Streetwise for Friday, February 16, 2018

The late Madame Marie of Asbury Park would have tried to convince you that tarot cards and tea leaves provided a degree of insight into the future of all things, including the stock market. Personally, I would suggest you use data related to the health of the economy instead.

While not perfectly correlated, the economy and the financial markets are intertwined, meaning the economy’s cyclic behavior will play a key role in determining a successful investment strategy.

Data regarding the economy’s health is not hard to obtain. We are continually bombarded with a prodigious stream of economic news, reports and statistics. The problem is to distill out the information that is salient to making profitable investment decisions.

Investors often utilize so-called “expert opinion” to capsulize economic information. However, it should come as no surprise that the experts often have a self-serving motive at hand. While these economists often have impeccable credentials, they also understand where their employers’ profits are coming from.

Government economists are in a similar position. They are charged with advising an administration on economic matters. Should they then be faulted for defending the administration’s resulting economic programs and policies?

As an investor, you are probably best advised to view such opinions with a degree of skepticism, while at the same time balancing them with your own personal judgment in assessing what various economic indicators portend for the future.

When selecting any economic indicator, be sure to keep in mind the four key attributes: relevancy, timeliness, availability and stability. For example, the most widely watched indicator for measuring inflation is the Consumer Price Index (CPI).

Every month the Labor Department samples the prices of items that make up a representative basket of goods. A change in the prices of these goods will move the index up or down.

This past week the Labor Department reported that the CPI increased 0.5 percent during January as households paid more for gasoline, rental accommodation and healthcare. The CPI rose 0.2 percent in December. The year-on-year increase in the CPI was unchanged at 2.1 percent as the large price gains from last year dropped out of the calculation.

If you exclude the volatile food and energy components, the so-called core CPI rose 0.3 percent. That was the largest increase since January 2017 and followed a 0.2 percent rise in December.

The year-on-year rise in the core CPI was unchanged at 1.8 percent in January, also because of less favorable base effects. The core CPI is viewed as a better measure of underlying inflation trends.

While the markets reacted negatively when the report was first released, calmer minds prevailed with the realization that inflation is not of imminent concern. However, the expectation that pricing pressures resulting from rising wages and material costs will prompt a faster pace of interest rate increases from the Federal Reserve has not gone away.

A pickup in wage growth as the labor pool shrinks will likely contribute to higher inflation later this year. Price pressures will also be fanned by the fiscal stimulus resulting from the $1.5 trillion tax cut package and an increased level of government spending.

Nonetheless, the decision by the Fed not to raise the Fed funds rate beyond the currently expected levels will largely depend on inflation remaining within acceptable bounds, specifically about 2 percent over the medium term. Unfortunately, the January CPI data may do little to enhance the Fed’s confidence.

With the January inflation report, the Labor Department incorporated some methodology changes that could inject volatility into the data going forward.

For example, used car prices changed to a single-month price change from a three-month moving average. Smart phones are now quality-adjusted to account for the rapid rate of technological advancements and improved quality to customers.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.