Siegel deflation01 commodity price higher puts a floor underneat

Siegel: US Stocks Looking Very Attractive
By Olivier Ludwig | July 07, 2011

Page 2 of 4   Ludwig: At the risk of overplaying the comparisons with a year ago, it seems to me that after the Fed’s retreat in Jackson Hole, Wyo., last summer, when Bernanke first floated a trial balloon about the possibility of QE2, something was unleashed that pushed up stock prices. But that doesn’t seem to be in the cards right now. Siegel: No, it doesn’t. Ludwig: So where does that leave the economy? Siegel: The position of Bernanke and the Fed at the present time is that QE2 actually worked to the extent that it reversed the core deflation in the economy. It also looked very promising early on, as jobs were created right away. That has sagged recently, but not stopped. Last week was quite incredible. It was the first time in two years that we’ve had a 5 percent increase in stocks in a week. That was another purpose of QE2, to reflate asset prices. It’s very possible the situation could have gotten a lot worse, and QE2 stemmed that tide. The arguments Bernanke used to do QE2 were based on deflation, not just the slowness of the economy. Deflation has stopped, and turned around. So, his main lever to get unanimity on the FOMC is gone. He will not be able to get a majority to do it again just because the economy is slow. It was the deflation risk that he used to push that particular policy. Bernanke is saying he thinks the slow patch in the first half was temporary, and will disappear in the second half of the year. He’s definitely in a wait-and-see mode. It’s premature for him to say anything because of one or two months of a disappointing labor market—especially when we look at manufacturing: It looked like it was dropping off a cliff. But the last couple of indicators have been very, very good. We are over-influenced by the very recent data we get. There’s often a lot of noise in that data, and Bernanke just wants to get a better signal. That just takes time. Ludwig: Do you see any risk of deflation returning, and that the economy will find itself at a very similar precipice as the one he perceived about a year ago? Siegel: You can point to the fact that home prices are actually down. But I personally think they’re scraping on the bottom, and they’ll scrape on the bottom for quite a while. Overall, deflation seems unlikely, first of all because commodity prices have moved higher even though they’re softening now. So that puts a floor underneath the whole price structure, because even though we look at core inflation or deflation outside of food and energy, they do seep into core prices. We do have net job creation; unemployment is not rising, wages are pretty stagnant, but they’re not going down. So I don’t see any deflationary pressure, but then I don’t see any inflationary pressures either. Ludwig: What is your sense of the oil market in the broadest sense? If you listen to geologists like Ken Deffeyes … Siegel: You mean Peak Oil? I actually believe in Peak Oil. But we’re also on the verge of some tremendous breakthroughs in energy technology. Five years from now, I’m not sure the internal combustion engine will be the operative mode for automobiles.