When I was a kid, I accepted things pretty much as they were. Sure, I would fantasize about being the next Otto Graham or Joe DiMaggio, but I never dreamt of distorting reality. For example, I caddied at a prestigious Country Club and would get to play there on Mondays. Like all golfers, I used to visualize my shots before I struck the ball. If I had done what I had visualized, I would have made Ben Hogan look like a duffer. But I hardly ever made shots as I had visualized and I had to accept the consequences of my failures. I never thought of changing fact to fantasy back then, but I learned how it's done later in life.

I learned this wonderful skill from a bunch of whiz kids from the best business schools in the country. If they didn't like a business or situation, they just sold the business or took an eraser and changed the numbers. Selling a business or changing numbers is easy. It takes no skill or expertise. But it's not dealing with reality. As a chemical engineer, I had to deal with physical reality. If a vessel were leaking a poisonous chemical, we had to physically fix the leak. We couldn't stop the leak by assuming it wasn't leaking. A lot of people in today's world don't understand that because they never dealt with physical reality. So they create a fantasy world of false assumptions and distorted numbers that doesn't exist. They are lying to us, and we believe them.

Today we got the CPI inflation report for May 2007. It showed that consumer prices rose at the fastest rate in 20 months, powered by surging food and energy prices. That's really bad news -- but not if you don't count food and energy prices. "They're too volatile." The core rate of inflation, i.e., without food and energy, rose only 0.1 percent in May, much less than 0.7% for all items. So today's inflation report was really good news. Really?

What we have here folks, is The Federal Reserve Board's version of "The Big Lie" as promulgated by Adolph Hitler and Joseph Goebbels. Make the lie preposterous enough, make it big enough and repeat it often enough and the "thick-headed numbskulls" will believe it. Indeed, stock traders swallowed the spin and stock prices took off. Even if you're offended by Wall Street's antics, forget about it. It's more profitable to fly on the wings of Inflation Fantasies.

It's been a long time since rising inflation and rising interest rates have been headline news. But they were this week, and that's not good for stock prices. Rising inflation destroys wealth and rising interest rates raises costs. Ironically rising inflation is seen as an enemy, which it is, and rising interest rates is seen as a weapon to fight inflation. Together they can devastate an economy, torpedo corporate profits and cause a bear market.

As Chairman of The Federal Reserve Board, Dr. Bernanke's job is to maintain monetary stability and to ensure full employment. (The latter task was added to the Fed Chairman's job a few years ago to make the politicians happy.) Nevertheless, his real job is to fight inflation. So he and his associates, known as Fed Governors, have been railing against inflation ever since he took office in February 2006. Moreover, Dr. Bernanke followed in the footsteps of his predecessor and raised interest rates several times after taking office. The last interest rate increase took place in June, a year ago. At that time he said the Fed would consider pausing in their rate hikes since a slower economy would moderate inflation.

First quarter, 2007 GDP growth recently was the lowest in four years, a tepid 0.6%. So investors thought Dr. Bernanke would finally lower interest rates. This move, they thought, would spur the economy, ensure solid corporate earnings and help stock prices go higher. But Dr. Bernanke fooled them. In a speech this week, he said he expects the economy to get stronger over the next few quarters, so he would remain vigilant in the battle against inflation. In just a few words, he crushed any thoughts of an interest rate reduction anytime soon. Stock prices fell sharply.

To be fair, Dr. Bernanke never indicated that he was more likely to lower interest rates than he was to increase them in his fifteen months in office. On several occasions his statements were misinterpreted, (see my essay of 05/05/06), and even I thought that he would lower interest rates. But I should have known better - The Fed Chairman lowers interest rates only after the economy has gotten into trouble, not while it's still showing signs of life, (see my essay of 07/14/06).

Our Market Climate Graphs show that interest yields on 90-Day T-Notes, 10-Year T-Notes and AAA Corporate Bonds bottomed in June 2003, but have not risen substantially since Dr. Bernanke took office. Inflation, as measured by the CPI, is about where it was in June 2003, but hit a high of 4.7 %/yr. in October 2005 and a low of 1.3 %/yr. in December 2006. At this point, it is much lower, 2.6 %/yr., than it was in February 2006, 3.4 %/yr., when Dr. Bernanke entered office. So it seems to me that neither inflation nor interest rates have moved much since Dr. Bernanke has been in office and that the media is overreacting to Dr. Bernanke's comments. So we should not worry at this time.

We should start worrying about high inflation and interest rates when they stifle the economy and cause earnings to go lower. VectorVest tracks these data in our Investment Climate report, shown below, and it interprets the data with the Truth Chart. (See my essay of 03/28/03.) Right now, the Truth Chart is saying we are in a Case 4, Bull Market Scenario in which earnings, inflation and interest rates are rising. This scenario has been going on for a long time and will continue to do so, provided that Dr. Bernanke is right about the economy. For now, we do not have to worry about high inflation and high interest rates, The Deadly Duo.