Dow Jones Average is Down
Then Rebounds

Federal Reserve's Beige Book Indicates the Economy Continues to Grow

June 17, 2007
By: Jerry Cole - Retirement, Investment

Just when it looked like the worry over rising interest rates would take the Dow Industrial Average down to a full scale 5-10% correction this week, along came the Federal Reserve's Beige Book report. This periodic economic report indicated the economy continues to grow moderately without serious wage or price inflation.

After plunging 129.95 points Tuesday, the Average reversed course on Wednesday and soared 187.34 points. It added 71.37 points on Thursday and it is up another 93 points this afternoon, therefore flirting with another record high closing. Helping to fuel the positive outlook was the retail sales report this week.

Retail sales rose more than twice as much as expected in May, up 1.4% as consumers shrugged off higher gasoline prices and increased their spending on cars, clothing and building materials, a Commerce Department report showed.

Bond action also contributed to the up move in stocks. After pushing the yield of the 10-year Treasury note to a five-year high Tuesday, some investors who had bet on higher yields took profits. That sent bond yields lower which had the effect of making stocks more attractive in comparison.

It seems the market is satisfied that inflation is under control for now. However, import prices, which are monitored closely by the Federal Reserve policy-makers as a potential source of inflation, rose for the fourth straight month on higher petroleum costs. Indeed, crude oil for July delivery surpassed $68/bbl this afternoon.

Also remember that retail sales, as excellent as they were, include gasoline prices at the pump. A gallon of gas averaged $3.15 in May, according to Energy Information Administration, up from April's $2.85. The higher gas prices will, at some point, begin to slow spending on other goods. This, coupled with the downturn in housing which has slowed consumer borrowing against their homes, may keep the economic growth at a manageable pace.

Why must we be concerned about inflation? The short answer is because we need to know how much money we will need to retire. According to Wikipedia, the word inflation refers to a general rise in prices measured against a standard level of purchasing power. For the last few decades, inflation in the United States has averaged roughly 3.5% per year. Inflation has been especially low in recent years, averaging approximately 2.5% per year. This may seem like a relatively small number, considering in many states individuals pay twice that in sales tax.

But when it comes to inflation, the small numbers are deceiving. Since inflation rates are compounded, the real rate of return may be much higher than the stated rate. For example, a 35 year-old man may determine that he will need $40,000 a year during retirement to maintain his current standard of living.

However, when he reaches age 65 in 30 years, even a low 3% annual rate of inflation will have reduced the purchasing power of that $40,000 to the equivalent of $16,000 in today's dollars. The situation would be exacerbated if inflation were to increase above the 3% rate.

So you have to be well aware of inflation. Proper portfolio diversification will help protect against the ravages of inflation. Because of this, equities belong in many portfolios Remember, to create long term wealth - be an investor, not a speculator.

(The opinions expressed are solely those of the author and not Gen worth Financial Securities Corporation.)