30 Jul 2004 Slower Growth Not All That Bad
The U.S. economy slowed to a 3% rate in the second quarter according to the government report just released. The slower than expected growth was the result of rising energy prices and the weakest pace of consumer spending in three years. Consumer spending which represents 70% of the economy increased only 1% after rising 4.1% during the first three months of the year. The slowdown in GDP follows an upwardly revised 4.5% growth rate for the first quarter. The bond market responded favorably to the news as the inflation pressures fall with slower growth.
While the consumer took a vacation during the second quarter, he may be coming back in the third. According to the Conference Board’s and by theUniversityofMichigan’s measures of confidence the consumer is feeling better. The Conference Board’s measure reached 106.1, a two-year high. Higher confidence numbers means consumers are more willing to make large purchases.
That fact remains evident in the nation’s housing market. U.S. sales of previously owned homes rose 2.1% in June to a record annual rate of 6.95 million houses. Prices have been pushed to their highest levels ever, according to Bloomberg. Sales of new homes fell .8% in June, less than expected to 1.326 million, but are still at the second fastest pace on record.
Durable goods orders rose .7% in June after falling for three months because of greater demand for automobiles and business equipment. While the growth was less than expected, it represents a sustainable lever according to many economists. Just released, the Chicago Purchasing Manager’s Index far exceeded expectations as factories boosted production to meet backlogs. It indicates that growth may be returning to after a second quarter slump.
At this point 61% of companies have reported their earnings for the quarter and on average they are up 41% over the same period last year, according to the Wall Street Journal. The largest quarterly gains have come from Internet Services (1,251%) and Coal (910%); there are two disparate industries. Other strong performers include Pharmaceuticals (640%), Communications Technology (425%), and Forest Products (236%). Top losers so far for the quarter include Precious Metals (-53%), Pollution Control (-41%), and Diversified Financial (-25%).
It appears the nation’s economy is settling into a sustainable level of growth with inflation under control. Slower growth means the Fed will can be more gradual in its efforts to raise short term interest rates to what they consider policy neutral levels. Continuing record low rates are the result of a policy of stimulus the Fed no longer feels is necessary. Historically, gradually rising rates have not proven bad for stock markets. The expectations are generally that corporate earnings will continue rising, driving stock prices higher. As this happens, managers feel more confident to hire and invest in their businesses. Aside from rising oil prices which will likely run their course soon, the major uncertainties facing investors now are the incalculable risk of terror attacks and what appears to be a 50/50 horserace to November. A new president means uncertainty on issues such as taxes and regulations, critical components of corporate earnings projections. Only time (and the Electoral College) will answer those questions.
We believe the market will continue to trend mostly sideways until the election, broken only by occasional volatility. These periods will continue to produce bargains in some very good companies. For instance, retailers such as Wal-Mart, Target, and Lowe’s now trade at relative valuation levels not seen in the past five years. Investors have oversold them out of fear or shortsightedness. In just 11 days Coca Cola has fallen more than 16% (not yet a bargain though). Profitable growth companies have reported earnings that matched analysts’ expectations only to see their stocks fall 10, 20, even 30% in a day. In short, investors have a low degree of confidence in the sustainability of long-term growth. Value stocks such as oil companies, natural resources, and basic materials currently rule the day. We are not wed to a growth strategy or a value strategy. We don’t know how long the financial asset confidence malaise will last, but strongly believe that buying valuable corporations paying dividend rates twice those of money market rates, while few want them, and selling them when everybody wants them, is a sound strategy.