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Bush Boom on Strong Footing
By Alexander Paris
Barrington Research
As we listen to politicians, strategists and fellow travelers of the liberal persuasion attack President Bush's economic record on television talk shows night after night, we can't help but wonder what planet they are from. We might normally excuse it on the basis that anything passes for the truth in a presidential election year, except that the rhetoric has had a major impact on the stock market. By not making any progress at all so far this year, investors have been ignoring what has been an economic academy award worthy performance by the administration.
At his inaugural, Bush was inheriting not only the office of president but also a recession that was just beginning as he delivered his acceptance speech. In light of the huge excesses created during the final bubble of the Clinton years, by all rights it should have been a very severe economic correction. Instead, helped by several tax cuts and other timely fiscal and monetary policy moves, it turned out to be one of the mildest U.S. recessions on record. Of more direct interest to investors, the Bush 2003 tax cut also slashed taxes by half on dividends and capital gains and cut taxes by 7% across all tax brackets, which significantly raised after-tax returns. Larry Kudlow, a good supply-side economist, reminded us in an Investors Business Daily article that the positive effects of this kind of tax relief do not fade as quickly as Keynesian-type tax cuts that focus on putting money directly in consumer hands. He notes that supply-siders realize that lasting increases in consumer income and spending power come from the creation of new jobs. The jobs, in turn, are created by businesses that need funding from capitalists putting their money at risk for adequate after-tax returns. The Bush tax cut relieved the long-standing double and triple taxation on investment. Say's Law, dating way back to the eighteenth century and popularly summarized as supply creates its own demand, was interestingly never disproved by Keynesians, though they gave it a full frontal attack for years.
Keynesian-inspired liberal economists, focusing on the consumer portion of the tax cut, are predicting a sharp slowdown in economic growth as that initial stimulus wears out. Their cure for the mythical economic problems is to raise taxes and, failing that, to strip out the investment incentive Energizer Bunny portion of the tax bill that would do the most to keep the recovery going. To the extent that supply-side tax cuts raise investment and, therefore, long-term productivity growth, they will also help contain inflation by increasing the supply of goods.
Let's look at the economy under Bush. Despite the inherited recession, before his first year was over, GDP began to grow again in the fourth quarter of 2001 and has grown consistently for ten straight quarters. In the year since the second Bush tax cut in 2003, real GDP has been growing at around a 5% annual rate and corporate profits, adjusted for depreciation and inventory adjustments as reported in GDP data, are running more than 35% ahead of a year ago. Instead of rolling over and dying, the consumer sector is healthy, with real income and consumer spending rising by 4%-5%. The U.S. manufacturing sector, moribund for over four years, has been on fire for months. Business confidence has returned and spending on equipment and software has been rising at a 12%-13% rate. All this time, despite a year long explosion in commodity prices and skyrocketing oil prices, helped by strong demand from China and the weak dollar, the CPI is rising at a manageable 1.6% rate.
Recent reports indicate that the boom is intact. First quarter GDP growth was recently revised modestly higher, to 4.4% from the 4.1% initial estimate, with nominal GDP growth at 7.2%. The revision was primarily the result of stronger-than-earlier-reported inventory investment, state & local government spending and exports, which were partially offset by a higher estimate for imports.
The major contributors to first quarter growth, as in the initial estimate, were personal consumption, business spending on equipment and GDP components as follows:
Personal Consumption rose 3.9%, with a decline in durable spending mostly due to autos, offset by higher spending on nondurables and services.
Nonresidential Investment was up 5.8%. Within the category, business spending on structures fell 7.0%, compared to a 1.4% decline in the previous quarter. Business spending on equipment & software rose 9.8% compared to 14.9%.
Residential Fixed Investment rose 3.8%, exports were 4.9% higher and imports rose 5.9%. Exports are in a strong cyclical recovery, but, due to the strength of the U.S. economy, imports have been rising even faster.
Federal Spending accelerated sharply in the first quarter, with a 9.2% increase. It was led by defensive spending (+13.2%), with nondefense spending up 1.5%. State & Local Government Spending declined 0.7% due to still depressed finances.
