17 Feb 2006 Good News Is Good, This Week

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. 

As the Wall Street Journal points out, the warmest January in U.S. history inspired shoppers to swarm malls, boutiques and big-box stores, generating the biggest gain in U.S. retail sales in nearly two years and pointing to a sharp rebound in first-quarter economic growth. After rising an anemic 0.4% in December (a very cold month in parts of the country), retail sales rose 2.3% last month, the biggest gain since May 2004 and more than double the gain economists expected.

The strength in retail sales was almost universal among apparel retailers, furniture stores, home and garden centers and more. Retail sales make up more than a third of total gross domestic product, so GDP forecasts will likely be raised substantially. According to the WSJ most economists expect better than 4% growth in the first quarter, and some were throwing around 6% forecasts, a growth rate achieved in only one quarter in the past six years.

Readers will recall from Briefs over the last couple of years that betting against the U.S. consumer was a losing proposition. In fact according to Bloomberg, consumer spending has not shrunk in any year since 1980. And most economists expect it to continue in 2006.

The long anticipated testimony of new Fed Chairman Ben Bernanke before the House Financial Services Committee ran counter to expectations. He was quite a bit more hawkish on inflation than the ‘intelligence’ on him had anticipated. As reported by the WSJ he said the economy had sprung back into action after a fourth-quarter snooze and warned that inflation was dangling over the economy like a grand piano. He ticked off several potential pitfalls for the economy, particularly the risk of a sharp slowdown in the housing market, but dismissed them all.

Bernanke even joined the chorus of voices saying that the “inverted yield curve,” typically a harbinger of an economic slowdown, was different this time. Finally, he gave a quick nod to the amazingly low inflation numbers of recent years, but said that some of that success was due to the Fed’s inflation-fighting credibility, and he vowed to keep that record polished to a high shine. In other words, there may be more than just the two rate increases widely expected until now.  But for now, markets are giving Mr. Bernanke the benefit of the doubt.

Another major engine of the economic recovery, housing, continues to suggest that the doomsayers are either too early or just wrong.  Housing starts in January jumped 14.5% to a seasonally adjusted annual rate of 2.276 million units, the highest since March 1973. The gain dwarfed economists’ forecasts, and ran counter to other recent signs of weakness in the housing market, including three straight months of declines in sales of pre-owned homes, which represent the bulk of the market. Given that January was such a warm month, the numbers are likely skewed and will come back in line February and March. What impact that slowing will have on the economy remains in question.

In other markets, oil is down 5% for the week while gold is on the rebound after dropping about 5%.  Brazilian stocks look to finish the week up over 6.5% while the Latin American region is up 3.7%.  The European Monetary Union Index is up .6%. Japan is flat for the week and China is up 2.9%.

Our largest gainers this week in descending order are Schick Technologies 12.3% (Quest), iShares Brazil 7.5% (Quest), Franklin Resources 5% (Quality and Income), Apple Computer 4.6% (Quest and Quality), Caterpillar 4.5% (all models), Toyota 4.2% (Quality and Income), FedEx 4.2% (Quality), and BellSouth 4% (Income).  Our worst performing positions are mostly in the oil services industry, TransOcean (Quest), Schlumberger (all models), and Nabors (Quest).  Red Hat has had a tough week as it has declined 4.5%.

Questions remain about how far Mr. Bernanke and his policy committee will go with rates. Mr. Bernanke talked tough on inflation and indicated he would not be as gentle as earlier expected, but we remain hopeful that he will not go too far with rates. We hope that Mr. Bernanke and others are right when they say that an inverted yield curve does not foretell of recession, this time. We also hope that he is just as open-minded to the possibility that a strong global economy might not necessarily generate inflation, this time?  We’ll see.