In my Hotline this morning I featured an indicator that argues the economy is oversold, and that is a bullish indicator for the stock market. However, with consumer and corporate debt at record levels relative to GDP (as I have noted over and over), and with auto and housing extraordinarily strong during last year's so-called recession, I would have to question not only (1) how oversold the economy is but (2) also how vigorous the recovery will be and, (3) when the Fed will tighten.
I do not believe the consumer side of the economy is oversold, but I do believe the"producer" (manufacturing) side of the economy is very oversold. How versold you ask? Well, at least in terms of the year-to-year change in the Producer Price Index we are at deflation of 2.6%. This is the lowest rate of inflation in 52 years! This lack of producer pricing power has been a huge live for corporate profits in the cyclical industrial and material sectors, but it appears so overdone that even a modest whiff of inflation could be quite bullish for profits in these oversold sectors. At the very least I think this chart calls into question whether the Fed has eased enough. What I do feel strongly about, however, is that any Fed tightening in the face of a too strong U.S. dollar and sharp deflation in producer prices is unthinkable to me for the foreseeable future (Joe Kalish says probably not before September).

In conclusion, PPI deflation indicates the Fed will remain friendly and the producer side of the economy is severely oversold.
<ul> ~ quelle</ul>
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