Just right ... I think
Some call this a "Goldilocks" market. Everything looks just right, right? So why not buy?

My buddies and I call this a "Hooray for Everything" market -- no matter what happens, Mr. Market seems to cheer.

  • Employment numbers look rate-raisingly strong? Hooray!
  • Housing market cratering? Hooray!
  • Consumer spending comes in below holiday-season hopes? Hooray anyway!

In short, everyone thinks stocks will continue to rise this year, or at least it seems that way. In a Business Week roundup for the new year, the experts, along with many others, showed how bullishness was not only evident but even rampant. Some fund managers are talking about increasing their use of margin again for 2007. They're that sure it's going to be a good year.

Short attention span?
At least they were a month ago.

I notice that even the perpetually rose-tinted "Business Outlook," up front in last week's Business Week, has already begun to backtrack from what the pundits were crowing about recently. In fact, it's backing off the "rate cuts a-comin'!" story to propose something along the lines of "things are so good that the Fed will just hold the line." Either way, of course, the main point is still that everything is great.


We'll find out this week just how long Mr. Market holds that conviction in the face of this week's consumer price index and producer price index numbers. November's digits caused a bit of a stir, with the 2% PPI rise the biggest since the early '70s, and the "core" or "wishful thinking because we don't like the other one" PPI up 1.3% in the largest gains since 1980. The market seems to have written off those rather disturbing numbers as just so much untidiness, but I wonder whether it's as simple as that.

An exception proving the rule?
I'm not normally one for making too many investment calls based on macroeconomic gut-staring, but I think the current bull market might just be a lot of bull. So this week, keep an eye on the numbers. Writers and their speed-dial insta-pundits -- many of them, quite possibly, drawn from the newly margined "Hooray for Everything" crowd -- are going to be making all sorts of claims about the power of Intel (NASDAQ:INTC) or Apple (NASDAQ:AAPL) to move the market. In fact, they're already doing it. But it's producer and consumer prices that will determine the real future for the stock markets in 2007.

That's because, despite his nickname, "Helicopter" Ben Bernanke and the rest of the Fed poobahs have made it pretty clear that they're more concerned with drowning inflation than in doling out more free money, at least for the immediate future.

So if the PPI and CPI are uncomfortably high, Mr. Market might just start to price in rate increases, meaning things should be much different from a month ago, when just about everyone seemed to believe we'd be seeing rate cuts by early 2007, or maybe mid-year.

If money costs more
If they work -- and they don't always -- higher interest rates increase costs of borrowing and put a chill on some of those earnings-growth plans out there. Remember, many of these depend on borrowing cash to buy back shares, such as the window-dressing we're seeing at Home Depot (NYSE:HD).

Of course, higher borrowing costs make real growth pricier, too. A quarter of a point here or there, rippling across the entire corporate food chain, and you can imagine how much more it might cost a company like FedEx (NYSE:FDX) to get hold of some of those expensive new machines from Boeing (NYSE:BA). Or how much more GM (NYSE:GM) might have to shell out for any number of long-overdue upgrades.

On the consumer side, higher interest rates would probably put a bigger dent in the deflating housing bubble, possibly inducing American consumers to (gasp!) stop spending so much more than they earn. Will the equity-refi market continue to run at higher costs? Would a bump in credit card rates cause people to keep the plastic in their pockets?

And finally, increasing interest rates can lure investor cash away from overheated equities. If we can earn bigger returns, without much risk, by sticking money in the bank, the price we're willing to pay for risky stocks comes down accordingly.

Foolish bottom line
Other pundits are continually pointing to average market P/E ratios to make the point that today's "markets" still look "cheap." They do look that way, but I think such an argument misses a couple of real points -- the first being that business cycles do exist, and price-to-earnings ratios based on peak earnings and high margins can begin to look very expensive indeed when the denominator slips, as it always does ... eventually.

More 'spensif money, of course, is one of those things that can shrink the denominator in a hurry.

Any one of the interest rate effects could turn 2007 into a year that proves the Street wrong. Add a few of them together, and we could see "Hooray for Everything" turn into "How Did This Happen?"

Invest accordingly.

At the time of publication, Seth Jayson had shares of Home Depot and Intel but had no positions in any other company mentioned here. View his stock holdings and Fool profile here. Intel and Home Depot are Motley Fool Inside Value recommendation. Fool rules are here.