for a longer healing process.  In the meantime,  the US investor waits and waits for the next fix.  Smile
Apr 4, 2012 1:12PM
How rediculous, the inflation rate is easily double the "target rate".  Actually, inflation is running at near 8 or 9 percent.  However, real assets are in a deflationary cycle with a long way to go down yet.  Meanwhile the policy makers unable to get the economy kick started with "funny money" keep trying to inflate.  Cash(dollars) is no longer king, owning precious metals in the form of smaller quantities which can be traded easily are a better bet.  Cash is being "taxed away" by conficating savers investments.  Defacing currency is the most insidious thing a government can do to its citizens. 
Apr 4, 2012 1:00PM
QE3 in June? Hopefully not. The economy and the market need to work without the extra help or the future will be very bleak (probably already to late thanks to QE1 & QE2). If it's all going to fail and go to h**l, let it go now and take Obama with it.
Apr 4, 2012 1:58PM
Wow - an honest market appraisal on MSN, how did that happen ? But don't worry, Bernanke will make sure his pals on the street get their fix - even if real inflation takes off under the invisible blanket they keep it under.

I believe Unemployment rate will tick BACK up to 8.5% or even 8.6%....


We shall find out this Friday April 6th at 8:30AM ain't gonna be good this time around!!



Apr 4, 2012 3:29PM
Here's an idea: 

Why can't Fed policy focus on a stable, i.e. neither increasing nor decreasing, money supply? Wouldn't that mediate a fair exchange of money for value across all industries? Wouldn't that ensure neither inflationary nor deflationary episodes and put the lie to this nonsense we call the "business cycle?"
Apr 4, 2012 1:13PM
Well, I gather the charts are "reversible" in a few "months"?  Anyone with any semblance of a brain has seen the inflation tick for years' and counting. The economy is in the tank and not a thing can be done ... now.  Let the "'entitlements' roll for those that should not be in college supported by their "parents".  Let's have welfare ladies have more 'babies' and .. we will certainly pay for that.  If you think inflation has not been here for years' then you are daft in brain-cells.  Head on with the Gen-X nonsense in pundits, here.  They are now bending over and grabbing their collective asses....they know crap! Inflation will be rampant and soon.  Print more money!
Apr 4, 2012 3:00PM


How can Bernanke say "QE3" with a straight face?    Eye-rolling



Apr 4, 2012 2:10PM
someone jdmeck: agree with you 100%, enough of the printing and obama's bullcrap, get him out, China must have made one hell of a deal for ole lady obama to be some kind of queen of the world or something when they buy us. house tax's going up in Ct. about 3 to 400 more bucks a year, must be giving some more raise's and gas for the bus's, i'm disabled and i can't write tax's off or mortgage and i still have to pay home tax's ****, my kid is done with school.
Apr 4, 2012 2:02PM

and more lay offs coming, hope obama counts them this time when the employment numbers come out, yahoo, 2000, best buy and sears 1000's,  maybe someday this idiot will understand fuel runs this country, we are not in the horse and buggy years but he sure is putting us there, i told my son, if you buy land make sure you have a good running brook or river you will need it for power.

sure wuish obama got his **** together, to late.

everyone wants stimulis, that is one reason we are where we are, nowhere. obamaboy is never going to get out of this mess with printing "F:" in money. stop the print, raise interest a point and lets see if that works, nothing he has done works, spend and spend, maybe it is true, the SOB is selling us to China.

Apr 4, 2012 1:50PM
The reason wht Anthony is right about a June QE3 is because Obama will need a boost inthe stock market to get re-elected.  Howeve, the boost will be dampened by the prospect of Obama ending the 15% dividend rate if he is re-elected.
Apr 4, 2012 1:31PM
For once, I totally agree with  Anthony Mirhaydari's analysis and recommendations.  Until the FED revs up the money printing press the stock market isn't going to go much higher.  Anthony is also right in his prediction that QE3 is inevitable.  Now would be a good time to buy gold and silver before the central banks flood the financial markets with more cash and send the price of commodities significantly higher.
Apr 4, 2012 4:36PM
Obama blames Bush and Romney for inflation worries....LOL
Apr 4, 2012 3:25PM
The market hits a four-year high, then drops for two days, and this guy declares victory.  He's been calling for a bear market since October, which was actually the market bottom.

Great job on your 2% gain after a 30% loss.  Excellent work.

Apr 4, 2012 2:02PM
Can't we have a referendum on this disastrous Adm.?
Apr 4, 2012 2:52PM
if i was a investor i would, worry more about corruption, then inflation  
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[BRIEFING.COM] The stock market finished an upbeat week on a mixed note. The S&P 500 shed less than a point, ending the week higher by 1.3%, while the Dow Jones Industrial Average (+0.1%) cemented a 1.7% advance for the week. High-beta names underperformed, which weighed on the Nasdaq Composite (-0.3%) and the Russell 2000 (-1.3%).

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