News & Insights
The Economy Hits an Oil Slick and Powers Through
Economic growth for the second quarter of this year has just been revised upward to 3.3%, up from the 2.8% originally stated. At the stated rate of economic growth the economy should be able to generate enough jobs to keep the employment rate stable to improving. The revised 3.3% rate, while relatively strong, is lower than the consensus number going into 2004. The chief reason in our view for the trotting but not galloping economic growth can be found in the high price of oil. The persistently high price of oil acts as a tax, which retards economic growth. The price increase has in fact done some of the work of the Fed, which has begun to ratchet up rates to cool incipient inflation. Ironically, inflation in the price of oil tends to dampen the rest of the economy, helping to keep a lid on prices in other sectors.
The underlying economy is strong. Corporate profits continue to rise, albeit at a slower rate of growth, the return on capital investment is strong and personal disposable income continues to rise. These trends should support the current rate of consumer spending and quicken the purchases of capital goods by business. Continued low interest rates should also support the housing sector although some cooling off in this area would be expected after such a torrid three-year rise in prices. If, as expected, the equilibrium price of oil drifts down closer to the $35 to $40 level then the economy should grow at a healthy 3.5% to 4% next year.
Stocks, Bonds and Cash
While the economic situation seems benign, the condition of the markets is less certain. We believe that stocks in general will rally upon any reading of a sustained lowering of oil prices, though after an initial bounce upside in the general level of stock prices will be limited. Within the universe of U.S. stocks, high quality dividend-paying issues should continue to outperform pure growth stories.
Bond yields are low and the combination of heavy purchases of U.S. bonds by foreigners should keep them low for a time. We believe that the yield on 10 year treasury bonds will trend upward over the next year from its current 4.2% to around 5% to 5.5%, putting pressure on bond prices. At the risk of sounding like a broken record, duration of bond portfolios should be shorter than the market.
Foreign Shares, Real Estate and Alternatives
The developed and emerging foreign markets still look attractive relative to the U.S. market. Real estate as represented in the REIT indexes has rebounded since its sell off in the spring but still offers some value and merit consideration in a diversified portfolio. The strong growth in the Chinese economy seems destined to continue with only minor periodic setbacks, putting pressure on the price of basic materials and certain commodities. An emphasis on commodities, either through materials stocks or through managed commodity funds, should be a good diversifier in a long-term portfolio.
The Altavista Investment Team - Fall 2004