"The dividend is such an important factor
in the success of many stocks
that you could hardly go wrong
by making an entire portfolio of companies
that have raised their dividends
for 10 or 20 years in a row." Peter Lynch

(The missing graphic above is just the Connolly Report logo)

Inflation's Return? (June 1999, Volume 20 No.3 page 436)

DRAFT #4
What happened on May 14, 1999 seems to have been significant: the Labour Department in Washington announced an unexpectedly sharp 0.7% rise in consumer prices in April to 2.3%. . This was the highest headline increase since October of 1990. (Our rate was up too but not by as much.) The day before the Dow reached a new all time high of 11,107. The day of the announcement the Dow dropped about 200 points. This index, although rallying strongly twice, has not been higher since. Could this be the end of the great bull market?

On May 18, the Federal Reserve abandoned its neutral stance on short term interest rates. The Fed adopted a bias toward tightening. On June 17, Fed chairman Greenspan confirmed he was leaning toward raising interest rates in coming months if inflationary pressures warrant.

These events were not a bolt from the blue. The bond market has been signaling a return of inflation for some time: long term rates are up. For instance, 30-year Treasury bonds are up almost a full percentage point from a low near 5% last fall to over 6% as I pen this on June 25. U.K. gilts, German bunds, and even Japanese government bond yields have increased in recent months. Because the common stocks we follow are considered to be interest rate sensitive, we must keep an eye on interest rates. Interest rates are a significant factor in the determination of the price of our shares. Quite simply, if interest rates continue to rise, the price of our shares will fall. Indeed, this process has already begun. Have you noticed yields of shares in the list have risen? For those of us with capital to invest, better bargains (yields) could lie just ahead. Those of us with capital already invested in dividend paying common shares, will enjoy continued dividend growth. Day to day fluctuations in price do not really matter. If you did not sell when prices were high, why would you consider selling when prices are lower?

In recent years, interest rates have played a critical role in the astounding advance of the stock market generally. If April's data is not just a blip in inflation numbers (May's data was neutral), the stock market has lost two of its props: benign inflation and low interest rates. Will corporate profit growth, fuelled by rising productivity, be able to pump the market on its own? If interest rates continue to rise, I don't think so.

I do not think an outburst of inflation is likely. However, my own bias has changed with this latest sign that inflationary pressures are on the rise. I'm now thinking disinflationary trends have less chance of taking hold (say 20%) and that renewed inflation is the more likely scenario...eventually (60%). Inflation, it seems, has not been vanquished.