The stock market experienced a bout of acrophobia during the second quarter.  The S&P 500 Index® plunged nearly 8% between May 5th and June 13th.  Investors have become anxious that building inflation pressures will cause the Fed to keep turning the monetary screws.  We think inflation fears are overdone.

Structural forces will keep inflation in check.  First, the ability to outsource labor costs combined with reasonable growth in productivity will keep unit labor costs from escalating.  Second, technology allows consumers to compare prices among various merchants.  This information makes it difficult for companies to pass through price increases.  In Asia, unit labor costs are actually falling.  In short, we think the long-term forces are more disinflationary than inflationary.

The downshifting of growth expectations could cause more choppiness in the stock market until late in the year.  However, we also believe the market is laying the foundation for a more rewarding 2007.  Valuations are reasonable (neither cheap nor expensive) and we do not believe the Fed intends to push the economy into recession.  In short, we think we are likely to get a mid-cycle slowdown.  The rate will be slower, but both the economy will grow and profits will continue to improve.

Foothills Asset Management’s commentary is provided for informational purposes only and should not be construed as investment advice. Statements that are non-factual in nature constitute only current opinions that are subject to change without notice. Foothills assumes no responsibility or liability from gains or losses incurred by the information herein contained. You should consult with your own financial advisor before making any financial decisions, including investments or changes to your portfolio.