19 Aug 2005 Economic Growth Remains Strong and Widespread

On most every front, housing, manufacturing, jobs, consumer demand, jobs, and corporate profits, the economy looks strong.  Growth should be sustainable for the foreseeable future, as long as the Fed doesn’t go too far with their rate increases.  Unfortunately, recent inflation data is not sufficiently benign to suggest the Fed may slow their pace any time soon.  On the positive side though, oil prices which topped $67.00 last Friday may have peaked. 

As our friend Don Hays points out, the U.S. Strategic Petroleum Reserve is only 244,000 barrels away from being filled to capacity.  It has been a significant drain on the world’s oil supply oil since President Bush’s directive to fill the reserve in November of 2001.  Just recently though, the American Petroleum Institute reported that U.S. oil demand fell 3% year over year in the month of July.  This was the largest monthly year over year drop in three years. U.S. oil demand typically leads world oil demand.  News reports fromGermanyandIndiaare also showing diminishing demand.

The National Association of Home builders reported that homebuilder optimism fell for the second month in August as rising mortgage rates threatens to erode the record pace of home sales.  Mortgage rates have risen for six weeks.  Housing was the workhorse of the economy during the early stages of recovery and has sustained its growth to present.  A slowing is widely expected, but certainly not a collapse.

Manufacturing may now be moving into a position of leadership.  The New York Fed reported that manufacturing in that state expanded more than expected.  It represented the third month of expansion and reinforced expectations that manufacturing would add to economic growth this quarter as production builds up to replenish inventories that were drawn down from April to June.

International investors increased their holdings of U.S. assets in June by $71.2 billion, the most in four months.  Corporate bonds were the big winners as yields on government debt declined to 3.9% during the period, the lowest in a year.  The inflows were more than enough to cover the $59 billion trade deficit in June.  Also supporting the dollar’s climb, the Congressional Budget Office said it expected the federal budget deficit to fall to $331 billion in the 2005 fiscal year on higher tax receipts, according to the Wall Street Journal.

Prices paid by consumers rose a half a percent in July, the most in three months, led by new record prices in fuel costs.  Incentives on automobiles and cheaper apparel helped keep the overall number low.  When food and energy are excluded, the index rose only .1%, smaller than expected.

But prices at the producer level didn’t fare so well in July, according to the government.  The Producer Price Index rose 1% while the core rate, which excludes food and energy, rose .5%, the most since January.  The effects on consumers will likely be muted though as competition in many industries is strong enough to limit the ability of companies to pass along higher costs to customers reducing their profitability.  Notable exceptions include freight and express carriers which have been successful tacking on fuel surcharges.

Jobs data suggests that companies are adding workers as the economy grows.  Until recently, productivity gains were sufficiently large to meet the rising demand on producers, but it can only go so far.  It may be that companies must now add new people to meet rising production requirements.

With over 80% of companies reporting this quarter, corporate earnings are up an average of 24% over the same period last year.  Leaders include Internet companies, Real Estate Holding and Development, Oil Equipment and Services, and Biotechnology.  Among the losers are Automobiles, Recreational Products, Pharmaceuticals, Mortgage Finance, and Semiconductors.

Stocks are undervalued now relative to other investments such as corporate and government bonds.  The real estate phenomenon is likely diminishing as well.  There is a huge global glut of cash on the sidelines too.  Among the S&P 500 alone, corporations are sitting on over $600 billion in cash; that’s almost 80% of the revenues they generated during the last four quarters.  The fact that businesses don’t need to borrow money contributes to low corporate bond yields and makes stocks all the more attractive from a safety and growth standpoint.  The combination of low inflation, growing global economies, and surplus cash could make stocks the most attractive choice for several years to come.