April 26, 2011 - The old saying goes: They never ring a bell when the market (gold, oil...you name it) hits its high....or its low. Something tells me I hear a faint bell in the distance. And it's not coming from the market, even though the Dow Jones Industrial Average is up almost 31% from its low in the last year of 9596, hit on July 1, 2010. Any market that moves that much, that fast, has to be approached with caution.

You get the picture. Prices are going higher. Alarm bells should start ringing. Not only will these have to reach an apex (hopefully sooner rather than later), but they also signal inflation is just around the corner.

When manufacturers have to pay more for raw materials to make their products, they can either squeeze their margins (which many are doing now) or pass along those costs to consumers. That's going to happen soon. I know one apparel manufacturer that is raising prices on all its shirts by $5 a piece, just to cover the cost of cotton. You'll see higher prices in all apparel within weeks or months. Increases in prices on airline tickets (already starting to show) due to oil as well as higher prices at the pump (we've all felt those in the last few weeks) are here now. Delivery services have to raise prices to help defer higher gas prices. The ripple effect will be felt by everyone. Fruits and vegetables are going higher. So are processed foods.

For investors all of this requires extra care in choosing stocks. Picking the energy sector at this stage in the game seems a bit risky. Just how high can oil go before more drilling starts or the sheiks open the pipes a little wider? Also, when prices rise quickly, they have a tendency to retreat fast as well. Then if the underlying reason for the upward push in prices still exists, a commodity will go higher again, maybe even to new highs. The difficulty is knowing the timing of those almost certain developments.

Further, investors need to watch what management is doing in terms of pricing. Like the apparel company referenced above, are they raising prices to offset the new costs or are they holding them, willing to sacrifice profits to keep market share? If they aren't passing along higher costs, then expect profits in those companies to be lower. A good example recently was Netflix (NFLX). It reported a banner quarter with great numbers all around. But the stock went down. Why? Because its raw material, movies, will be going up. It's costs are going higher. Investors don't expect to see the same profitability even with more subscribers and better revenues.

Costs are going up everywhere you look. That will have to be reflected in consumer prices at some point. The companies that don't pass along the current expenses will pay the price in quarterly profits. On the other hand, these surges in commodity prices may be temporary and holding prices will keep market share. Companies that raise retail prices may see fewer sales and lose some of their customers.

It's a tricky time. Bells are ringing (not for me and my gal). Some of them are for prices that got too high too fast. Some of them signal inevitable inflation if they keep going up. Investors need to listen and approach cautiously.

- Ted Allrich