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On The Economy, Stocks & Protectionism

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
July 17, 2007

IN THIS ISSUE:

1.  US Economy Improved In The 2Q

2.  BCA’s Latest Thinking On The Economy

3.  The Bull Market In Stocks Continues, Sort Of

4.  Angelina Jolie Stock Index – What’s Next?

5.  Fed Holds Steady Again, Lowers Inflation Concern

6.  Protectionism May Be The Greatest Threat To The Economy

 

Introduction

This week, we take a fresh look at the latest economic reports to see if there has indeed been a modest rebound in the economy since the very disappointing 1Q growth.  Most analysts believe the economy did improve in the 2Q, at least in several key areas, and the employment situation remains very strong.  I will also share with you BCA’s latest forecast for the US and global economies.

Next, we examine the state of the US stock markets which have been on a bit of a roller-coaster for the last two months.  While disappointing economic news stalled the market’s powerful advance in June and earlier this month, the major indexes surged to new record highs late last week.  As I have suggested all year, the bull market does not appear to be over.  BCA agrees as you will read below. And get ready for a chuckle as I tell you about the new “Angelina Jolie Stock Index.”

Finally, I touch on an economic and market threat that is growing in popularity, especially among the Democrats.  The threat is protectionism, and most of the Democrats running for president are threatening to put up trade barriers and restrict free trade.  Should they be successful, that could choke off the economy and end the equity bull market.  

US Economy Improved In The 2Q

Most economists and market analysts believe the US economy rebounded somewhat in the 2Q following the very disappointing showing in the 1Q.  While the government’s first estimate of 2Q GDP will not be released until July 27, most pre-report estimates suggest the economy grew by around 3% (annual rate) in the 2Q as compared to only 0.7% in the 1Q.  I will be very surprised if the economy grew by 3% in the 2Q – 2% is probably more reasonable.

Economic reports over the last few weeks have been mixed, with some sectors rebounding nicely, while the housing sector continues to worsen as expected.  Let’s run through the recent reports, and then I will share with you The Bank Credit Analyst’s latest thinking on the economy and the equity markets.

As noted above, on June 28, the Commerce Department released its final report on 1Q GDP, revising the weak number up from 0.6% to 0.7% (annual rate), following the rise of 2.5% in the 4Q of last year.  The Index of Leading Economic Indicators rose 0.3% in May (latest data available).

The manufacturing sector continued to recover with the ISM Index rising to 56.0 in June, and it has risen for the last three consecutive months.  Hopefully, that portends an improvement in factory orders and durable goods orders which were both down in May.  ISM’s non-manufacturing (services) index was also higher in June at 60.7.

The housing slump continues as has been widely expected.  Sales of new and existing homes fell modestly in May (latest data available).  The median home price for existing homes fell to $223,700 as compared with $228,500 a year ago.  The inventory of unsold homes rose to 4.43 million in May, representing an 8.9-month supply.  Housing starts also fell in May, while building permits actually rose modestly.

So, the housing slump continues, but it has not been a disaster except in the sub-prime market.  Even with the blowup in the sub-prime space, there is still little evidence that the sub-prime problems have spilled over to the prime mortgage lenders.  

Consumer confidence, which had rebounded sharply in December and January, has been falling in recent months. The Consumer Confidence Index fell 4.6% in June and has been down in three of the last four months, influenced significantly by the sharp rise in gasoline prices. Conflicting somewhat, the University of Michigan’s Consumer Sentiment Index rebounded in late June and is higher again for the first half of July.  So maybe consumer confidence has bottomed.

Despite the earlier drop off in confidence, consumers continue to spend.  This is key because consumer spending accounts for apprx. 70% of GDP.  Consumer spending increased 0.5% in May, along with personal income which rose 0.4% in May.  The government reported that Personal Consumption Expenditures (PCE) rose at an annual rate of 4.2% in the 1Q, equaling the PCE rate in the 4Q of last year. 

The main reason that consumers continue to spend is the very strong labor market.  The unemployment rate remains very low at 4.5%, and jobs are plentiful.  People tend to spend more when they are confident about their jobs. 

The bottom line is, unless consumers sharply curtail spending, we are not likely to see a recession unfold.  Instead, what we are likely to see is a couple more quarters of below-trend growth (something less than 3%), followed by a gradual rebound next year.  A recession is not likely unless there are some major negative surprises later this year or next.

