Economy slows, inflation grows - Protect your assets

June 10, 2006

As we reported April 1, the U.S. economy is slowing in the second quarter. On Friday, the U.S. Labor Department reported that only 75,000 jobs were added in May, lower than expected and an early signal of a slowing economy. Federal Reserve Chair Ben Bernanke is also concerned with the slowing housing market and slower consumer spending, which will contribute to further slow economic growth.

At the same time, sustained high oil prices at around $70 per barrel have finally contributed to higher than expected inflation. Over the past three months the core inflation rate was at 3.2%, higher than the 2.8% averaged over the last six months. The unofficial target rate is at 2%.

What It Means:
Bernanke’s comments at the International Monetary Conference caused a nearly 200 point loss on the Dow Jones Industrial Average. Investors are concerned about the combined threats of slow economic growth and inflation. This puts the Fed in a bind - does it raise rates to curb inflation (it’s #1 mandate), thus risking even slower growth? Or vice versa? This tough situation is of special concern to investors because Bernanke is new, and therefore untested. Bottom line: increased volatility in the markets, which hate uncertainty.

Action Steps:
Not too different from what we said last week - but every week we are getting further confirmation that this is not a temporary correction, but more likely the beginning of at a several month trend. Higher Fed funds rates (needed to combat inflation) means less money available for small startups - so lessen your allocation in small caps. With short term interest rates increasing, money market funds are starting to look attractive again. Another option, to protect yourself from inflation, is Treasury Inflation Protected Securities, or TIPS. Since global growth is projected to be higher than U.S. growth, an allocation in international markets will also help protect your portfolio.

Before taking any action, however, be sure that any changes are within the asset allocation goals you’ve established for your portfolio. To get help - call your financial planner.

Source:

Remarks by Chairman Ben S. Bernanke At the International Monetary Conference, Washington, D.C. June 5, 2006