APRIL 6, 2004
I. MARCH 2004 COMMENTS...STOCKS CONSOLIDATE THEN RALLY...BONDS WEAKEN AS JOBS INCREASE
- Stock prices consolidated for much of March, before the market rallied at month's end. A slowing earnings expansion and lack of new jobs growth were cited as concerns restraining investor optimism after a year of good equity performance.
- Bond rates remained near historic lows, as Fed policy changes seemed far off, inflation remains subdued and corporate loan demand is growing only modestly.
- The hallmark event since our last report was the strong jobs report released in early April. The U.S. economy added 308,000 jobs last month, marking the best employment gain in four years. Stock prices responded positively to the good payroll news but bond prices dropped. Investors interpreted rising employment as a sign that the Fed may begin to raise interest rates earlier than expected.
- April will see the majority of quarterly earnings reports, which will be very strong. Stock buyers should find comfort in earnings and positive commentary from companies.
II. ECONOMIC OUTLOOK ...BROAD AND SELF-SUSTAINING RECOVERY...CAPITAL SPENDING, OVERSEAS STRENGTH TO COMPLEMENT JOBS GROWTH
- Economic indicators have remained favorable. Purchasing managers reported strong production, backlog, new orders, and employment trends in manufacturing. Confirming the strength were reports of slower delivery times, reflecting scattered bottlenecks, especially in transportation. Low inventories and strength in prices paid imply strong wholesale price data for crude and intermediate goods.
- Capital spending is driven by corporate profits. S&P 500 operating earnings are close to record levels and capital spending is about 20% higher than a year ago. Federal investment tax incentives are also contributing to corporate outlays. This bodes well for the industrial and technology sectors.
- In contrast, the consumer sector outlook is mixed. Rising employment and tax refunds are major positives. Housing and autos will show little incremental growth compared to 2003. Rising oil prices will act as a tax increase, reducing consumer disposable income. On balance, moderate consumer growth is anticipated.
- Recent dollar weakness will benefit exporters while raising prices of imported goods to U.S. consumers. Global economic growth may approach 5% in 2004-2005.
III. FIXED INCOME OUTLOOK ...JOBS REPORT PUSHES RATES HIGHER...INFLATION REPORTS STILL BENIGN...COMMODITY PRICES REFLECT GLOBAL GROWTH
- The long-awaited producer price report showed a 0.1% increase in February when that report was finally released on April 1st. Excluding food and energy, the PPI was also up 0.1% but products in earlier stages of production continued to surge. Intermediate goods rose 0.9% while crude goods were 2.5% higher. Steel prices rose 5.9% and plywood was up 15.2%. Basic industrial materials rose 5.5%. Consumer goods prices were more stable, rising 0.3% or 0.2% excluding food and fuel.
- Compensation costs appear more important than material costs in corporate pricing decisions. Wages continue to grow modestly although benefit costs are expanding quickly. In recent weeks, more companies have raised product prices.
- Reflecting GDP growth and the rising stock market, Federal tax receipts have been stronger than expected. This mirrors the improving state and local budget conditions seen in earlier months.
- The strong jobs report prompted many observers to forecast initial Fed tightening moves as early as August. We still believe the Fed would like to see several strong monthly employment reports prior to raising the Fed Funds rate. Significant moves upward are not likely until after the election. Investors should keep risks manageable in the fixed income arena by avoiding longer maturities.
IV. STOCK MARKET OUTLOOK ...PRICING POWER RETURNING TO SELECT SECTORS
- Strong earnings and cash flow trends have resulted in much-improved dividend distributions. Substantial increases have been common among financial services stocks. The typically low-yielding technology issues have also distributed higher payouts.
- Technology and productivity-enhancing production processes enabled rising U.S. industrial production (on a multi-decade basis) during a secular decline in manufacturing employment. Thus, operating margins in the industrial equipment area, aided by price increases, are rising rapidly.
- Discretionary consumer spending for travel, vacation, entertainment, lodging, and restaurant meals should grow strongly as incremental consumer dollars shift away from housing and automobiles.
- Energy prices continue to rise and related stocks offer attractive investment alternatives, particularly in natural gas, deepwater drilling services, refining/marketing, and oil field support services.
- Healthcare and consumer staples offer attractive defensive characteristics as investors begin to anticipate rising interest rates. Rising rates are a negative for certain sectors of financial services but the rising stock market buoys many issues among retirement benefit managers, mutual fund families, and asset gatherers in general.
NOTE: VISIT US AT ANY TIME IN OUR OFFICES OR AT OUR WEBSITE,
www.beacontrust.com