02 Dec 2005 Will US Economic Strength Continue?
The economy continues to expand, in spite of hurricanes, high energy costs, and Fed Funds rate increases. The weeks’s crowded raft of economic reports was kicked off by housing. The reports were mixed, but generally point to a slight cooling. The National Association of Realtors reported Monday that sales of existing homes fell 2.7% in October to a seasonally adjusted annual rate of 7.09 million. Houses stay on the market longer as the inventory of homes on the market rose to a 4.9 months’ supply in October, from September’s 4.6 months’ supply. Meanwhile, housing affordability dropped as the median sales price rose 16.6% on an annual basis to $218,000. That was the biggest jump in 26 years.
According to Bloomberg and Merrill Lynch, the housing industry accounts for about 5% of the economy, however, it generated half of the economy’s growth in the first six months of the year and more than half of the private jobs added since 2001. New home sales, released on Tuesday, came in surprisingly strong, rising 13% to a record 1.424 million-unit annual rate.
Following the energy price shocks and the aftermath of the Gulf hurricanes consumers showed remarkable bounce. The Conference Board’s Consumer Confidence reports jumped to 98.9 from last month’s reading of 85, the biggest rise in more than two years. Consumers acted on their confidence as they stormed the malls following the Thanksgiving holiday to create the second biggest holiday selling season since 1999. Durable Goods orders increased more than forecast by 3.4%, which suggests that demand will encourage more production to sustain economic growth.
On Wednesday the government reported that theU.S.economy expanded at a 4.3% annual rate from July through September, in spite of hurricanes and record energy costs. The increase compares to a 3.8% increase in the second quarter of the year. The better news was that the economic expansion and the high energy prices have not caused inflation. A measure of inflation closely watched by the Federal Reserve rose at the slowest pace since the second quarter of 2003.
The year over year CPI inflation rate, excluding food and energy, was up only 2.1% in October. It was down from a 2005 peak of 2.4% during February. The comparable personal consumption deflator was up only 1.8% in October, down from 2.3% during November 2004. During Q3, it was up only 1.2%, at an annual rate. Productivity and globalization are keeping inflation under control. Productivity was up 4.1% in the third quarter, at a seasonally adjusted annual rate. That’s up from 2.1% during the second quarter.
Globalization is another major component of the ceiling over prices. Global competitive pressures in almost every industry and at almost every level of production have severely limited the pricing power of producers keeping end-prices down. Inexpensive clothes from Asia drive retail sales. Cheaper yet more powerful microchips and semiconductors from Asia restrain global chip prices thereby fueling the huge wave of new electronic consumer gadgets that appear to be must-haves. Cable companies have announced price increases, but a move is afoot in the FCC to offer customers the ability to pick and pay for channels individually. Cable’s higher prices will do nothing more than steel their competitors in the telephone and satellite businesses to ramp their offerings to market faster.
Energy supplies and prices have returned to pre-hurricane levels, helped in part by less heating demand over much of the country. Globalization also played a huge role in replacing crude oil inventories in this country immediately following the hurricanes. Oil producing countries shipped as much oil as they were able in order to stave off a possible U.S.energy-caused recession. The crisis was averted through the efficiency of global markets and logistics.
Another testament to the strength of our economy is U.S. job growth. Non-farm payrolls jumped by 215,000 workers in November, while manufacturing payrolls increased by 11,000. Compensation gains were also up for the month. These trends further enhance consumer confidence and spending ability.
So what about the market? The Fed holds all the cards regarding the U.S.economic expansion. If they overshoot with rate increases the economy will falter and the market will lead it by a few months. Gold is already suggesting it to some degree, although market bulls say the recent rise in gold and other precious metals has more to do with demand than the foretelling of U.S. or global recession.
Corporate earnings in the U.S.don’t look as rosy as they have in past 10 quarters. The S&P 500 forward earnings projections are deteriorating. As a favorite market strategist of ours, Ed Yardeni points out, total S&P 500 forward earnings are up 16.3% year over year, but just 6.7% when energy is excluded. In November the Energy sector accounted for 53% of the change in forward earnings, down a tick from October’s record high of 54%. Energy’s share of the S&P 500 forward earnings is up to 14.1% from 6.0% in late 2003 and is at the highest level since 1986.
Don Hays, another favorite market strategist, is calling for U.S. market weakness in the coming weeks by both fundamental and technical measures. He believes the Fed will go too far and too long with high rates and stall the economy. A more near-term concern for Mr. Hays, along with Mr. Yardeni, is that when investors see the forward earnings of integrated oil companies coming down due to lower oil prices, they will likely ratchet down U.S. stock prices in general.
We have taken profits on all of our Integrated Oil companies, but we expect to hang on to our oil service providers like Schlumberger, Transocean, and Nabors. These companies are seeing rising demand and profits in spite of oil prices coming down. Nevertheless, we expect the stocks to be weak near-term in sympathy with the expected weakness in the integrated companies.
As a further measure of caution, we plan to take profits in those companies where valuations appear high relative to a potentially slower economy. Cash will likely be held while some will be added to our Latin American and Asian holdings.