The key to understanding which stocks can take a little inflation in stride, says Eric Sorenson, a Salomon Smith Barney managing director who's studied the effects of rising prices on stocks, is determining which have earnings-growth prospects above 15 percent. Companies experiencing demand that strong won't be stymied by rising prices.
That puts technology stocks, whose average growth rate is now around 20 percent, and small caps, which trade on their earnings expectations rather than on macro issues, at the top of the list, says Smart Money magazine (1755 Broadway, New York, NY 10019)."The sectors to avoid? Interest-rate-sensitive utilities and most large caps with slow growth, such as those in the consumer-staples sector."
Here, courtesy of Smart Money, are the three most useful leading indicators for predicting inflation:
-- Leading inflation index. A watchdog that includes everything from the growth rate of the federal deficit to import-price changes, the LII is published by Columbia University's Center for International Business Cycle Research and reported by (www.dismalscientist.com) during the first week of every month.
LII accurately predicted spikes in the consumer price index in both 1976 and 1994 months before they happened. It's also presciently foreseen the Fed's four interest-rate changes since 1993.
So how do you read it? Investment guru Elaine Garzarelli, who describes LII as Alan Greenspan's personal early warning tool, told Smart Money that she watches for a series of four consecutive upticks, which suggests a Fed rate hike.
-- National Association of Purchasing Managers' price index. This index tells you whether manufacturers are facing higher prices for the goods they buy. And if you're thinking that smokestack industries don't matter in the new economy, think again. The fate of the industrial companies typically foreshadows what's coming next for everybody else.
"They lead inflation," Morgan Stanley Dean Witter Chief Economist Stephen Roach told Smart Money. "While the index fell like a stone over the course of the Asian financial crisis, it's now recouped all it lost."
Roach advises that if this indicator pops above 60 (it was recently 54), watch out. You can keep tabs at (www.napm.org) on the first business day of each month.
-- Productivity. Increasingly, economists believe that our remarkable gains in productivity are allowing the economy to grow rapidly while prices remain stable. Any break in these gains would make everyone question the economy's potential for future growth. Devotees of this particular indicator, including Greenspan, watch for the release of this all-important number on the seventh of the second month of each quarter. Check it out for yourself at stats.bls.gov.
If the year-over-year growth in productivity continues to increase at a 2 percent to 3 percent rate -- or more, as it has recently -- we're in fine shape, concludes Smart Money.
"If it slips to something closer to 1 percent, the average pace over the last 20 years, then we may be in for rising prices.