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3rd Quarter Economic Review
Certainly the third quarter faced a number of worrisome economic and geopolitical events. The Israel-Hezbollah face-off, spiking oil prices with gasoline well over $3.00 a gallon, a meaningful decline in housing, and early debate on the intentions of the Federal Reserve Board, were a few of the concerns that dominated headlines. Yet, through it all, equity prices recovered nicely after an early-July decline. The armed conflict between Hezbollah and Israel was quickly put to rest. With both sides acquiescing to world opinion and pressure, it brought a quick sense of relief. However, fears from that conflict, the potential for damaging tropical storms, and the status of Iranian and Nigerian oil production all boiled together to drive oil to $78 a barrel and gasoline prices to well above $3 a gallon. With at least a temporary cooling of hostilities and the quiet passing of tropical storm Ernesto, both oil and gasoline prices retreated. In one month, after an early-August high, oil retreated from nearly $78 to $61 a barrel and regular gasoline could be purchased at prices approaching $2.00 at some locations, down from $3.08, a decline of 35%. This pattern closely resembles the spike and subsequent decline following last summer’s Katrina/Rita double whammy. Housing recession The housing industry, however, continued to deteriorate from last year’s peak. While the many measures of housing activity took over a year to all post negative readings, a very clear housing recession is now underway. The first pinhole in the bubble was the decline in condominium sales in early 2005. The most recent and final data point has been the year-over-year decline in housing prices. Will the decline in housing have damaging repercussions on consumer spending and credit? While conceivable, we view it as unlikely. To date, the decline has been orderly and slow to develop. Price declines have been more noticeable in areas which had the most spectacular increases and in which speculative fervor resulted in overbuilding. To be sure, the housing decline will mean slower economic growth, but the overall effect is more in the nature of reducing growth from 31⁄2% to 21⁄2%, rather than sparking a general recession. The dissipation of the spike in gasoline prices should have a very positive effect on consumer attitudes. With the peak driving season past, lower gasoline prices could persist through December. This would at least cushion the negative implications in the housing picture. The decline in oil prices generally is also a positive for manufacturing and transportation costs. Consumer attitudes Employment is growing at a monthly average of 120,000, below the 170,000 monthly averages of the past two years, but still at a pace sufficient for continuing growth in personal incomes. Weekly readings of initial unemployment claims have been low and stable, giving no hint of any decline in employment. Wage gains continue to reflect a shift to higher- paying jobs, although declines in construction employment may moderate that shift. Interest rate stability On August 8, The Federal Reserve Open Market Committee voted to forego its regular pattern of periodic .25% interest rate increases, as it had for the past three years. This pause recognized that the current 51⁄4% rate may be sufficiently high to slow the economy to a sustainable level, thus allowing inflation to recede, but not disrupt overall economic activity. Time will tell whether this change is a pause or an end to the interest rate tightening. To date, the yield on U.S. Treasury bills suggest no immediate likelihood of higher rates. A positive environment Stable interest rates, improving profits, higher operating rates, and strong balance sheets, provide a positive environment for business investment spending. Continued employment growth points to continued growth in personal incomes — a positive environment for consumer spending. In effect, the back-ground is right for a soft landing. Equity prices are very reasonable and should allow for positive investment returns as we head toward 2007. • • • Joe Harrison’s keen ability to interpret economic trends and data enables him to position client investment portfolios for long-term growth. If your portfolio is not reaping the rewards of Joe’s stewardship, why not contact him today at (216) 830-1131 or jah@mimllc.com |
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