Market frets over
inflation

Investors pour over every single
economic report to find signs of
what is to come

NEW YORK » The government's monthly jobs report is one of the most closely watched indicators on Wall Street, but just what does it tell professional investors, and should it matter to the rest of us?

With Federal Reserve policy makers in the midst of a rate-tightening cycle, virtually every piece of economic data is being viewed with an eye toward inflation. If growth accelerates and inflation rises, the Fed is likely to be more aggressive in raising the overnight lending rate, which would almost certainly be bad for stocks.

"The professional investors, and to some extent, the small investors, can't ignore that the financial markets are on severe inflation watch," said Anthony Chan, senior economist with JPMorgan Asset Management. "Anything that provides a whiff of overheated economic conditions or a hint of increased cost pressure, such as higher commodity prices, will create nervousness."

On its face, yesterday's employment report looked to be a disappointment. Only 110,000 jobs were generated in March, half the 220,000 economists on Wall Street were expecting. But it was initially interpreted as good news for stock investors because it seemed to allay fears that the economy was overheating.

That notion was eclipsed a short time later by an Institute for Supply Management report showing a surge in service sector activity. The data, inadvertently released two business days early, reignited inflation anxieties and helped sink a stock market already pressured by record-high oil prices.

Despite Wall Street's knee-jerk reaction yesterday to the seemingly conflicting pieces of data, experts recommend individual investors focus on the key data points that matter most to members of the Fed's Open Market Committee -- the monthly jobs report and inflation measures such as the Labor Department's Producer and Consumer price indexes.

"The question for 2005, especially after the ugly stock market quarter we had, is how bad is it? Are companies really not growing earnings at all or has earnings growth just slowed down? I think most professional investors are not sure," said Janna Sampson, director of portfolio management at Oakbrook Investments. "In a time of uncertainty, you start paying more attention to the things that serve as early indicators, and the employment report is one of those."

There's a limit, of course, to what data for a single month can reveal, a point underscored by the frequent revisions of the employment report. But taken in a broader context, the jobs report holds some telling insights about what lies ahead for stocks.

"The concern is that if the economy continues to grow very strongly it will cause the unemployment rate to drop, and that will mean tighter labor markets, higher wage increases, and that threatens to create higher inflation," said Kenneth McCarthy, chief economist at the Center for Innovative Entrepreneurship, a nonprofit group. "That's where the employment number, because it covers the entire economy, has an important impact on the market."

Strong employment growth also could be a sign that companies are confident about their ability to expand -- and push through price increases.

Despite yesterday's dismal trading, analysts said the March employment report offered a near "Goldilocks" scenario for the market, with a number that suggested a just-right pace of jobs growth. It showed the economy is growing, but at a slow enough rate that it was not likely to cause wage inflation or pricing pressure.

The jobs report also can offer clues about which industries are hiring, or raising wages. But interpreting these details may require some additional research, said Chan of JPMorgan.

For example, the report shows 26,000 construction jobs created in March. A novice investor might interpret this as a sign of growth for homebuilders, but those who have been watching the market know these stocks have been trading at high levels for quite some time, and that higher long-term interest rates are expected to curtail their momentum in the months ahead.

"Everyone knows rates are going up and housing doesn't wear a bulletproof vest," Chan observed. "You have to look at everything in perspective."

What individual investors should do, Chan said, is pay close attention to the next set of inflation statistics, the PPI and the CPI, particularly the "core" statistics that remove volatile food and energy prices, since those are the ones Fed policy makers and professional investors will be watching.

Looking back at monetary tightening cycles since 1958, Chan found the economy wound up in a recession 66 percent of the time, partly because the Fed erred on the side of doing too much, he said. Investors can take some comfort in the fact that the current group of policy makers have been careful to raise rates slowly, bumping them up at just a quarter percentage point each time.