Friday, May 22, 2009

Inflation Expectations To Pressure Equities

This is a headwind for equities that has started to pop up over the past couple of weeks. Yet, it has taken years to ferment and likely will persist for the foreseeable future. The headwind I am talking about is inflation.

Inflationary pressures -whether real or perceived - will likely remain high, and this can be seen in our inflation indicator that looks at the trends in crude oil, gold, and yields on the 10 year Treasury. See figure 1, a weekly chart of the S&P500 with our inflation indicator in the lower panel. With strength this past week in crude oil, gold, and yields, the indicator is back in the extreme "high inflation" zone.

Figure 1. SP500 v. Inflationary Pressures

As discussed in the article "More Headwinds To Worry About", inflationary pressures are a significant headwind for equities even in the bull market of the 1980's and 1990's. This should be clear from the study presented in that article. When the trends in crude oil, gold, and yields on the 10 year Treasury are strong and rising, equities tend to under perform.

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