On Friday the Industrials came within less than one point of closing at a new record high, which would have confirmed recent highs in the Transports. However, the day prior, the Industrials set a new intraday high, showing that this market still has energy bubbling beneath it.
The recent outperformance of the Transports, hitting new high after new high, has everything to do with lower fuel costs. Nearly all transportation requires oil in some form or another, and when one of the largest costs a company has to manage declines, profits tend to rise. Hence the bid under Transportation related companies.
Below is a chart of WTI Light Crude, in significant decline since the middle of June. The 50-day moving average has just declined through the 200-day, signaling a change in trend. Booming oil production in the US has created a heavy supply of oil, as well as worries over whether there is enough demand to meet the increased supply. China is one of the world's top oil consumers and recent trade data is showing that its oil-import growth is slowing.
Cheaper oil provides temporary relief for consumers as it translates to lower gasoline prices. This chart shows the spot price of unleaded gasoline falling in sync with oil. From mid-June to the present we see a 50 cent decline, which equates to about 16%.
This brings up an interesting topic. Over the years I've heard many people complain how ridiculous it is that the Fed often relies on core inflation readings that exclude food and energy. Heck I've made this complaint myself. The main argument is that most of what consumers buy is food and energy, so how can price changes in those two areas be ignored when it comes to inflation readings? There are two sides, and an edge, to this coin.
First, remember that the inflation data the fed relies upon for conducting monetary policy is different from the inflation data used in other aspects of the economy. For example, none of the prominent legislated uses of the CPI exclude food and energy. Social security and federal retirement benefits are adjusted using the All Items CPI-W, which includes food and energy, and Individual income tax parameters as well as Treasury Inflation Protected Securities (TIPS) use the All Items CPI-U (also includes food and energy).
The reason that various inflation measures are also calculated without their food and energy components, called the "core" rates, is because food and energy prices are volatile. You don't want to conduct monetary policy decisions based on short-term price movements of volatile items. I hope you would agree that it would be nonsense for the Fed to make long-term, broad based policy decisions because market dynamics temporarily pushed the price of oil down 16%, or because a season of light rainfall caused corn and grain prices to spike.
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The point here is that changes in the price of goods are not always the result of money supply conditions. The Fed's goal is to promote price-stability in the long run. They should absolutely be keeping an eye on price fluctuations in food and energy, but reacting to the volatile nature of these items by expanding or contracting the money supply would be inappropriate.
The above content was an excerpt of Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