Change in Inventories added 0.75% to first quarter GDP growth, increasing by $28.2 billion, up from a $9.0 billion increase in the fourth quarter. That left real final sales (GDP less inventory changes) up 3.7%, up from 3.4% in the fourth quarter.
All in all, it was a good report, with the economy growing faster than its long-term potential, but with good sustainable growth. The growth was very broadly based, with only weakness in autos and state & local government spending. Business spending is very healthy and focused on equipment and software spending. Spending on structures, which is still weak, tends to lag business spending. There were increased price pressures in the quarter, due primarily to the bigger-than-expected surge in world commodity demand, which is currently in the process of at least a temporary moderation, except for energy. Corporate profit growth continues strong. Total profits with IVA and CCA adjustments were up 31.6% from a year ago, while pre-tax and after-tax profits also had strong gains. The recent increase in job creation will help to sustain the recovery. Overall, we find it difficult to understand how President Bush's opposition can use the economy as a political issue.
Job Growth: By now, we would hope that investors have tired of hearing about the lack of job growth in political speeches. It looks like the cyclical recovery in job creation is well underway and we are on track to create over 2.5 million new jobs in 2004. If that is attained, the unemployment rate should fall to around 5.1%. It will lag the growth in jobs since workers not currently seeking employment, who are therefore not counted among the unemployment numbers, will start to re-enter the job market as conditions improve. The labor force participation rate is currently at a cyclical low of 65.9%, down from the previous peak of 67.3%. Many also believe that the establishment survey, which reports payroll jobs, has been significantly understating job growth.
A Walk on the
Not-so-Dark Side
Now let's address some of the concerns bothering investors and offsetting the continuing positive underlying fundamentals described above and the possibility that they may be fading in influence in the period ahead. They include some legitimate economics and investment-related concerns that have negative potential, but may have been overstated or already fading. Others are clearly non-investment emotionally based factors that defy normal investment analysis.
Iraq, Terrorism and Politics
We'll start with the latter, more difficult to analyze, emotional factors. The rocky road to winning peace in Iraq, together with the related acceleration in terrorist activity, is undoubtedly a major factor negatively affecting investor sentiment and the stock market in some unmeasurable way. The negative impact has, unfortunately, been substantially magnified by the shameful politicizing of the vents in Iraq and attempts to battle terrorism at home assisted by the extremely biased nature of the media coverage with its own anti-administration political agenda.
While it is difficult to be too definitive, we have the feeling that we've seen the worst as far as the negative impact of Iraq on the market. Attention is shifting from the skirmishes with terrorists and foes of a democratic Iraq to preparing for the June 30 turnover to an Iraqi governing council. Though it may be the result of our watching the Fox News channel instead of the networks, it also seems like there is a growing awareness and backlash against the overly liberal coverage. The story about the LA Times carrying front-page stories and pictures on Abu Ghraib prison for 28 straight days while relegating any good news to the inner pages has been picked up and repeated often. Similar stories about the extreme negative bias of the New York Times are getting similar increased attention with a new book on the subject. Disney refused to show the new unabashedly political and factually challenged Michael Moore movie. We cannot promise the problems in the Middle East or with terrorism are going away any time soon, but coverage may begin to get a little more objective. Once the election is over, the shrill political rhetoric about Iraq, terrorism and the economy should also moderate. As for Hollywood, perhaps the best policy is simply to ignore the airheads.
Getting to something a little easier to analyze, the large and growing federal budget deficit is one of many other investor concerns, particularly in light of its potential impact on future inflation. We have certainly criticized Bush's guns and butter spending strategy. A recent estimate had the fiscal 2004 deficit at $521 billion, or 4.25% of GDP. Incidentally, this percentage has been significantly high on occasion in the past. It should be remembered that several timely Bush tax cuts went a long way toward allowing only a shallow recession instead of what could have been a much bigger correction following the major excesses of the bubble years. As a result of two personal tax cuts in 2001 and 2003 and the corporate tax cut in 2002, federal taxes as a percent of GDP have fallen from 20% in 2000 to a little over 16%. We can't think of many things more positive for the economy than transferring this spending from the government to individuals. We are less concerned about budget deficits that are temporarily increased by tax cuts since they increase economic growth, which, in turn, eventually works to lower the deficit.