BCA’s Latest Thinking On The Economy

Martin Barnes and his fellow editors at BCA continue to believe that the US and most global economies remain in what they call a technology-driven “long-wave upturn” in which growth surprises on the upside and recessions are few and mild. This has been BCA’s main thesis since mid-1994.  Here is a sample of their latest analysis:  

“From a big picture perspective, the economic and financial environment remains in remarkably good shape, given the various events of recent years.  For example, the global economy is enjoying its strongest run of growth in three decades, yet inflation is low; the equity bull market is in its fifth year, yet valuations are reasonable in most regions; the housing bubble has burst, but there has been little impact on employment and consumer spending; large global trade imbalances have proved to be more sustainable than generally expected.

As we have discussed repeatedly in the past, the favorable environment owes a lot to the bullish supply-side effects of globalization, technological innovations and market reforms.  Importantly, these are structural not cyclical developments.”

In short, BCA believes that the ‘long-wave upturn’ has further to run, that the US economy will come out of this so-called soft patch next year, and that a recession in the next year is certainly not the most likely scenario.  If there is a recession in the next few years, BCA expects it to be fairly short and benign, as was the recession of 2001-2002, barring some major negative surprises.

BCA’s ‘long-wave upturn’ forecast has been the most accurate of any I have seen since 1994.  I’m not second-guessing them now. 

The Bull Market In Stocks Continues

In my June 12 E-Letter, I suggested that the US equity markets might be ripe for a downward correction following their red-hot performance over the last several months.  I also suggested that if such a downward correction were to occur, that might well present a buying opportunity for those who are still under-invested in equities.

As is often true in bull markets, downward corrections don’t tend to last for long.  The major market indexes saw weakness in June and earlier this month, as you can see in the chart below.  The S&P 500 peaked just above 1500 in early June and then retreated in what looked to be the beginning of a downward correction.  But on Thursday of last week, both the S&P 500 and the Dow Jones soared to new record highs. 

The Dow gained 284 points to a record 13,862, up 2.09% in that one day, its largest single-day gain in almost four years.   The S&P 500 Index rose to near 1550 last Thursday, thus eclipsing its all-time high set in early 2000.  Both the Dow and the S&P are above those record levels as this is written.

Investors who were hoping for a significant downward correction and a convenient opportunity to jump back in and get fully invested were disappointed when the major indexes surged to new record highs.  Bull markets are rarely accommodating to those who come to the party late.

[Editor’s Note: Of course, I cannot help but point out that if readers had some of the successful money managers I recommend on your team, you would not be anguishing over how and when to get fully-invested in this bull market.  Professionals would be making those decisions for you, and you would have more time to do what you’re good at.]

How about BCA’s thoughts on equities at this point?  Here is a brief overview.  As you probably gathered from the BCA quote above, the editors remain bullish on the US stock markets, as well as most foreign equity markets.  As for the US markets, BCA rests its continued bullish case on not only its continued positive outlook for the US economy, and continued relatively low interest rates and inflation, but also on the following points:

1. Valuations are reasonable with the S&P 500 trading at 15 times 12-month forward earnings.
2.  Earnings growth has peaked but it continues to outperform expectations.            
3. The benign inflation outlook means that interest rates will not rise to punitive levels.
4. The re-leveraging of corporate balance sheets favors equity holders over bond holders.

So, BCA remains bullish on US equities for a variety of reasons.  But like me, BCA agrees that the easy money in stocks has already been made, and that risk and volatility will continue to increase in the months ahead… Another argument for professional management.  

Angelina Jolie Stock Index – What’s Next?

Humor me for a moment or two here.  Those of us in the money business are continually amazed at the plethora of new investment ideas and schemes, new indexes and new funds which are trotted out week after week by the large mutual fund families, major Wall Street brokerage firms and others.  What will they think of next?  Well, here’s a new one on me.

Most of you recognize Angelina Jolie - noted film star, current live-in companion of Brad Pitt, and daughter of actor Jon Voight.  According to a recent ‘People Magazine’ article, Angelina is currently ranked as the most beautiful woman in the world, and her face is recognizable to 81% of Americans. 

Well, leave it to Wall Street to find a way to create yet another “index” – this time, one to supposedly track the fortunes of Angelina.  A fellow by the name of Fred Fuld at Stockerblog.com has developed an Angelina Jolie stock index that is tracked at stockpickr.com.  In a stroke of brilliance (laugh), Fuld decided to create a stock index made up of the movie production companies for which Angelina has made films.

