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Inflation Outlook Moderate Despite Spike in Energy Prices

By Alan Levenson, T. Rowe Price Chief Economist

Ination concerns have become more prominent since political unrest in Libya—a major oil producer—raised the specter of a 1970s-style oil supply shock. Indeed, the roughly 15% increase in crude oil prices during the second half of February translates into a rise in the pump price of gasoline of a bit less than half that magnitude.

Even as oil prices show signs of stabilizing, the full impact of the

U.S. Industrials Continued from page 9

production on U.S. soil.

While some of the later-cycle industrials in the Small-Cap Stock Fund produce and sell their goods in emerging markets, Mr. McCrickard’s holdings are more

  • rmly positioned near their U.S.

customers. Manufacturing more of their products overseas could cost them more, not less.

An example: Tennant, which makes industrial sweepers, scrub- bers, and other heavy equipment. Approximately 60% of the com- pany’s revenues are generated in North America. While the company produces and sells globally, it has kept 60% of its workers in North America, resisting the temptation to offshore more of its operations.

“They say that they can make things just as cheaply in Minneapolis as in China,” Mr. McCrickard says. “It may be unique to them. But there’s not as much of a disadvan- tage to being in the United States.

Similarly, Acuity Brands, an electrical equipment manufacturer, keeps its manufacturing base close to its customers. With 97% of its sales in North America, 14 of its 16 manufacturing facilities are in the

late-winter runup will likely lift the retail price of a gallon of regular gasoline into a $3.75 to $4.00 range by midyear.

Yet the upward pressure on energy prices predates the fears of supply disruption related to political unrest in the Middle East and North Africa (MENA). Crude oil prices began to rise sharply in early September as better economic data dispelled fears

United States and Mexico.

Some of these kinds of holdings, Mr. McCrickard cautions, have already been beneting from the expectation of the economy moving into an expansion phase. But other industrials, particularly related to housing and construction, he says, “still have a long way to go.”

The prices of small companies tend to uctuate more than larger rms. Growth-oriented stocks can have sharp price declines as the result of earnings disappointments, and value- oriented stocks carry the risk that the market will not recognize their intrinsic value for a long time or that they are already appropriately priced.

As of March 31, 2011, stocks mentioned by Mr. Rottinghaus made up 9.9% of the U.S. Large-Cap Core Fund; by Mr. McCrickard made up 2.5% of the Small-Cap Stock Fund; and by Mr. Giroux made up 3.6% of the Capital Appreciation Fund. Emerson Electric, mentioned by Mr. Fath, makes up 1.3% of the Institutional Large-Cap Growth Fund. It was not held by the other funds.

that last spring’s Greek debt crisis would spark a double-dip recession.

And oil had company in the commodities space. In the half year to mid-February, while the price of crude oil rose roughly 30%, indexes of raw industrial materials and raw food commodities prices advanced by roughly 25%.

In the past, swings in commodity prices—energy and food in partic- ular—were driven signicantly by transitory changes in supply caused, for example, by geopolitical develop- ments or unanticipated weather patterns. More recently, however, the rise of fast-growing emerging countries in the global economy has injected a lasting increase in demand for a broad range of commodities.

The upshot is an upward shift in the degree of commodities-based ination relative to the state of the U.S. economy.

These effects are greatest in the energy sector, where the crude input is a predominant component of the rened output. The pass-through is weaker in food production. Nonetheless, the consumer price index (CPI) for food has also acceler- ated in recent months, lifting the year-to-year ination rate to 2.3% in February from -0.2% a year earlier.

Moderate But Rising

As the commodity content of domes- tic products declines, the available capacity in a particular industry—and associated labor, distribution, and other costs—becomes a more impor- tant determinant of price pressure.

Thus, apart from food and energy—in the so-called core ina- tion process—margins of available slack in labor and products play

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