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1st Quarter Economic Review
A volatile stock market worked its way higher during the quarter. A strong start in the early weeks of the year was followed by a retreat in February and a recovery in March. To no one’s surprise, the Federal Reserve Board continued its program of steady interest rate increases at its January and March meetings. Fed watchers examined every written and spoken word of the new chairman, Ben Bernanke, to discern any signs of change from the “Greenspan Era.” None were noted. The yield curve inverted as long bond demand continued to put pressure on long yields. In March, the curve flattened with long rates moving modestly higher, as the focus on potential inflation increased. Economic expansion on track Economic expansion, the underlying foundation for the stock market, remained on track. We expected real GDP growth in the first quarter to approach 4%, although some expect 5%. The normal transition from a consumer-led to a business-led economy is underway. The business investment momentum that began in the second half of 2005 continued into 2006. February Y-T-D orders for non-defense capital goods, excluding the highly volatile com-mercial aircraft orders, were up 8.0% year-over-year. In January, non-residential construction was up 5.6% and manufacturing construction was up 11.3%. Plant capacity utilization increased to 81.2% in February 2006 and should continue to increase throughout 2006, driving increased business spending. No “bubble” The long-awaited housing slowdown is underway in an orderly fashion, rather than a “bubble burst.” Housing starts in 2006 will likely decline to 1.85 million, down from 2.07 million in 2005. We expect another orderly decline in 2007. Concerns about energy costs moderated considerably, aided by a record-warm January; changing consumption habits; and increased supplies and inventory. Natural gas prices plummeted more than 50% from the high of $15.38/mcf on Dec. 13, 2005. Oil prices remain volatile but are down about 10% from Katrina-related highs last fall. We expect the core CPI will be up about 2% this year, about the same as 2005. Productivity still growing One of the factors least discussed is the sustained growth in productivity. Trend growth has been 3% and non-financial corporate productivity growth is at a 30-year high of 5.2%. This is a critical factor underpinning our projection of continued solid corporate profit and investment growth; increases in consumer income and spending; and low inflation. Personal wealth growing The savings rate has been negative for eight of the last ten months and was a negative 0.4% for all of 2005, causing much consternation among some observers. In simplest terms, the savings rate is the difference between income and spending. It is NOT a measure of wealth creation. For example, over the 12-twelve month period ending in January of this year:
Personal wealth in the aggregate is at record levels and is growing at record rates. Bullish outlook With a solid economy as the foundation, we remain positive about the stock market. We expect, however, that the market will remain volatile as it is buffeted by geo-political developments, political polarization in Washington, and unwarranted economic pessimism. We will continue to take advantage of that volatility in our disciplined search for high-quality value investments. • • • If you’re not currently a Midwest Investment Management client, you could miss out on the market growth Norm Klopp foresees for 2006. To discuss the numerous advantages an account relationship can offer you, contact Norm at (216) 830-1135 or nfk@mimllc.com |
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