That is not to say that the substantially increased budget deficit does not represent a potential problem for the economy. Depending on how it is ultimately financed, it could add to long-term inflationary pressures. For example, should foreign investors suddenly decide to cash in a portion of their huge portfolios of dollar assets accumulated because of the big trade deficits, the Fed could be forced into supporting the growing Treasury debt by monetizing it. But that is in no major trading partner's interest. The money supply has been falling on a year-over-year basis for some time. Without a shock, the U.S. can soon start to grow out of its budget deficit. With a new capital spending recovery underway supported by favorable tax incentives, productivity growth should remain at a 3% rate. Add to that normal population growth, and the economy can grow at 4% or so for some time. At that rate, the deficit will fall. According to the OMB, the Bush administration will be making a new push on spending restraints in the coming budget.
There will still be plenty of debate over the budget. The House and senate reached a tentative agreement on a $2.4 trillion fiscal 2005 budget plan and a compromise limit of an extension on expiring tax cuts to one year. But the Senate especially is divided on the plan, with some pushing for strict pay-as-you-go rules for one year with exemption for several Bush initiatives, including the expanded 10% tax brackets, elimination of the marriage tax and an increase in the child care tax credit to $1,000. Opponents argue that it would make it impossible to pass future tax cuts while raising the possibility of tax increases. An earlier Bush budget proposal called for $183 billion in tax cuts over the next five years while the most recent House plan allows only $138 billion. The recent House/senate agreement also ignored the Bush request to make almost all of the tax cuts passed in 2001 and 2003 permanent instead of expiring at the end of the decade.
Investors have been adjusting to the fact that there must eventually be an inflection point in monetary policy when the Fed will begin to raise interest rates again. With sufficient warning from Alan Greenspan and other Fed officials lately, investors have generally begun to assume that monetary policy is rapidly approaching the first Fed rate increase as early as the late June meeting. Investors are awaiting the government's May employment report and, if job creation is once again significantly over 200,000, it should be the final signal for a June rate increase. At the same time, we suspect that investors have also come to believe that when the Fed's tightening policy begins it will be conducted on a measured basis.
Given our assumption of continued healthy economic growth in the second half, this would imply three or four quarter-point increases in the Fed Funds rate over the remaining five FOMC meetings this year. Since we are starting with the rate at a 46-year low, we doubt that the increases would be enough to derail the economic recovery, or even significantly slow it. On the other hand, since it should be widely discounted, we would not be surprised if the first rate increase would be the signal for a better stock market in line with the notion of sell on the rumor buy on the news. In fact, the market could start to anticipate this phenomenon before the Fed meeting.
A new Fed tightening phase will not likely have an immediate impact on business borrowing at the banks. After years of reducing costs and working capital needs, business is now increasing spending and starting to add to the workforce. Consequently, it is showing more interest in bank borrowing. According to Fed figures, roughly a third of domestic banks are reporting the highest loan demand from business in more than nine years. But that doesn't mean the Fed tightening will have a sudden big negative impact on bank lending. With business loans depressed for some time, business pretty much has a buyers' market at the banks, which are much more accommodating than during the downturn and have significantly relaxed loan standards, with defaults on junk bonds at a four-year low in the first quarter. Commercial and industrial bank loans in mid-May were at around $870 billion, down around 7% from a year earlier. Banks were able to offset the decline in business loans with big surge in mortgage lending, but that is also now on the decline. Business lending has changed in recent years, with large firms increasingly going directly to capital markets and bypassing banks. Even during the recent period when both business and bank loans have been stagnet, the bond market has remained fairly active. Moreover, after several years of reducing costs and concentrating on cash flow generation, business is flush with cash that it will utilize first for its increased financing needs.
