19 Dec 2003 Santa in January?

Good news on jobs, leading economic indicators, and comments from the Philadelphia Federal Reserve sent stocks soaring on Thursday.  So far this year the Dow and S&P are up roughly 24% while the NASDAQ is up 46%.  Stocks are poised to have their first up year since 1999. 

The consumer remains fully engaged in this plodding recovery as indicated by Bed Bath & Beyond’s earnings.  The country’s leading housewares retailer advanced 5 1/2% Thursday on better than expected earnings and an increase in next year’s expectations.

Recent consumer confidence polls such as Michigan Confidence and the Conference Board have shown more pessimism than the actual retail numbers actually indicate.  The latest reports on the retail sector have generally been positive.  Earlier this week, WalMart, among mostly upbeat comments, drizzled slightly on the parade when it said that its sales for the final month of the year would likely be at the low end of expectations, as shoppers delayed holiday purchases and bought more gift cards, not counted as sales until redeemed.

A study by CNBC discussed this morning showed that retail sales for the month of December as a percent of the annual total had dropped from 14% to 12% since the 80’s.  WalMart indicated the same earlier this week in their comments.  More shoppers are delaying many of their purchases until after Christmas.  The main reason is that they expect prices to drop considerably after the Christmas rush.  Further, retailers have found that dropping prices earlier in December actually causes shoppers to expect that they will drop all the further in January.

This phenomenon is demonstrated very well in car sales.  Historically, the best time to buy a car was just before the new model year was introduced.  Car dealers dropped prices on their remaining ‘older’ inventory to clear it out.  Following the trauma of 9-11 car manufacturers feared sales might stall.  To counter the threat they added huge incentives to induce buyers to act.  The incentives worked, but now they find it difficult to remove them.

One of my clients, a manager of a large local car dealership, says that he learned that the big three are nowhere close to abandoning their incentives.  Financial inducements are now expected by new car buyers.  To compensate dealers for the revenue reductions caused by the incentives, manufacturers offer allowances to offset them.  But lately, dealers have had to use some of those dollars to compete locally.

Declining prices, low interest rates, and lower taxes all make for great times for consumers.  The problem with this trend is profits.  Without them businesses will not risk additional capital or hire new workers.  And without job growth consumers begin to worry about job security and cut back on consumption causing a downward spiral in the economy.

But that is not happening now.  Job growth has stabilized and has even begun to improve according to the Federal Reserve.  Corporate profits are improving and will likely continue given low inventories and continuing demand.  The fly in the ointment is the declining money supply.  Granted, there is a huge supply of cash now and the Fed is likely quietly sopping some up, but it certainly warrants watching.  Stock prices decline when money supply tightens.  The broadest measure of the money supply, M3, has declined $143 billion or 1.6% in the last three months.

The great sustainer throughout the past four years of economic uncertainty has been extraordinary growth in productivity.  All that technology that was bought in the 90’s has been effectively employed now.  Businesses have learned how to use it and even to stretch it as evidenced by the continued low levels of capacity utilization in our manufacturing sector.

Through cost cutting made possible by technology and higher productivityAmerica’s corporate profits are on the rise and will likely be aided further by the declining dollar.  The dollar hit a new all-time low against the Euro yesterday at .8781.  Gold neared at 7 ½ year high at $413.30 and is an excellent indicator of what expectations will be for the dollar going forward.

The dollar will likely continue falling as long as U.S. interest rates remain considerably lower than European rates and according to the Fed statement last week that could be for months to come.  There was also no indication from the European bankers’ meeting last week that they would lower rates.

There are several risks of a declining dollar.  One is that it pressures U.S. stock and bond prices when foreign holders are prompted to sell their dollar-based holdings to stem their losses.  But if theU.S.markets remain stable or even increase, dollar denominated securities may be all the more appealing to foreigners when they can buy more shares than they could when the dollar was more expensive.

Another downside to a falling dollar is that foreign imports into this country become more expensive.  In other words, dollars buy less foreign currency, so they buy less foreign currency denominated goods.  If Americans’ appetites for imports continue, buying them over comparable, cheaper American products, the effect becomes inflationary.

Publicly, the Fed says they are convinced that inflation is not a risk in the near term and are willing to keep rates low for a “considerable period.”  Before last week’s Fed meeting markets indicated the Fed would begin raising rates by May of next year.  But odds have dropped considerably they will even raise by then, after release of the Fed Open Market Committee minutes last week.  It now appears that rates will remain low for months to come.

Add sustainable corporate profits to the mix demonstrated in today’s numbers and we have a foundation for sustainable economic expansion and market growth.  Corporate giant General Electric said recently that it is seeing noticeable improvement in both its short and long cycle businesses.  Just a few months ago, management wasn’t seeing any growth.  With its diverse ownership of so many leading cyclical industries, this conglomerate is an excellent bellwether of the business economy, just as WalMart is for the consumer side of the economy.  Their positive comments of late are welcome indeed.

Happy Chanukah to our Jewish clients and friends as the Festival of Lights begins tonight at sunset.  The Brief will not be published next Friday as I will celebrate Christmas with my family.  My hope is that you and yours experience the peace that comes in the knowledge of the true meaning of Christmas.