Is Inflation Inevitable?

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Last week, a long-time subscriber from Minnesota wrote, "It seems obvious to me that the only way out of this 'ECONOMIC CRISIS' is to inflate the dollar. Please comment on the likely effect of Bernanke's plan to issue more Treasury Bonds to 'fight unemployment' and to stir the pot for inflation. This should artificially cause my portfolio 'value' to explode exponentially and result in a huge tax bill when I sell."

I replied with this:

"Thanks for writing.  You may be right.  In any case, the key to successful investing remains unchanged.  Watch the market carefully, interpret unbiasedly, and act accordingly.  As Jesse Livermore wrote, "Markets are never wrong; opinions are."

But that was a very short answer.  Here's the long version, for all my readers.

For almost two years now-since the crash bottom in 2008-I've been reading that the flood of money that the U.S. government has poured into the system will cause inflation … but it hasn't yet.

And why?

Because both consumers and businesses are deleveraging.  They're cutting back on debt, either because they want less exposure to risk (having witnessed the pain caused by excessive leverage in 2008-2009) or because banks have forced them to.  And they're spending less and saving more because they have little confidence in the future of our country's economy.  (Having a Clinton or a Reagan in office would help on that front.)

And my opinion-which I've stated here before-is that this deleveraging will continue far longer than most people expect.  So you shouldn't worry about inflation.  In fact, I believe that because inflation was the bogeyman of the 1970s, you won't need to worry about it until most people who coped with it then are dead!

But these opinions are worth less than two cents when it comes to investing in the stock market, and here's why.

When it comes to stocks, the best indicator of what a stock will do tomorrow is what it did today.  And the best indicator of what a stock will do in the next month is what it did in the past month.  In short, the stock itself is a primary indicator.

Secondary indicators are things like sales and earnings.  In the long run, they are vitally important, which is why institutional investors spend so much time analyzing financial statements and projecting future earnings.  But in the short run, they're not much help.

Tertiary
indicators are things like inflation rates, unemployment rates, housing starts (these days it's foreclosure rates), trade deficits, the value of the dollar, industrial production rates, the price of oil, etc.  They matter to some extent, but they're the least helpful of the three groups.

So why do people spend so much time talking about these things, if they're not much help?

Because everyone else is doing it, and thus it feels comfortable.

And because it's intellectually easier than taking about charts.

Even the dimmest bulb knows enough to say, "Unless unemployment rates come down soon, it's going to be a rough holiday season."

But try talking about last Thursday's big gap up by Netflix ( NFLX ) , on three times average volume, and in most circles you get blank stares.

Yet one picture of that Netflix chart (to me) is worth a thousand words!

It tells me that investors in Netflix aren't thinking about whether Bernanke's moves will raise the inflation rate.  And they're not worrying about their capital gains being eroded by inflation.

No, they're excited by the company's accelerating rate of revenue growth-31% in the third quarter, up from 27% in the previous quarter.  They're impressed by Netflix's management , which has managed this fast growth while maintaining after-tax profit margins between 7% and 9%.  They're thrilled by the prospect of recurring revenue from 16.9 million subscribers.  And they're salivating over the company's lower costs of customer acquisition.

I'm excited about all those things, too.  But … remembering that these are all secondary indicators, I put the greatest weight on the action of the stock itself, which is why that big gap up on high volume speaks volumes to me.

And I don't worry about inflation at all.

---


Editor's note:  Netflix ( NFLX ) has been favorably mentioned here before many times, but we mention so many names that you may have missed it.

If so, you should consider subscribing to Cabot Stock of the Month, which focuses your attention on one high-potential stock every month.

Netflix was featured in Cabot Stock of the Month way back in February, when it was trading at 65.  Back then, editor Timothy Lutts told his subscribers, "Today's story is about revolutionary new ideas.  They lead to great growth companies, and they lead to great growth investments.  In Cabot's case, successful revolution-driven investments have included Amazon.com, Yahoo!, Google, Crox, XM Satellite Radio, Qualcomm, Taser, Home Depot, Intuitive Surgical and Green Mountain Coffee. Going forward, we expect many more, and we expect Netflix to be one of them."

Subscribers who bought back then are looking at profits of 166% … and looking forward to more.

If you'd like to get in on the ground floor of the next Cabot Stock of the Month (out tomorrow), click here .

---

Now, one "problem" some people have with investing in Netflix is the stock's price.  It's roughly $170 a share.  Ditto for Apple ( AAPL ) , trading above $300 and Google ( GOOG ) , trading above $600.

If you're in the habit of buying a round thousand shares of a stock, you're going to balk at the prospect of buying these stocks.  We know; we've heard that message from many readers in recent weeks.  But you shouldn't!  Those high prices don't stop the pros, so why should they stop you?

If anything, you should favor stocks with higher prices, because it means they won't be tugged up and down by the emotional actions of amateurs.

So if you can't afford a thousand shares, just buy 10 or 20 or 100.  At the end of the day, it's the dollars that count, not the shares.

---

As to individual stocks,

Today I want to highlight another company demonstrating acceleration of revenue growth AND acceleration of earnings growth.  The reason I like these characteristics in a stock is that it tells me analysts have to keep ratcheting up their estimates, and thus their targets, and so institutional investors have to keep buying more.  And it's institutional investors that drive stock prices.

The company is Riverbed Technology ( RVBD ) , and its business is booming today as companies all over the world work to make their Wide Area Networks (WANs) work faster.

Like Netflix, Riverbed saw its stock gap up last week after an excellent earnings announcement.

Just look as these numbers.

While analysts were expecting revenue of $135.3 million, the company pulled in $147.8 million!

And while analysts were expecting earnings of 27 cents a share, the company earned 34 cents!

Guess how fast those analysts are revising their estimates now, and how fast price targets are being raised, and how fast buying plans are being revised.

And it's not the first time!

Just three months ago, after the company released a crackerjack second quarter earnings report-and the stock gapped up-Mike Cintolo added the stock to the Model Portfolio of Cabot Market Letter, writing, "The company's Steelhead hardware and software are the best at WAN optimization. In a nutshell, that simply means that Steelhead makes a company's network-which could span across a campus or a continent-much faster. And that allows not only higher productivity among workers, but also helps customers avoid the cost and time of constructing entirely new networks. Looking ahead, the importance of corporate networks (and thus, the demand for faster speeds) is only going to increase, especially as companies put more and more of their resources in far away data centers. Riverbed's second quarter report was outstanding, causing the stock to gap out of a consolidation. And, impressively, it hasn't given up any ground, even during the minor market pullback of the past couple of days. Shares could always drop a point or two, but we think buying here will work out over time."

When Mike wrote that, the stock was trading at 36.  Subscribers who followed his advice are looking at three-month profits of 56%, with the expectation of much more ahead.

To join them … and to be assured of getting the all-important profit taking sell signal on RVBD when the time comes, click here .

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Publisher
Cabot Wealth Advisory




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AAPL , GOOG , NFLX , RVBD

Cabot Heritage Corporation

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