Nevertheless, investors have had to adjust to a new environment in which interest rates will be rising. But while investors have been awaiting the first Fed increase of the Fed Funds rate, the new environment is already well in place. Global interest rates have been on the rise due to market factors and tightening monetary policy. The UK and Australia, for example, have already been raising rates and other central banks are contemplating changes. In the U.S., the 10-year bond rate has increased by over a hundred basis points in anticipation of the Fed. The global economy is picking up momentum and easy monetary policy is no longer needed. So, first Fed rate increase is likely already priced into the market.
Though a rising interest rate environment may not have a negative impact on the overall economic recovery for some time, investors will have to adapt their investment strategy to the new environment. Some industries will be affected more than others. The housing industry has historically been a major beneficiary of the easy monetary phase of the cycle, as it was again this time, and will be negatively impacted by rising rates. With a lag, the household furnishings market will be similarly impacted. Some countries will be more negatively impacted than others as well. The U.S., the UK, Australia and Canada, for example, have all had very strong housing activity that has been a major economic driver and could therefore see a bigger reversal. In Europe, on the other hand, housing activity and overall economic growth have not been as strong and there is less to reverse. The automotive industry has followed a similar interest-rate sensitive pattern as housing and the zero-rate financing incentives will be more expensive to maintain. The various financial industries have differing sensitivity to rising rates, but the overall financial sector does not do well in a period of rising interest rates. Emerging countries that have been major beneficiaries of cheap financing for years may also be more vulnerable. Many, however, have anticipated the change and have been restructuring debt and lengthening maturities. We cannot possibly sort through all the potential ramifications of a rising interest rate environment. Suffice it to say, the rising interest phase of the cycle has begun. Although it is not as negative an environment as the market has been fearing, it is a difficult one that requires different strategy.
While commodity prices surged for a year, oil prices have risen to 20-year highs and gold had a sizable move before cooling recently, inflation at the consumer level has remained relatively tame. The core rate for the first four months of the year was up 1.8% from the same year ago period compared to a 1.1% increase for all of 2003. Moreover, it will probably remain under the Fed's acceptable 2% rate the rest of the year, with a modest increase in 2005. The Fed mentioned inflation expectations at its last meeting for the first time in a long while, almost a welcome change from its prior concerns about deflation.
For all the talk in the media about rising inflation expectations, the evidence is fairly mixed. What there is may be reflecting that the bulge in commodity prices was significantly affected by demand from China, which is likely to be ebbing. One accepted measure of inflation expectations, the spread between regular and inflation-adjusted Treasury yields, has been widening modestly in recent months. Most surveys of economic forecasters still expect consumer inflation to remain under 2.0% over the next year and at least one Fed survey indicates inflation of around 2.5% over the next ten years. Futures markets indicate a decline in commodity price inflation expectations. The combination of the large trade and budget deficits along with the currently high rate government spending growth certainly hold the potential for higher inflation down the road. But, with slowing commodity prices likely ahead and continued strong productivity, as discussed below, inflation at the consumer level should remain relatively controlled over the next year or so. Consequently, it is liable to diminish as a negative market factor in the near term.
One key factor helping hold consumer inflation down has been the substantial increase in productivity growth. Even before the recent accelerated pace of economic growth and, therefore, improving top-line growth for business, profit margins and earnings were able to expand, even in the face of sharply higher commodity costs. While business would always prefer to pass along higher costs in the form of price increases, the penalty of not doing so has been more painless than in the past, when productivity growth was much lower. Consequently, the commodity price inflation was largely isolated in the crude goods portion of the producer price index, with some leakage into the intermediate goods prices. They were passed through even less to the finished producer goods prices and to the final consumer.
