Bulls Tag-Teamed by TheStreet.com Dynamic Duo

It all seems like good news, but leading bears do not agree.  One week ago we predicted that this would happen.

Oil prices (and the prices of other commodities) have moved lower.  The market reaction has been to treat this as bullish.  The Fed is under less pressure to tighten again.  Much Fedspeak has suggested that they want to see the effects of past tightening.  Most have commented that the year-over-year inflation rate, however measured, will moderate.

It seems bullish.  It fits our definition of normal progress to The Glide Path.  Every fund manager or trader should have some knowledge about what is normal and be willing to change views if indicated by the data.

Barry Ritholtz sees one potential negative side.  We already have inflation since oil prices went up and now this is evidence that the economy is getting weaker.  In other words, we are headed for stagflation whichever way oil moves.

Doug Kass sees a different potential negative side.  Since oil prices are moving lower the economy will get stronger.  The Fed will now have to step in and raise rates further.  In his excellent trading diary on TheStreet.com’s professional site, Doug writes:

No one in the fourth estate — I mean no one — is mentioning the stimulative impact on the economy (and the possible Federal Reserve implications) of the sharp drop in the price of energy products.

Jeff Bagley, another fine writer on the site, objects to this analysis with a practical and insightful comment:

Let’s not outthink this: A fall in energy is the opposite of inflationary; it reduces costs.

In fact, bond market participants don’t view oil’s recent decline as
inflationary at all. Just the opposite, in fact. Long-term inflation
expectations, as measured by the spread between Treasuries and TIPS,
have fallen in recent weeks, down from about 2.65% to the current
2.40%.

The bond market is signaling future cuts in short-term rates, not increases.

Barry and Doug both make money for their investors regardless of their base views because they make astute counter-trend trades.  (Doug made a great trading call to his readers today on energy stocks.)

Our audience at "A Dash" is a bit different, and so are my motives in writing.  The average trader — and maybe the average hedge fund manager — is not sufficiently agile to make these counter-trend trades.  It is a good idea to understand what constitutes normal data, and be on the right side of major moves.

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2 comments

  • Barry Ritholtz September 13, 2006  

    I’m not looking for stagflation — GDP can slow, but I doubt we see 14% inflation. If anything, the oil price drop is deflationary.

  • oldprof September 14, 2006  

    Barry — Thanks for stopping by and commenting. While I tried to capture your musing about a slowing economy, your comment was a long way from ‘Stagflation.’ It is something you have talked aobut before, but not in that post. I think our readers would appreciate it if you specified what you really expect — and also what might persuade you to change your mind.
    Thx- Jeff