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Outlook for the Stock Market Looks Great

Prof. Peter Morici - 4/29/2007

Friday, the Commerce Department reported that GDP grew at a 1.3 percent annual rate in the first quarter of 2007, down from 2.5 percent in the fourth quarter of 2006. This was below the consensus forecast of 1.8 percent and only based on preliminary data. There is a decent chance the first quarter figure will be revised upward.

The housing sector and the trade deficit were the main culprits. The falloff in residential construction subtracted 0.97 percent from growth. New home construction should bottom out in the second quarter, and then contribute to stronger GDP growth in the second half of the year.

Commercial construction was virtually flat, adding 0.07 percent to growth. However, the outlook for new business investment is improving, and commercial construction should be more vibrant the balance of the year.

Business investment in equipment and software added 0.14 percent to GDP growth. More importantly, new orders for capital goods surged in February and March, and investments in equipment and software should help rev up growth in the second quarter.

The trade deficit subtracted 0.52 from growth. This loss was held down by a dramatic drop in crude oil and refined petroleum product imports in February that cannot be sustained. The trade deficit will subtract from GDP growth for the balance of 2007.

Consumers continued to hold up the economy. With housing sales slowing, consumers have more money to devote to improving the homes they own and purchasing automobiles, furniture, clothing, and meals in restaurants.

Consumer spending grew 3.8 percent, and contributed 2.66 percent to first quarter GDP growth. Sales of new autos added 0.36 percent to growth, and new furniture and household equipment added 0.22 percent to growth. Consumers also continued to spend liberally for services, which added 1.51 percent to growth.

Going forward, expect consumers to remain resistant to the pinstriped pessimism of the dismal scientists, and to frustrate purveyors of consumer gloom at the Conference Board and University of Michigan. Those folks need to raise their window shades and look outside, because there is much to be optimistic about.

Stronger Growth and Rising Stock Prices Ahead

It is easy to see the glass as half empty, but we have likely seen the worst of things. Consumer spending and stronger business investment will likely raise growth for the balance of the year.

Homeowners still have considerable equity to finance more spending. Even with home prices falling the latter half of 2006, home equities were still up 55 percent over the last five years. In February and March, prices for both new and existing homes rose.

Housing sales may be slower in 2007 but the pace is still respectable. Consumers saw the values of the neighbors’ homes rising before Wall Street economists. Quite simply, prognosticators’ concerns about a consumer pullback have proven wrong.

Along with an expected bounce in business investment, consumers should power the economy up. Look for growth of 2 to 2.5 percent in the second quarter, accelerating to around 3 percent for the second half of the year.

Higher global oil prices will continue to push up U.S. inflation but the Federal Reserve can do little to dampen these pressures by raising short-term U.S. interest rates. With moderate growth ahead, look for the Federal Reserve to stand on the sidelines until at least September.

Stock prices will continue to outperform the U.S. economy. Most large U.S. companies earn a good deal of their profits abroad. The combination of strong growth in Asia, coupled with moderate growth in the United States, is good for their bottom line.

A weaker dollar makes U.S. equities a particular bargain for foreign investors, especially in Europe. Large U.S. multinationals earning significant shares of their profits in Asia will prove a great play for Europeans who sit on strong euros and pounds but have few good investment options at home.

Surging corporate profits, moderate growth and steady interest rates at home, and more robust foreign demand for U.S. equities should power up U.S. stock prices. Saddle up your bull and set your sights on Dow 14,000.