As we've written, we continue to believe that the higher productivity growth will be sustained for a lengthy period and will probably be reinforced by another sizable capital spending cycle, which is just getting underway. Overall productivity grew at a 4.5% rate in the first quarter compared to the previous quarter and 5.5% from a year ago. Productivity in durable goods manufacturing, which especially lends itself to efficiency improvement on the factory floor, was up 5.9% sequentially and 7.4% from a year ago first quarter. During all of 2003, productivity growth on nonfinancial companies had the biggest increase since they began tracking the series in 1959. Overall output rose, employment fell, unit labor costs declined by 1.5% and unit profits were up over 20%. Looking forward, output will continue to grow, job growth will improve but not keep pace because of productivity, labor costs will remain subdued, profits will continue to increase and inflation will remain under control.
The recent record $46 billion March trade deficit, extending a long period of accelerating deficits dating back to 1997, undoubtedly added to investors concerns, though most likely they don't fully understand all the factors that contribute to the imbalance or the implications of the deficit. We have certainly alluded to the potential negative implications of the growing deficit. In one respect however, the investors concerns ignore some very positive aspects of the deficit, namely that it is reflecting a healthy underlying economic recovery. It was only a couple of years ago that exports were falling at close to a 15% annual rate, while they have now been rising at a 14.6% rate for the most recent year ending March. The weaker dollar has been part of the explanation but, even excluding that, U.S. manufacturers are much more competitive, thanks to higher business investment, more rapid productivity growth and technology gains.
Imports have been growing even faster, however, leading to the higher trade deficit, but it is not due solely to materialistic U.S. consumers, as many foreign countries have charged. U.S. imports of consumer goods have been rising at just over a 10% rate over the past year. Reflecting the improving industrial sector, however, imports of industrial materials have been just as fast and capital goods imports have been rising at nearly a 17% rate. Imports are well balanced, reflecting a stronger U.S. economic recovery relative to many countries, and providing a significant positive stimulus for foreign countries, especially for Europe, from where most of the criticism is coming. In time, the trade deficit will begin shrinking as other economies recover and increase their own imports.
The potential problem of the large and growing deficit has been the corresponding increase in dollar-denominated assets in foreign hands that finance the deficit. They have been financing our budget deficit as well and, in the process, have helped keep U.S. interest rates lower than they would have been if the deficit had to be financed with domestic savings or by the Fed. The risk is, if, for some reason, the foreign holders of U.S. assets should decide to dump a significant portion of their portfolios onto the market before the deficit starts to recede on a more gradual market-related basis. The result would be a sharper decline in the dollar, a bigger-than-expected jump in interest rates and higher domestic inflation. Given the importance of the huge U.S. market for goods and services and the key role of the dollar in world affairs, such a dumping of assets would be nobody's best interest, but it is a risk.
There is no doubt that the sharply rising oil and gasoline prices have represented a significant part of the negative investor psychology that has been masking the more positive underlying economic and earnings fundamentals. However, it is equally clear that the current price represents such a confluence of different factors - including the effects of politics, war, unrest in the Middle East, reductions in supply caused by environmentalists, rising global economic growth, and a temporary spurt in demand from China - that it is difficult to discern what the true continuing level should be. Even with the recent surge, we don't believe oil is not excessively expensive to the extent that it threatens the economic recovery. Nor is it, in the strict sense of the term, inflationary. In the U.S., when gasoline prices move up to $2/gallon, people demonstrate in the streets. At the same time, it is $5.80 a gallon in the UK and something around that in Europe and they grin and bear it.
Business is also becoming less sensitive to oil prices. After being subjected to the OPEC embargo in the 1970's and the continuing threat of supply disruptions in the Middle East, business has been taking steps to make itself less vulnerable to spikes in energy costs. That's why the most recent surge in oil and natural gas prices is taking so long to be reflected in higher core prices. Some industries, such as airlines, truckers, tire makers, and petrochemicals, will feel the pressure more than others. But energy is a relatively small percentage of costs of most manufacturers. Even so, it is steadily finding ways to economize on energy. Cogeneration has also been getting popular in recent years. This is a process of capturing waste heat from a gas-fired furnace to heat boilers, which, in turn, heat plants.
