User Rating: / 0
PoorBest 

Thursday, 15 February 2007 00:00 Written by James Van de Voorde

The stock market started off the new year with a continuation of the momentum built during the final months of 2006.  Perhaps a harbinger for the remainder of 2007, the Dow Jones Industrial Average, S&P 500 Composite and NASDAQ Composite rose 1.27%, 1.41% and 2.01% respectively in January.  According to the so-called “January Barometer”, a rise in the S&P 500 in the first month of the year has been followed by a full-year advance in 85% of years since 1970 with an average annual increase of 11.7%.
   The data continues to support the case for a moderating “Goldilocks” economy that is performing “just right”, strong enough to support earnings growth and wage increases yet soft enough to keep inflation pressures at bay.  After rising 2% in the third quarter and 2.6% in the second quarter of 2006, the U.S. economy grew at a surprisingly strong 3.5% rate during the fourth quarter.  Full-year GDP growth for 2006 came in at 3.4%, surpassing the 3.2% growth of 2005 and the 20-year average pace of 3.1%. 
   It was the consumer that again came to the rescue during the fourth quarter.  Lower energy prices and stable interest rates helped fuel an annualized 4.4% rate of consumer spending.  Consumer spending contributed 3.1% to fourth quarter growth and was strong enough to offset the negative impact from construction spending which declined at an annualized rate of 19.2% and reduced GDP growth by 1.2%. 
   The strong GDP report all but eliminated the diminishing odds for any imminent reduction in interest rates as the Fed Futures now signal only a very slight chance for a rate cut by mid-year.  It would seem, however, that the Federal Reserve might have some flexibility should the housing market deteriorate, since prices for personal consumption rose at an annualized rate of 2.1%.  The Personal Consumption Expenditure (PCE) Index or so-called PCE deflator is the Fed’s preferred gauge for inflation and came in just above the Fed’s 1% to 2% comfort zone.  With moderate GDP growth as inflation remains subdued, the table seems well set for stable monetary policy in 2007.
   The Federal Reserve Open Market Committee (FOMC) met at the end of January and left the target for short-term interest rates unchanged for the fifth consecutive meeting.  While interest rate policy remained steady, the Fed’s post meeting statement did change slightly with a more upbeat assessment of both economic growth and inflation.  The statement pointed to “somewhat firmer economic growth” and “readings on core inflation that have improved modestly in recent months”.  Gone from the statement are references to high energy prices, yet the Fed’s inflation vigilance remains in tact as “the high level of resource utilization has the potential to sustain inflation pressures”.  Also of interest, the Fed reported “some tentative signs of stabilization in the housing market”, decidedly more upbeat than the “substantial cooling” in the housing market witnessed by the Fed in December.     
   Too soon to call a bottom in the housing market, we believe the Fed reference to “stabilization” may be part “bully pulpit” moral suasion and part plain old wishful thinking.  Just as the Fed attempts to control inflation expectations by jawboning the virtues of Fed vigilance, the Fed may be attempting to persuade would-be homebuyers that the coast is (almost) clear.  Perhaps Fed-induced expectations for a bottom in housing would actually help stabilize the sector, allowing the Fed to stay the course and avoid what they seemingly dread most, a hand that forces them to cut rates.
   The National Association of Realtors recently reported that pending sales of existing or “used” homes increased at an annualized rate of 4.9% in December, the largest increase since March 2004.  However, sales of existing homes in the U.S. dropped 8.4% in 2006, the sharpest decline in 17 years, with inventories up 23.3% for the whole year.  So, December’s monthly increase comes only on the heels of a brutal year for housing and may have been influenced by unseasonably warm weather.  More time is needed to see if December’s read is the start of any new trend.
   Meanwhile, the homeowner vacancy rate, which measures the number of empty homes for sale, rose to an all-time high of 2.7%, compared to 2% at the end of 2005.  The growing number of vacant homes for sale implies an overhang of supply that might require a sharp reduction in price to purge inventories.  Further, the large number of empty, unsold properties does not bode well for new construction activity, which will likely remain a drag on GDP for at least the next quarter or two.
   The housing market’s woes were recently confirmed by the ISM manufacturing index report, which came in at 49.3 in January, down from 51.4 in December and below the consensus of 52.  However, the ISM services index report at 59 came in much better than January’s 56.7 and the consensus expectation of 57.  The ISM data continues to point to a contraction in manufacturing and expansion in services.  Given the recent 3.5% growth in GDP, it is clear that services and the resilient consumer are holding up the U.S. economy.  
   Despite these mixed messages, the economy seems to be stabilizing at a more sustainable pace.  While moderation in earnings growth is expected, the current price earnings ratio for the market at 16.5 is sufficiently attractive to boost the stock market in a stable inflation, steady interest rate environment.

< Prev		Next >