28 May 2004 Economy Gaining Strength
Yesterday, the Commerce Department revised upward its estimate of how fast the economy grew in the first quarter of this year by two tenths of a percent. The report also showed that corporate profits jumped 31.6% in the quarter ended March, the biggest increase since the first quarter of 1984.
These profits are a good indication that capital spending and hiring will continue. Initial jobless claims continue to fall, falling to 344,000 last week. Numbers under 400,000 demonstrate a healthy labor market. In fact, current claims represent only 2.6% of payrolls, which is down from an average of 3.1% in the 1990’s according to Bloomberg. Jobs are coming back and, to the surprise of those criticizing the quality of new jobs, wages and salaries increased by $57.8 billion in the fourth quarter of last year, $18.3 billion more than previously estimated.
The components of GDP growth tell an even more remarkable story. Inventory replenishment accounted for .75% of the rise in GDP. Inventories still remain historically low, so that component of GDP growth appears solid. Residential housing construction was revised higher to show a 3.8% rate of growth compared to an initial 2.1%. Business fixed investment rose at 5.8% and was led by a 9.8% rise in spending on new equipment.
Detracting from GDP growth was the nation’s trade gap. We imported $525 billion more goods at an annual rate than we exported last quarter. This differential is due primarily to the fact that theU.S.economy is stronger than those of our trading partners. The strong consumer, aided by tax cuts and low interest rates is also a major factor.
With 91% of companies in the Dow Jones US Total Market Index reporting their first quarter results it looks to be a blowout for corporate profits. Earnings are up an average of 31% for the period from end of last year to March 31st. The hands down winners have been Basic Materials and Technology companies with average increases of 113% and 112%, respectively. Standout industries within the sectors are Communications Technology, up 1,655%, Biotechnology, up 684%, Full-line Insurance, up 322%, and Office Technology Equipment, up 263%.
The consumer is slowing a bit, however. The government reported this morning that personal income rose, higher than expected, while personal spending declined, but not as much as expected. As interest rates and energy costs rise and the effect of tax cuts and home re-financings abate, it is normal that the consumer would slow his spending somewhat. It is encouraging though, to see personal income on the rise. Income rises will serve to sustain consumer spending strength in future quarters.
Finally, the PCE Deflator (personal consumption expenditure), a measure of inflation tied to spending, rose 0.1% last month. According to today’s report it was 1.9% higher than in April of last year. The Fed is paying close attention to inflation numbers as it gauges how fast it will need to raise rates to what it thinks are more policy neutral levels. The ultimate speed and degree to which they raise rates have a significant impact on currency, stock, and bond markets. We continue to think that they will be moderate in their policy adjustments, minimizing market volatility to the extent possible.
Conditions are improving for world markets. Recent events inIraqshow some promise that the news does not have to get worse daily. The Associated Press just announced that Iyad Allawi, a neurologist, has been unanimously endorsed by the Iraqi Governing Council to become Iraq’s new Prime Minister. The militant priest Moqtada al-Sadr has indicated he will cease military resistance if theU.S.meets certain conditions, which might indicate a trend toward acceptance of the new Iraqi government. Oil prices are likely to fall asSaudi Arabia,Kuwait,Nigeria,United Arab Emirates, andMexicohave all indicated they will boost supplies.
It is our opinion that stocks are currently discounted for a degree of inflation/interest rate risk, high energy risk, degradation of the Iraqi situation, and terrorism. To the extent that these events fail to materialize or are mitigated, markets have some appreciation potential. We believe that all the above risks except terrorism and possibly Iraq have been over-discounted by the market, but only time will tell.