Improving News Continues

Early this week investors were treated to a very nice surprise when the Federal Reserve reported that manufacturing in New York State expanded considerably more than expected this month.   Orders and sales grew the most since January, bolstering expectations the economy will accelerate in the second half.  The DOW rose 202 points as investors said the report may foreshadow a strengthening in U.S. manufacturing, which contracted from March through May.  The New York results prompted Bear, Stearns & Co. and Lehman Brothers Inc. to raise their forecasts for Thursday’s Fed report on factories in the Philadelphia area according to Bloomberg.

A separate report on Monday showed that U.S. homebuilder optimism increased for a second straight month in June as mortgage rates fell to a new record low. The National Association of Home Builders’ Housing market index increased to 62 in June from 57 in May. A gauge of optimism for the next six months rose to 70 from 69.

You will recall from last week’s Brief that corporate profits hold the key to leading us out of this economic slump and that numerous corporations will announce their second quarter earnings projections over the next several weeks.  The most notable announcement came today as General Electric maintained its 2003 profit outlook, defying five major analysts who just yesterday reduced their annual earnings forecasts because the company’s May orders fell short.

The GE story reveals just how vital corporate profit recovery is to analysts, companies, and investors in the current environment.  The stock market was down sharply yesterday in the face of good economic reports from the government.  But five analysts downgrading a global industrial bellwether like GE was too much for shaky investors to handle.  Analysts are paying close attention to every piece of data on a company and companies find it vital to set the record straight with shareholders when analysts get it wrong.  Market futures on the Dow Jones Industrial Index rose 35 points this morning on GE’s announcement that they would still hit their earnings target.

Deflation fears eased a bit this week as The Labor Department reported that U.S. consumer prices, excluding food and energy, had the biggest rise since August of last year, easing concern that deflation might sap the economic recovery.  The core consumer price index rose 0.3%, three times the median forecast, after holding steady in each of the previous two months.  The Labor Department inWashingtonsaid the overall index was unchanged in May, tempered by a drop in energy prices, after falling 0.3% in April.

On Tuesday the Commerce Department reported thatU.S.housing starts rose 6.1% in May.  Builders broke ground on 1.732 million homes at an annual pace last month.  Construction was completed on 1.784 million housing units at an annual rate, the most since January 1987, and on single-family homes at a 1.409 million annual clip, the most since October 1978.  Single-family home sales have risen in eight of the last nine months.

Also on Tuesday, the Federal Reserve reported that industrial production rose in May for the first time since February giving signs that manufacturers may be gearing up for increased demand.  But, the factory capacity in use number remained at a troubling two-decade low.

All the pieces of the puzzle for economic improvement are in place; including a declining dollar, low interest rates, a third Federal tax cut, lower oil prices, easier business credit terms, and rising business profitability.  However, companies remain reluctant to expand their production until they see improving demand.  The high amount of excess capacity and competition make it difficult to raise prices to improve profits.  But most economists expect the factors, just mentioned, to virtually insure that economic growth will accelerate in the second half.  Indeed, many of this week’s reports support that thesis.

In international trade, the deficit in theU.S.current account, the broadest measure because it includes investments, widened to a record $136.1 billion in the first quarter.  The size of the shortfall equaled 5.1% of the nation’s gross domestic product, also the highest ever.  The deficit represents money theU.S.has to borrow overseas to pay for the goods and services Americans import and to finance investment not covered byU.S.savings.  With theU.S.economy projected to grow faster than many of our trading partners, imports are expected to continue strong, while the outlook for exports isn’t as secure.  But a cheaper dollar makes American exports cheaper for foreign buyers, ultimately reversing the flow of dollars back into the U.S.

The trend of job losses may be stabilizing and even reversing.  The number of Americans filing for state unemployment benefits held above 400,000 for an 18th straight week, but the report showed a decline of 13,000 claims from the week before.  The less volatile four-week moving average of claims fell to 432,000 from 435,000.  Unemployment alone will be sufficient reason to expect the Fed to cut rates next week by at least a quarter of a percent if not a full half.

More good news came yesterday as the Conference Board released its index of leading indicators, reporting an increase of 1% in May.  It represents the biggest jump since December 2001 and was far better than the 0.6% increase predicted by economists.  Also yesterday, the Federal Reserve Bank ofPhiladelphiareported that their factory index rose to 4 from a minus 4.8 in May, expanding for the first time since February. The six-month outlook was the highest in a year.

We await news from corporateAmericain the coming weeks as to how well they are doing individually.  But early indications are positive and the second-half recovery thesis appears to be firmly on track.  We look for continued, if occasionally uneven, improvement in the economy and corporate earnings in most sectors.  The market should mirror the economic and corporate results as it appreciates, perhaps not as steadily or quickly as we enjoyed during what now seems like such a long time ago.