As for the concern that rising oil prices will threaten the economic recovery, when oil prices move up you can always count on seeing reports by college professors showing that all recessions are associated with increases in oil prices, as we are now seeing. Even if oil prices did rise before many recessions, it doesn't mean there is a causal relationship. Most commodity prices rise at the end of economic expansions. Easy monetary policy that helped stimulate the preceding boom is usually tightened and, with a lag, triggers lower economic growth. Fed policy is usually tightened about the time when oil and other commodity prices, along with general inflation, is on the rise. When oil prices do significantly impact the economy, it is usually the result of the Fed's response to the higher oil prices, not the prices themselves. We remember vividly during the 1970's when the widespread concern was that the petrodollars pouring into the OPEC countries would not be recycled back into the rest of the world, thereby hurting consumers and causing a recession. The Fed responded with a massive increase in the money supply, leading first to double-digit inflation and then to the recession it had feared when it finally tightened again. Surprise! It was the Fed not oil prices that caused the inflation and the following recession. In fact, most of the earlier postwar recessions were, in effect, inflationary boom/bust cycles created by the Fed policy. It took the advent of President Reagan and Paul Volcker to reverse the terrible wave of such cycles and set the country on the path to a secular disinflation.
Help on the Way: In response, particularly from California and New York State, the administration is considering the removal of fuel blend regulations in order to boost supplies. These federal regulations, which require special gasoline blends for at least a dozen metropolitan areas to lessen air pollution, have significantly raised gasoline prices in the affected areas, since fuel from neighboring areas cannot be shipped in to meet increases in demand. The administration is also considering modifying the approval process for building or expanding refineries. Of course, a good part of the current high prices would have been avoided if Clinton had signed a 1995 bill that would have opened up the Artic National Wildlife Refuge to oil development. According to the Commerce Secretary, as quoted by Investor's Business Daily, this source would have provided 1 million barrels per day, a significant increase to the current 9 million barrel production in the U.S. Democrats are still holding up President Bush's energy plan, which includes development in the refuge.
Alternative Energy Sources: As economies has taught us, even monopolists cannot raise price at will, and that goes for groups like OPEC as well. High prices lead to conservation ad permanent reductions in demand and also stimulate supply. The U.S. is much less sensitive to oil prices today, for example, because of the OPEC oil embargoes of the 1970's. If OPEC tries to keep oil prices too high for too long, alternative sources of energy will also be developed. In fact, as a recent New York Times article pointed out, the U.S. has been slowly making progress with alternative sources like solar power, wind energy and geothermal, even before oil prices started back up. This is the result of declining costs of development and improving technology. U.S. production of alternative renewable sources was up 15.5% in the first two months of 2004, although it was still only 6.4% of domestic energy consumption and is headed to 6.7% this year. According to Cle an Edge, worldwide revenues from equipment and installation of alternative energy sources totaled $4.7 billion in 2003 and will rise to $30.8 billion by 2013. The article noted that costs of windpower-generated electricity in good wind sites are now under 5 cents per kilowatt hour, cheaper than natural gas. The industry could use the 1.8 cents/kw hour tax credit that expired at the end of 2003. Solar panels still cost significantly more than fossil fuel-generated electricity, but the cost has fallen from $100 per watt in 1976 to under $3 and is expected to continue to decline by 5% per year. Companies like Waste Management have been pursuing projects to convert garbage to energy. It has completed 31 projects and currently has 8 others in development. Any sustained period of high oil prices will increase the development and usage of all these and other alternative sources of energy.
Finally, there has been a concern that the blistering economic growth in China will be slowing down, which will, in turn, halt the growth in the rest of Asia and have negative effects on the U.S. recovery as well. There have been many signs that the Chinese economy has been overheating, especially in industries such as automotive, electronics, electrical goods, telecommunications equipment and all construction-related industries such as cement, steel, copper and aluminum. China has certainly noticed these signs of overheating and has been taking measures for some time to cool the economy. The Chinese central bank has already increased capital requirements for lending to these same basic industries and has told banks to cease new lending to them as well. Prior to that, it had increased reserve requirements to slow bank lending. With a 9.7% jump in first quarter GDP driven by over a 40% jump in investment, the government's target is well chosen.
