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Good News for the Economy and the Stock Market

Prof. Peter Morici - 4/19/2007

Monday, the Commerce Department reported March retail sales were up 0.7 percent from February. Less automobiles and parts, retail sales advanced 0.8 percent. Compared to a year ago, March retail sales were up 3.8 percent, and excluding automobiles and parts, retail sales increased 3.9 percent.

This substantial advance in retail sales is welcome news for the economy and stock market. Cold February weather, snow and ice discouraged shoppers, and consumers exhibited new vigor in March.

Along with moderate March jobs growth, this advance in retail sales indicates the economy has regained its footing, and moderate GDP growth will continue through the first and second quarters.

At this juncture the likelihood of a recession in 2007 is only one in four, and the Federal Reserve is not likely to change interest rate policy soon.

All this sets the stage for robust gains in stock prices.

Gasoline, Auto, Housing and Stock Prices

In March, the average retail price of gasoline was up 29 cents, or about 12 percent. Gasoline prices fell 7 cents in January and rose 3 cents in February. The recent surge in gas prices did not dramatically affect other retail sales. Non-gasoline purchases were up 0.4 percent in March, and retail sales less gasoline and autos were also up 0.4 percent.

Gasoline prices are continuing to rise in April but consumers will likely absorb these as they did in March. Although the housing market has softened since last summer, home prices are still up about 55 percent over the last five years. As importantly, the pace of existing home sales remains robust indicating homeowners enjoy considerable liquidity. This dramatically sets apart the current situation from the housing crisis of the early 1990s.

While homeowners may not expect much appreciation over the next year or so and values will fall in some cities and communities, homeowners still have a lot of untapped equity to finance additional spending. The reservoir of wealth created by the housing boom has not evaporated, and much of it is yet to be spent.

Losses in the sub prime lending will most affect firms that specialized in brokering these loans, but most sub prime borrowers can be transitioned into conventional mortgages. The broader impact of defaults will be modest and widely dispersed across capital markets. Needed changes in lending standards will not prove too discomforting.

The resiliency of the mortgage financing sector has dramatically improved since the Savings and Loan Crisis. Adequate access to mortgage financing will remain available to sustain the resale market and finance a recovery in new home construction later this year.

Overall, housing values are providing consumers with ballast as the economy and jobs grow more slowly.

Stock prices are still up about 15 percent since August, and this has compensated for falling home equities on household balance sheets.

The realization that housing prices are moderating but not collapsing, enduring real estate liquidity and a buoyant stock market, should keep consumers spending through 2007, albeit growing at a more moderate pace than in recent years.

In 2007, retail sales should advance at about a 5 percent pace, and support GDP growth in the range of about 2.4 percent. The Federal Reserve should not raise interest rates, and the outlook for stock prices remains strong, as profits continue to grow, especially among firms with significant overseas operations.

Supported by decent retail sales and overseas profits, stock prices should advance about 10 percent in 2007.

Strong Sectors

In January, retail sales were particularly strong for furniture, building materials and garden supplies. Homeowners tend to spruce things up when they decide not to sell and stay in their homes a few more years.

Other strong sectors included clothing and accessories, and sporting goods, hobby, and book and music stores.