The film companies in the index include Sony, Viacom, Time Warner, News Corp., GE, Disney, Dreamworks, MGM, Comcast and Lionsgate.  According to Fuld’s thinking, if you are bullish on Angelina’s career, you would buy this index which consists entirely of film production companies.  Now that is a real stretch of judgment!!

Never mind whether or not these are strong, profitable and/or growing companies.  Also, never mind that there is no guarantee Angelina will ever make another movie for them, or that what movies she does make in the future may, or may not, be blockbusters or even profitable.

So, how has the Angelina Jolie stock index done recently?  Over the three months ended June, the Dow Jones rose 9.5%, while the so-called “Angie Index” gained only 3% according to stockpickr.com.  Obviously, I do not recommend you buy this silly index!

Thank you for indulging me in this momentary loss of focus.  But really, what will they think of next?  Shall we move on to more intelligent discussion?  Yes, we will.


Fed Holds Steady Again, Lowers Inflation Concern

At the latest Fed policy meeting on June 27/28, the FOMC left the Fed Funds rate unchanged at 5.25% as was widely expected.  The rate has been flat at 5.25% for over a year now.  It will not surprise me if the rate remains at 5.25% for the rest of the year. 

The Fed’s policy statement in late June had some encouragement on the inflation front.  Here is an excerpt from the statement:

Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector. The economy seems likely to continue to expand at a moderate pace over coming quarters. Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. [Emphasis added.]

The latest inflation data we have is for May when the Consumer Price Index rose 0.6% and was up 2.7% for the last 12 months.  The “core” CPI (minus food and energy) was up only 0.2% in May and was up 2.2% year-over-year.  2.2% is getting close to the Fed’s supposed target of 2% or less for core inflation.

Protectionism May Be The Greatest Threat To The Economy

Most economists and market forecasters, including BCA, include a caveat to their predictions such as: “barring any major negative surprises.”  You’ve seen me include that same caveat many times as well.  When we read such caveats, we usually think of wars, natural disasters, financial crises, etc.

But in my view, perhaps the most likely ‘major negative surprise’ looming out there is the real threat of protectionism.  As noted in the Introduction, most of the Democrats running for president, and many others in Congress, are increasingly talking about trade barriers and other restrictions on free trade.  This scares me!  Let’s talk about it.

Put simply, protectionism is bad, and free trade is good, in my opinion.  It really is just that simple.  Let’s take a look at what constitutes protectionism and exactly why it is bad for the economy, as well as a look at free trade and why it is good for the economy.

Protectionism is the impeding of trade between nations. This impediment can take several forms such as tariffs on imported goods, quotas restricting the amounts of particular goods that can be imported, or even a ban on imports of certain goods from certain countries. Governments can also discourage imports with restrictive legislation targeted at specific goods. The motivations behind protectionist policies are generally to protect domestic markets and industry (ie – jobs).  In the end, however, this is almost never the result.

Famed economist Murray N. Rothbard once refered to protectionism as “the destruction of prosperity.”  What Rothbard had to say on the subject of protectionism was very much on-target, including the following quote:

“All trade is mutually beneficial to both parties - [foreign] producers and American consumers - otherwise they would not engage in the exchange. In trying to stop this trade, protectionists are trying to stop American consumers from enjoying high living standards by buying cheap and high-quality [foreign] products. Instead, we are to be forced by government to return to the inefficient, higher-priced products we have already rejected. In short, inefficient producers are trying to deprive all of us of products we desire so that we will have to turn to inefficient firms. American consumers are to be plundered.”

In short, protectionist policies are bad for consumers everywhere.

Free trade, on the other hand, allows for the flow of goods and services between countries without restrictions or government interference. Truly free trade does not exist, even in well-known international agreements such as the North American Free Trade Agreement (NAFTA). While there are many who are critical of trade agreements such as NAFTA, and rightly so in some cases, it is critical that we make trade as unhindered and as ‘free’ as realistically possible.

The consumer benefits from free trade directly in the form of lower priced quality goods, and greater availability, which in turn creates an increase in competition in the global capital markets.  Free trade, or even nearly-free trade, is a boon to consumers and therefore economies.

International trade is a vital issue and should be a major issue in the upcoming general election. Why?  Because the mood in Washington (not just among Democrats) and in several key primary states is leaning very much toward some form of protectionism.  There are frequent calls for protectionist measures against China and other Asian players.

