JUNE 9, 2004
I. MAY 2004 COMMENTS...BONDS RETREAT...STOCKS MIXED...MIXED MAJOR TRENDS
- Stock prices gave ground early in the month, then recouped in the closing weeks of May. Corporate developments were uniformly positive, with earnings strong, profit margins at historic highs and many sectors enjoying pricing power for the first time in years. Employment data is increasingly positive. Job creation is recovering with virtually all areas of the global economy expanding.
- Offsetting the positive corporate developments are concerns over rising inflation and interest rates. The Federal Reserve has warned that it is ready to gradually raise rates. In addition, higher oil prices are apparent with every trip to the gas station.
- Chinese authorities are slowing the rate of growth in their economy. These efforts are affecting everything from steel scrap prices to shipping rates to production schedules of their suppliers. Geopolitical concerns continue. Iraqi sovereignty is scheduled for month-end. The US Presidential election outcome remains uncertain.
- Strong corporate earnings offset geopolitical concerns leaving equities little changed in May. Bond prices seem likely to continue to decline as investors expect the Fed to increase interest rates in the months ahead, perhaps beginning as soon as the end of June.
II. ECONOMIC OUTLOOK ...CAPITAL SPENDING STRONG...RISING PRICES IN MANY SECTORS...PROFIT MARGINS AT RECORD HIGHS
- Meanwhile, evidence of renewed pricing power is apparent across a wide range of industries. Part of this reflects extremely low inventories at all stages of production. Vendor delivery times have lengthened greatly, encouraging producers to raise prices. Spot shortages will continue in select industries.
- Efforts to increase capacity are in full swing, and these efforts include decisions to hire additional staff. The strong May employment report confirmed expectations.
- Corporate earnings may be up as much as 30% in the second quarter. By July, the Federal Reserve will have met to consider interest rates, Iraqi sovereignty issues will be addressed, and we may have a clearer picture of the election prospects.
III. FIXED INCOME OUTLOOK ...MOST INFLATION MEASURES RISING...BUDGET DEFICIT DROPS...MORTGAGE APPLICATIONS FALL
- In April, the Consumer Price Index rose 0.2%. The core rate was up 0.3%. Wholesale prices rose as well, with intermediate and crude goods price increases earlier in the year now felt in the finished goods stage. Finished goods rose 0.7% in April. Intermediate and crude goods rose at the fastest rate in six months, as did energy.
- Corporate tax receipts have surged, in line with corporate profits, bringing some much needed good news to budget deficit calculations.
- Money supply growth has been strong in 2004 and home prices have risen about as rapidly as money supply. Nevertheless, mortgage applications have begun to decline as rates moved up off their lows. In auto sales, extremely large rebate deals are required to promote sales of large SUVs in light of rising gasoline prices.
IV. STOCK MARKET OUTLOOK ...VALUATIONS REASONABLE...GLOBAL GROWTH CONTINUES...RATES WILL RISE, NOT ROCKET...SELECTION IS KEY
- Over the next several months, many uncertainties facing the markets will move toward resolution. Typically, such developments result in higher stock prices. One such uncertainty is the U.S. Presidential election. In past Presidential election years, stock price gains in the second half of the year have tended to be considerably stronger than in the first half as uncertainty is reduced.
- Similarly, the Federal Reserve’s first rate increase may well signal a relief rally in stocks. Plans for Iraqi sovereignty, and for US troop deployment, may also become clear. OPEC efforts to increase oil output may bear fruit. Lastly, China may successfully slow its growth and avoid a feared recession.
- In looking at sectors, the outlook is perhaps most mixed for consumer discretionary stocks and for financial service providers. Rising rates typically spell trouble for automobile makers, homebuilders, mortgage originators, and some banks. Signs of trouble are present in these groups. In contrast, such areas as advertising, entertainment, and publishing are appealing, as are mutual fund management companies, global banking franchises, and specialty insurers.
- Rising global GDP growth still favors surface transportation, industrial manufacturing, materials and energy producers. Product prices are heading higher in these sectors for the first time in many years.
- Technology stocks would perform better if the U.S. dollar resumes a gradual downtrend. Opportunities are developing among select software issues.
- Valuations are very appealing among health care stocks but the political backdrop remains a concern for pharmaceuticals.
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