Market Generally Strong Amid Mixed News

We began the week with some surprisingly strong economic news.  As reported by the Institute for Supply Management,U.S.manufacturing increased in December by the largest amount since the last recovery from recession in June of 1991.  Manufacturing contributes about 15% to the nations’ economy.  Manufacturing and business in general have been slow to recover in this latest economic slowdown, but this latest ISM report showed much more strength than expected by economists.  Some economists are now raising their growth target for the economy from 1.5% in the first quarter to 2.5%, while others say the report probably overstates the amount of improvement. 

Tuesday was more downbeat as the government reported thatU.S.factory orders fell in November for the third time in four months.  Manufacturing orders declined 0.8% after rising 1.4% in October, the Commerce Department said.  Companies have been reluctant to boost orders until consumer and business spending strengthen, keeping just enough inventories on hand to meet current demand.  That caution is restraining economic growth and keeping the recovery uneven.

The economy is not yet adding jobs as it struggles to recover.  The number ofU.S.workers filing new claims for state unemployment benefits fell below 400,000 for the second time in the past three weeks, indicating that the worst stretch of firings may have passed.  Initial jobless applications decreased by 19,000 to 389,000 in the week that ended Saturday, the Labor Department said. That’s down from 408,000 the previous week and compares to an average of 405,000 a week last year.  Economists generally regard claims above 400,000 as a sign of a weak labor market.  The economy is not yet creating jobs faster than it is losing them, but the rate of loss is declining as is the expectation of layoffs by businesses.  The survey reported that businesses said they would cut 92,917 positions in the coming month, down 41% from 157,508 in November.

The consumer is showing signs of caution in the use of debt as indicated by the November Consumer Credit report. U.S.consumer borrowing fell in November for the first time since January 1998.  Borrowing through credit cards and other types of loans decreased at an annual rate of 1.5%, or $2.2 billion, the Federal Reserve said.  That follows an increase of $1.5 billion in October and would be the biggest decline since a $2.4 billion rate in October 1991.  Economists expected consumer credit to rise at a $3.8 billion.

On Tuesday, President Bush presented his bold fiscal stimulus package.  His plan provides incentives for companies to invest in equipment and create new jobs.  It also speeds up income-tax cuts enacted in 2001 and slated to take effect between now and 2010.  It ends the tax on stock dividends and provides money to states to help unemployed workers find jobs.  The package has been relatively well received in the business community, but derided by Bush’s political opponents as being mostly aimed at the rich.  It will likely be March or April before Congress enacts legislation and investors can have and adequate understanding of the final package.

The stock market has been generally positive so far this week on the news while treasuries have fallen.  The Dow is up 2% as of this morning and the Nasdaq is up 3.7%.  The best performing sectors have been those most beaten up over the past couple of years, such as computers, wireless communications, and utilities.  Software has performed best over the past month.

But those gains may be trimmed today following reports the economy lost jobs in December.  The Labor Department just reported that the economy lost 101,000 jobs last month.  The forecast was for a gain of 20,000 jobs.  But the closely watched unemployment rate held at 6%, as expected.

Greenspan, last month in a speech to the New York Economic Club, said “any significant fall in the current geopolitical and other risks should noticeably improve capital outlays, the indispensable spur to a path of increased economic growth.”  This week the speed of resolution of these geopolitical risks became considerably less certain.

Yesterday, Chief United Nations arms inspector Hans Blix saidIraqis still withholding information about its illegal weapons, and he pledged to seek interviews soon with scientists in Baghdadto find out more.  “We are not satisfied,” Blix told reporters after briefing the Security Council on a 12,000-page declaration that Iraqpresented last month in response to a UN mandate to disclose its weapons-development programs or face a possible war.  The evening newscasts seemed to focus mostly on Blix’s assertion that the team had found no “smoking guns” so far in their inspections, implying that there were none.  They largely ignored Blix’s dissatisfaction with Iraq’s failure to cooperate in several important aspects of his investigation, such as interviews with scientists and omissions of information about previous chemical and biological weapons programs.  Oil traders did not ignore Blix, however, as crude for February delivery rose $1.43, or 4.7% to $31.99 a barrel on the New York Mercantile Exchange, the biggest gain since December 23rd.

Today we hear that North   Korea is pulling out of the Global Nuclear Non-Proliferation Treaty calling its decision a protest against “hostile”U.S.policies.  What hostile?  Do they see tanks and troops forming at their border or aircraft carriers steaming across the Sea of Japan?  The only has been the stopping of oil shipments that were guaranteed as long as North Korea honored its non-nuclear agreement.  (The timing of the fuel cutoff is difficult for North Korea as temperatures in Pyongyang are forecast to drop into the mid teens today.)  Are they repeating their 1993 antics when Bill Clinton was President?  Is the North in cahoots with Saddam Hussein in diverting attention fromIraq?  All that’s certain is that their move has infuriated their neighbors China and Japan, supporters like Russia and the larger global community.  With that amount of pressure, it is reasonable to expect this situation will be resolved diplomatically.

Uncertainty continues to be the watchword restraining the broad stock market and sustaining the Treasury market.  The market choppiness, however, is declining as measured by market and individual stock volatility.  Opportunities exist in specific areas of the market and they can do reasonably well even amid uncertainty.  Some of those areas include healthcare, consumer non-durables, consumer cyclicals, financial and business services, media, certain communications companies, and software companies.  We still hold a healthy amount of cash and bonds to absorb shocks that may come our way, but we believe the risk/reward pendulum has switched to stocks.  Superb monetary and fiscal conditions combined with reasonable stock valuations in many areas dramatically improve the return potential of stocks in the coming years while reducing their risks in the short term.