It is worth noting in this discussion that the Chinese economy is poised to move into the #3 largest position in the world, behind the US and Japan.  The IMF estimates that China’s GDP will eclipse that of current #3 economy, Germany, this year.  China’s GDP in 2006 was apprx. $2.8 trillion, just behind Germany at $2.9 trillion for the same period.  China’s output of goods and services is estimated to have increased by 11% in the first half of this year, versus Germany’s 3% growth.

It would seem ludicrous to consider protectionist trade barriers against the third largest economy in the world, but China continues to be the number one target of those advocating tariffs on goods imported by the US.

Given this mood in many parts of the country, it should come as no surprise that the leading Democrat candidate for president, Hillary Clinton, is sounding very much like a protectionist these days.  In 2005, Hillary voted against the Central American Free Trade Agreement (CAFTA).  Last month, she announced that she opposes the pending Korean Free Trade Agreement, and has recently advocated trade sanctions against China unless they stop suppressing the value of the yuan.

This is very interesting.  Remember that Bill Clinton was one of the most active free-trade presidents this country has ever had, and NAFTA would never have seen the light of day without his tireless advocacy.  Yet he is campaigning across Iowa for his wife who is sounding like a 19th century mercantilist advocating protectionism.  One wonders how Bill and Hillary will bridge this important divide.

Here is one possible way they might do it (assuming, of course, that Bill really wants Hillary to win).  Bill may allow Hillary to continue her protectionist rhetoric during the primary races, particularly in those states where protectionist concerns are a big issue.  But if Hillary wins the nomination and the race moves onto the national stage, I cannot believe Bill’s legendary ego will allow Hillary to criticize free trade agreements, including NAFTA, which he considers to be one of his greatest accomplishments.  If so, it will be very interesting to see if Hillary migrates more toward the center on the issues of trade and protectionism should she win the nomination.

[Election Note: I find it quite interesting that Hillary has had to resort to getting Bill on the campaign trail with her so early – much, much earlier than had been anticipated.  Hillary’s ‘negatives’ in the polls are still dangerously high, and there are millions of Americans who would not vote for Hillary no matter what she says or does.  So, she has resorted to getting Bill on the trail with her since he is still a very popular past president.]

Conclusions

The latest economic reports suggest that the US economy improved somewhat in the 2Q.  The very strong US labor market and the global economic boom should assure that we are not headed into a recession anytime soon.  However, with the continued slump in the housing market, the US economy is likely to grow at a relatively slow pace for the rest of the year, with a rebound likely in 2008.

This is consistent with BCA’s latest thinking.  BCA maintains that the US economy is still in a technology-led “long-wave upturn” that likely has several more years to run.  Likewise, BCA continues to be bullish on the US equity markets as discussed above.  The latest surge to new record highs in the major market indexes is evidence that the bull market has further to run.

So what could derail this fairly optimistic outlook?  A recession is not likely just ahead.  There is no evidence that the Fed is going to hike interest rates significantly in the next year, what with inflation edging lower.  The sub-prime mortgage debacle does not appear to be threatening the major prime lenders around the country.  The occasional hedge fund blow-up has not stopped stocks from moving to new highs.

But there is one issue that increasingly concerns me – protectionism.  Most of the Democrat candidates running for president, including Hillary, are advocating protectionist policies against China and other foreign trading partners in Asia.  Protectionist policies could be the greatest threat to BCA’s long-wave upturn forecast.  Such policies would almost certainly be bad news for the equity markets, so investors should monitor developments closely.

Finally, if you are still on the sidelines of the equity bull market, or if you are still under-invested in the markets, I invite you to check out the professional money managers I recommend.  Go to www.halbertwealth.com or give us a call at 800-348-3601.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES:

New [Anti-Trade] Populism Spurs Democrats
http://www.nytimes.com/2007/07/16/us/politics/16populist.html?_r=3&hp&oref=slogin&oref=slogin&oref=slogin

After Iraq by Thomas Sowell
http://www.realclearpolitics.com/articles/2007/07/after_iraq.html

Is al Qaeda on the run in Iraq?
http://www.realclearpolitics.com/articles/2007/07/first_anbar_now_baquba_is_al_q.html

Dems find one government agency to cut back.
http://www.opinionjournal.com/diary/?id=110010343

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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