Where’s the Slowdown? . . . Where’s the Inflation?

The pessimists are finding it increasingly difficult to support their arguments for an economic slowdown or the renewal of inflation.  Yet, it seems just as hard for people to take the optimistic view.  The war in Iraq, the threat of terrorism, high oil prices, and potential boogeymen continue to throttle confidence. 

A survey released June 1st by the Washington-basedPewCenter for the People and the Press showed that Americans rated the economy the nation’s second biggest problem, behind the war inIraq and just ahead of terrorism.  But if everyone’s so melancholy how do we explain the booming housing market, or the blowout that the automakers have when they reduce prices by a couple thousand dollars?

The fact is, consumers ARE spending money, and they are confident enough to make large and long-term purchases such as houses and cars.  In fact, consumer confidence as measured by theUniversityofMichiganhas been up for the past two months, in spite of record high energy prices and continued glass-half-empty media bias on Iraq.

Today, the government said that industrial production rose .9% last month, twice what was expected by economists, and industrial capacity rose to 80%.  While much of this month’s production was driven by utilities as they scramble to generate electricity to keep us cool, other areas of manufacturing such as durable goods showed considerable strength.

An index of New York state manufacturing also unexpectedly rose in July to its highest level this year as orders picked up and inventories shrank.  The report also showed that inflation was not a problem as prices paid actually fell while productivity increased.

Earlier in the week the government released its report on prices in the manufacturing sector that showed a continuation of the downward trend in prices in most stages of production and consumption.  Costs of raw materials declined last month by the most since last September, so there are few higher costs to pass on to consumers.  The government said consumer prices were unchanged in June.  Discounts for autos, food, apparel, and computers countered the otherwise inflationary forces of high gasoline and other energy prices.

At the moment, the economy looks quite strong with few foreseeable hurdles.  But don’t worry; we’re not breaking out the rose-colored glasses just yet.  The concerns mentioned above will likely be with us for months to come.  And there remains the question of just how far the Federal Reserve will go to reach a non-accommodative interest rate stance.  If they go too far they risk stalling the economy’s growth.  Many economists argue that they are near the end of their increases with 4% being their target (the Fed Funds rate is currently at 3.25%).  The experts we follow believe they should stop sooner.  Time will tell.

For now, we believe we are well-positioned both at home and abroad to maximize returns.  Specifically, we like technology, certain healthcare providers, certain regional and global construction, and energy development.  Abroad we like the Pacific Rim,China, and Latin America.

We maintain a long-term focus in our strategy, but remain vigilant against risks that might excessively jeopardize portfolio values.  These risks might include an overzealous Fed, prolonged fiscal budget deficits, a rapid rise in interest rates, European recession, etc.  For now, investment opportunities and valuation outweigh the risks.