In most respects, what is going on in China has been duplicated in many countries over the years, including the U.S. as recent as the last bubble. With the government's help, too much money and overly cheap credit has been leading to malinvestment, too much investment in specific areas. In the last U.S. bubble, most of the malinvestment was in technology, especially telecommunications, and the stock market. In China, it is more basic and includes construction, cement, autos, industrial metals and other basic industries, consistent with the country's stage of development.
The domestic money supply in China has been out of control for some time for government-created reasons. There is a fixed dollar-yuan exchange rate, which the government has refused to alter, while at the same time it requires all foreign money coming into the country to be converted into yuan. You would have to be a financial Rip Van Winkle not to notice the mad rush of foreign countries into China, forcing the government to print huge amounts to yuan to absorb the inflow of foreign investment money. The huge money growth combined with low fixed lending rates has resulted in greater than 20% credit growth for the past couple of years.
There is nothing wrong with China trying to cool the economy. The unanswered question is whether it will be able to ensure a soft landing. The boom in China has been a major contributor to the sharper-than expected rise in commodity prices last year and China's recent efforts have contributed to declines in industrial commodity prices like steel and aluminum. But some of the same booming cyclical industries have plans to double their capacity in the next few years and there is concern that those expanded facilities are dependent upon the higher prices for success. If they come on stream when prices are weak, pricing can make it difficult to service the related loans. Any new defaults on top of large amounts of an estimated $500 billion of already non-performing bank loans (equal to above half its GDP) could lead to a liquidity crisis in China's banking system. Suddenly cutting off the supply of credit and raising interest rates will lead to insolvencies. There are expansion plans in other countries in response to the rise in commodity prices that will also be adding supply and pressuring prices. We don't know how it will turn out, but China recently announced that it was making good progress is slowing economic growth to a more sustainable rate.
Shifting Market Sentiment
Bottom Line, the stock market thus far in 2004 has been stalemated between two countervailing forces - strong underlying fundamentals and negative or uncertain investor sentiment triggered by a host of factors, some grounded in exaggerated fears of potential economic problems down the road and others that are purely emotional. All of them, in turn, have been fanned by political election-year rhetoric. As described, the underlying fundamentals are positive and sustainable and will eventually win out over the emotion and exaggerated concerns about inflation, interest rates and other factors discussed above. Consequently, while the market may require some additional backing and filling, the current environment represents what will turn out to be an excellent buying opportunity for accumulating equity positions.
In fact, there have been a few signs that shift toward more positive investor sentiment focused on the fundamentals may be getting underway. Despite the upcoming June Fed meeting, when most expect the first step in tighter Fed policy, continuing bad news from Iraq and renewed terrorist threats, the stock market ended May on a strong note sufficient to finish the month with gains in all market averages and two-thirds of the 100-plus S&P industrial indexes. Moreover, after a long relative correction since late January, the technology/Nasdaq sector led the market higher in May, with a strong 3.5% gain, indicating improving investor confidence. Cyclically sensitive industry groups dominated the May advance, while the defensive sectors, which had been performing better as investors ran for safety, lost ground as investors became more confident.
Editor's Note: Alexander Paris is editor of The Alexander Paris Report, 161 North Clark St., Ste. 2950, Chicago, IL 60601, 1 year, 12 issues, $195.
With over three decades of experience, Alexander Paris is one of the best-known and most well respected economists and investment strategists in the business. Throughout his career, he has expounded the virtues of his unique free-market credit-cycle approach to economic analysis, which has enabled him to predict all of the major turns in the economy over the past few decades. Mr. Paris has authored several books, including two editions of the best-selling The Coming Credit Collapse, and A Complete Guide To Trading Profits.
With his economic philosophy as a centerpiece, Mr. Paris founded Barrington Research Associates, Inc and Barrington Asset Management. Barrington Research Associates is a brokerage firm that provides economic and investment research to institutional investors. Barrington Asset Management, Inc. is a registered investment advisory firm specializing in small and mid-cap growth stock investment management. To subscribe to The Alexander Paris Report call 1-800-416-7479.
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