Picking an Inflation Yardstick

The Fed disregards food and energy costs, and consumers continue to shop. A recipe for a higher market?

By Joseph Lisanti

By at least one measure, inflation has been heating up again. The consumer price index posted a 0.6% rise in May, marking the fifth consecutive month that it has been higher.

The prices of two important liquids that affect the CPI have been in the news lately. On average, the cost of a gallon of regular gasoline rose almost 30% in the year ended May 31. And a quart of whole milk jumped in price by more than 20% over the same period. Energy and food items, however, are excluded from core CPI calculations because they are considered too volatile. The result is that core CPI, without seasonal adjustments, registered no change at all in May.

It should be abundantly clear that if you don't drive a car, heat or cool your home, or eat, your cost of living has been fairly stable. The rest of us may have noticed some prices climbing. But the good news is that shoppers in the U.S. don't seem to be bothered by the CPI advance. Consumers appear optimistic, or at least they have been telling researchers that they are. The University of Michigan's consumer sentiment index rebounded sharply in June. And shoppers spent about 5% more at chain stores in May. We see this as hard evidence that inflation, by whatever measure, doesn't hurt yet.

Equally important to the stock market is that the Fed looks at core CPI numbers when deciding how much to move the economy's interest rate levers. The muted gains in core CPI reinforce our contention that Mr. Greenspan and his colleagues will raise rates slowly.

While any increase in short-term rates could upset investors, we continue to believe that strong growth in both corporate profits and GDP will cause the S&P 500 to close up for the year. We advise 50% of investment assets in domestic stocks, 10% in foreign equities, 30% in cash, and 10% in bonds.

Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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