FEBRUARY 10, 2004
I. JANUARY 2004 COMMENTS … STOCKS MOVE AHEAD…BONDS HOLD
VALUE
- Despite some late January profit-taking, stock prices continued to move
ahead as we began the new year. Slower GDP growth in 2003's final quarter,
cautious Federal Reserve statements, and a lethargic job recovery, have all
restrained optimism following last year's substantial market
recovery.
- Bond prices rallied after last summer's weakness and have remained at
generally high levels. Inflation reports remain tame at this early stage of
the economic recovery.
- As we near the end of a traditional period of strength in the stock
markets, it is logical to expect some consolidation of recent gains. It is
also logical to expect rotation in leadership away from speculative issues
toward quality situations. Some of this has already been seen in the
December-January period.
- With labor and capital resources not yet being fully utilized, the
Federal Reserve is unlikely to raise interest rates in the near future.
Nevertheless, it would be reasonable to expect some consolidation of recent
stock market gains as leadership shifts to quality stocks and the pace of
the economic recovery downshifts to sustainable levels. Stock market
averages may grow more slowly in 2004.
II. ECONOMIC OUTLOOK …NEWS REMAINS FAVORABLE…PAYROLLS RECOVERING SLOWLY…GDP RISE MODERATE…RETAIL SALES STRONG
- Non-farm payrolls grew 112,000 in January, below economists' estimates
of 175,000 or more. Unemployment dropped to 5.6%. The average work week rose
nicely. The separate household survey of employment showed a very large gain
of 496,000. The household survey captures small business and self-employed
data better than the payroll survey.
- Retail sales rose sharply in January in spite of bad weather restraining
auto sales.
- Commercial and industrial loan activity in the banking system has turned
higher, suggesting inventory accumulation in its early stages.
- Consumer confidence has risen steadily over the past six months,
reflecting consumers expectation for better employment prospects, rising net
worth (homes and portfolios), lower taxes and/or reduced interest expense
from mortgage refinancings.
- Rising consumer confidence is echoed by rising business confidence.
Profit margins are at historic peaks and capital budgets show signs of
expansion. Corporate profits as a proportion of GDP are at 40-year highs.
III. FIXED INCOME OUTLOOK …INFLATION LOW AND DROPPING…GOVERNMENT RECEIPTS SET TO RISE…TRADE DEFICIT TO NARROW
- On a nationwide net basis, state and local operating budgets have
returned to surplus conditions. The federal deficit is large but perhaps not
as large as expected last Autumn.
- Inflation remains low. Consumer prices are well behaved, with the CPI
rising 2.3% in 2003. Excluding food and energy, consumer prices rose 0.1%,
and producer prices fell 0.1% in December. Prices for most industrial
commodities are rising rapidly but producers of finished goods still find it
difficult to raise prices, due partly to import competition from
China.
- Based on the decline in the dollar over the past year, the trade deficit is beginning to narrow. Manufacturing inventories are at extremely low levels. Average hourly earnings are growing at an annual rate of 2% while benefits are expanding three times faster. Export industries are strong, industrial production is rising, and employers will produce as much as possible using part-time workers to save on benefit costs. Profit margins should stay high, and the Federal Reserve may focus on employment data when contemplating changes in interest rates.
IV. STOCK MARKET OUTLOOK …TRANSITION TO NEW LEADERSHIP…SECTOR OUTLOOK
- The December-January period saw strength on the part of quality stocks
with strong earnings prospects and favorable dividend trends. Continued
dollar weakness provided support for exporters and other global
corporations. Expect the dollar to continue to move lower in the months
ahead.
- Energy stocks will benefit from worldwide recovery in demand and
earnings estimates seem apt to rise. Among materials producers, China
remains a major buyer of resources. Industrial companies are beginning to
add to capacity as operating rates rebound. A global economic recovery is
drawing down inventories. Transportation stocks look appealing as shipping
rates are rising and physical volumes increasing.
- Consumer discretionary spending is apt to rise as employment improves
and housing remains strong. Healthcare and consumer staples offer long-term
appeal as investors become more concerned over prospective interest rate
increases, and look to be more defensive in their portfolio
selections.
- Information technology has led the market for much of the past year and
appears ready to consolidate the large price gains of 2003. Financial stocks
can vary greatly in their appeal as mortgage activity weakens. Stocks that
are leveraged to corporate loan demand, employment data or stock market
activity are more appealing.
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