Dollars and Sense: Will a May selloff tank the markets this week?

A positive beginning. Stocks rose last Monday, with the Standard & Poor’s 500 and the Dow both broke through to new records. Some areas of the market that had slumped in recent weeks saw especially big gains, including technology stocks. Facebook, for example, rose more than 3 percent. Twitter rose more than 4 percent. The Russell 2000 index, which is made up of small company stocks, rose 2.1 percent, its biggest gain in two months. Stocks remained in positive territory last Tuesday. The S&P 500 cracked the 1,900 mark for the first time ever. The Dow also pushed further into record territory. The upticks came despite mediocre economic news. Retail sales grew a scant 0.1 percent in April, disappointing forecasters who expected more of an early spring pick-up. Economists had forecast a 0.5 percent gain.

Inflation worries. The slack retail number and a financial story we haven’t talked much about in a while—inflation—combined to send the markets down on Wednesday and Thursday. The government has been pouring billions into the economy with its so-called quantitative easing program, which is very little more than just printing money and increasing the supply of dollars in the economy. The fear all along about that strategy was that it would lead to inflation. But it was hard to make that case because the only signs of inflation we’ve seen have been asset inflation, mainly a boom in the stock market. And since the stock market boom was making investors richer, few people were complaining. But that may be changing. We learned last week that producer prices rose 0.6 percent in April. Economists projected a much smaller 0.2 percent rate. We do see a lot of month-to-month variation in that number, so it’s not really fair to extrapolate from a single month’s report. But if that rate continued for a year, it would put wholesale inflation at 7.2 percent, a dramatic rise from the 1 to 2 percent inflation we’ve experienced in the past few years.

That’s not all. I would dismiss that number if that’s the only indicator we had. But April consumer prices rose 0.3 percent. That’s the largest jump in the consumer price index since last June. Now these numbers don’t mean we’re headed for hyper-inflation. The 10-year Treasury bill yield, which is pretty reliable in projecting not the rate of inflation, but its direction, is fluctuating between 2.5 and 3 percent. That’s still very low, but it is up a percent or more in the past 6 to 8 months. So does this mean that all the bad consequences that people have been warning us about because of the Federal Reserve’s bond-buying binge are now coming to pass? It’s probably still a bit too early to tell, but the markets were down sharply on both Wednesday and Thursday, as the news about inflation started trickling out. So traders took the signs of inflation seriously, though I should add that factory production and homebuilder confidence also fell last month. These reports added to the gloomy mood on Wall Street on Wednesday and Thursday.

Earnings reflections. First quarter earnings season is mostly over. But you may remember last week I mentioned that we sometimes get surprises in the final day. That happened this time. Walmart, a Dow component, dropped 2.5 percent after its profit number missed analysts’ expectations. That was one of the reasons the market fell so far on Thursday. All in all, though, earnings season was solid. Nearly 70 percent of companies beat earnings expectations. That’s significantly higher than the historical average of 63 percent. But significantly fewer companies met revenue expectations. And that’s been the story for the past few quarters.

The week ahead. It will be a pretty light week for economic reports, and with earnings season over, the markets are not going to have a lot of new data to determine direction. Because the markets hate uncertainty, we sometimes see more volatile and skittishness when we are in a low-information week like this one. We’re also seeing a lot of traders positioning their portfolios for taking time off for Memorial Day—the so-called “sell in May and go away” phenomenon that can result in a rash of selling. I make it a habit not to predict the future, but I will say that the pressures on the market are all heading south.