AUGUST 6, 2003
I. JULY 2003 COMMENTS … STOCKS LABOR…BONDS WEAK…ECONOMIC INDICATORS POSITIVE
- Stock prices moved sideways for much of July as markets digested
earlier gains. Quarterly earnings reports were generally favorable
and management comments coinciding with those earnings reports
were more optimistic in tone.
- Bond prices continued to move lower, adding to the pattern
of higher yields that began in mid-June. The Federal Reserve
is not pushing up rates but, rather, expectations of a stronger
economy ahead are responsible.
- Early signs of economic recovery are present. The yield curve
is steep, leading indicators are higher, base metal prices are
rising, substantial fiscal stimulus is beginning and temporary
employment firms are reporting a pickup in placements. The stock
market correctly foresaw the implications for the economy. There
may be a pause as reality catches up with expectations.
II. ECONOMIC OUTLOOK … PURCHASING MANAGERS OPTIMISTIC…CONSUMER SPENDING STRONG…EMPLOYMENT PREDICATION MIXED
- Purchasing managers' surveys indicated economic expansion,
showing improved orders and production. Durable goods orders
rose in June and capital goods orders advanced as well. Construction
spending was little changed in June. The Federal Reserve's "Beige
Book" of business conditions referred to "nascent signs
of a recovery."
- Consumer credit growth exceeded expectations in May and retail
sales in June were quite solid as normal weather patterns prevailed.
Housing starts and permits both rose. Consumer sentiment readings
confirmed anecdotal evidence of stronger retail sales.
- The index of leading indicators gained modestly, as did industrial
production. GDP for the second quarter showed a revised gain
of 2.4%, up from the 1.4% gain initially estimated. During the
period, business spending rose 6.9%.
- Current employment indicators remain weak. While unemployment
fell to 6.2%, many job seekers stopped looking for work. Layoffs
from state and local governments still remain ahead. Nevertheless,
temporary employment has started to rise, with the May-June increase
in employment rolls at a seven-year high. Rising temporary employment
is often a harbinger of a turn in the job market. Weekly unemployment
claims have also declined to the lowest four-week average since
March. Cost control is still the byword in this recovery, but
rising business spending for both machinery and labor is in the
offing.
III. FIXED INCOME OUTLOOK … INFLATION REMAINS SUBDUED…COMMODITY PRICES SURGE…MORTGAGE RATES AT YEAR'S HIGH
- Wholesale prices rose 0.5% in June but the core rate, which
excludes food and fuel, slipped 0.1%. The gain was paced by a
jump of 7.6% in gasoline and 9.0% in heating oil. At the consumer
level, prices rose 0.2% and the core rate was unchanged.
- As interest rates moved up for most of the past 60 days,
mortgage rates exceeded 6% for the first time since December
2002. Mortgage rates had reached an historic low of 5.21% on
June 12th. Since then, mortgage refinancing activity has dropped
sharply.
- Industrial commodity prices in the Journal of Commerce Index
have soared since mid-May. It appears that the manufacturing
pick-up is outside the United States, probably in China and elsewhere
in non-Japan Asia. The Employment Cost Index is moderating after
a sharp rise in the ECI earlier this year as both wages and health
care expenses rose.
IV. STOCK MARKET OUTLOOK … FINANCIAL SERVICES…EXPORTERS…BRAND NAMES… ENERGY
- Efforts to increase profits are stimulating cost reduction
efforts. This is not a reflection of falling business activity.
Indeed, there is early evidence that business investment spending
is emerging from the doldrums. Production will likely respond
to stronger consumer demand now that the substantial tax cuts
have taken effect and household cash flows have been aided by
refinancing activity. We continue to favor financial services,
including banks, insurers, asset managers and diversified services.
- As the recovery in the world economy gathers steam, domestic
exporters offer select appeal. A weaker U.S. dollar will also
benefit the competitiveness and profitability of U.S. exporters.
Among these are several technology companies as well as producers
of industrial commodities, heavy industrial equipment, machinery,
and transportation products.
- Consumer staples sold in world markets enjoy recognizable
brand names in the context of much more favorable overseas demographics
and younger populations. The health care group also benefits
from domestic demographics of an aging population.
- Energy stocks offer appeal despite price vagaries in oil
and natural gas. Demand will recover with world growth rates
and prices will adjust much more rapidly than supplies.
- In the periods immediately ahead, earnings may need to catch
up with rising stock prices. The bond market's message is that
earnings will do just that.
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