Last week we discussed the abundance of global economic growth and how, so far, it had not been accompanied by excessive inflation.  Even in the face of commodity prices rising straight up, record oil prices, rising wages, and tight supplies in almost all raw material category.  The pressure relief valve is productivity.  It has been rising steadily all over the world, keeping a lid on inflation. 

The Fed may be near the end of its long-term tightening process according to minutes released from their last Open Market Committee meeting.  Since the release the equity and commodity markets have soared. The CRB index of commodities was up 5% in the following two days, led by petroleum, gold, copper, and platinum.  The stock market gains were boosted by materials, energy, and industrials.  Extra lift came from some superb earnings reports from individual companies in the groups just mentioned, as well as from some leading technology companies, banks, brokers, and pharmaceuticals. Is the return of “irrational exuberance” in our future?  One could argue that it already exists in the commodities and metals markets as well as the related company stock prices.  They are up huge this year following a two-year bull market. 

The airplanes of September 11th, the tech-bust of 2000, the corporate scandals of 2001, the wars in Afghanistan and Iraq, the relentless credit tightening of the Federal Reserve, spiraling oil prices, and increasing global Islamic unrest, separately or combined have failed to stop this economy of ‘steel.’  Will virus infected birds finally accomplish what the prior challengers have been unable to wreak?  The predictions range from not at all, to a total global depression. 

Interest rates are rising across the board.  Just last week we discussed the inverted yield curve and the problem it posed for banks and for those who borrow from banks.  Since our last Brief, the yield on the 10-year note has gone up 10 basis points, or a tenth of a percent, while shorter maturities such as the 2-year note is up only modestly.  The result has been a yield curve that is a bit more accommodative for banks.  Our experts believe the yield curve will not change much from here, remaining relatively flat (short term rates close to long-term rates), therefore challenging for banks, but not disastrous for them or the economy.  If the Fed raises the funds rate to 5% by May as many predict, then the 10-year Treasury bond yield will also likely to rise to 5%.

After a month and a half since our office flood we are now back to normal.  The wood floor is installed, carpets cleaned and laid, walls and baseboards replaced and painted, art hung on the walls, and furniture returned from various idle locations in our 30-story office building.  ‘Normal,’ whether real or imagined is nice, even if for a short while.  It’s what gives us a chance to catch our breath before the next round of challenge and growth. 

The year is progressing pretty much as investors anticipated.  Analysts continue to lower their earnings expectations as many corporate managers downplay their guidance for the coming quarters.  Mr. Bernanke of the Fed says he will continue to fight inflation as hard as his predecessor Alan Greenspan, yet he has some changes in mind.  The steady supply of oil continues to be clouded by instability inNigeria,Venezuela,Iraq, and most recently,Saudi Arabia.  But with current supplies high and prospects for slower global economic growth, the price of oil is down 4% for the year so far.  The same is not true, however, for gold, up 7.5% for the year, likely on inflation and global security fears.  But the best leading indicator of all, the stock market, is up.  The Dow Jones, S&P 500 and NASDAQ indices are each up about 3.5% so far this year while our model portfolios are doing better than that.  But, with all the uncertainty, the ride has been bumpy and should continue that way.

The stock market with all of its intraday gyrations finishes the week up nicely.  Following a decline on Monday, the last three days have culminated in a 1.8% rise in the S&P 500.  In contrast to last week, when good news was bad, investors decided the liked the sound of a roaring economy, especially if Fed Chairman Ben Bernanke doesn’t drown it out with the inflation drum.  On Tuesday, the government reported the strongest monthly gain in retail sales in nearly two years confirming that the economy is as strong as ever.  The Dow industrials rose 136 points, or 1.25% to 11028. 

More than half of companies have reported their calendar fourth quarter earnings to date and they are up an average of 14%, according to the Wall Street Journal’s Total Market Index.  These strong earnings suggest a continued strong economy.  So far, neither the Fed’s rate hikes nor the slowing housing market have managed to sap much of the economy’s vitality.  Employment indicators have been strong and consumer spending was robust during the last two months of 2005.  Gross Domestic Product in the first quarter of this year could easily exceed 4%, according to experts.

The latest economic news further clouds the picture and investors have acted on that uncertainly by selling stocks.  We expected a sell-off early in the year, but wonder if it has gone a bit too far. 

The fans and dehumidifiers are gone and the office is dry, quiet, and empty.  We hope to have the walls and trim and paint restored this weekend, with our furniture soon to follow.  We are very thankful for the quick response of the building management and their contractors.  We are also delighted that our network has continued to run throughout the event without skipping a beat.  In the midst of the ruckus we installed our new website.  Please take a look –