US economy set to exceed forecasts

Despite a mixed performance last week, the major indexes continued their slow and steady advance and moved higher for October. As of Monday’s close, the Dow is up 5.4 percent, the NASDAQ is up 7.7 percent, and the S&P 500 is up 4.9 percent thus far for the month. At 1039, the S&P is at its highest level since June 2002. The steady upward climb is consistent with recent market behaviour with the good earnings news comforting the bulls but not inspiring a huge rally. This week, 700 companies are due to report earnings. Thus far, most companies have met or exceeded guidance figures and analysts’ estimates. As it is typical for companies to rush out early with bad news on the hopes to recover with the later earnings announcements from other companies more with positive news, we would look for meet or exceed earnings trends to continue. We also note that many analysts are increasing 4th Qtr and 2004 estimates to be more in line with the economic growth path we now seem set on. “We’ve had a lot of earnings that have been in line or better, and the Street’s been yawning,” said Tom Schrader head of listed trading at Legg Mason.

“I think what you’re seeing today and over the past week is a good indicator of where the market is right now and will likely be through the end of the year,” said John Davidson president and CEO at Partners Re Asset Management. “As companies report, we’re seeing top-line growth, not just cost-cutting, driving earnings, and the economy seems to be improving,” Davidson added. In reviewing the wages and employment data for the US, it is now clear why consumer spending remained so strong over the past four years and why we are now clearly set into an economic growth cycle. The often touted concept that the debt-laden US consumer would at some point slow down, subsequently causing a further economic contraction turned out to be totally untrue. Statistics show that aggregate household income rose every quarter except one since the start of the recession.

Annual incomes have grown at 4.5 percent pace since 1999 to today’s level of $9.2 trillion compared to $7.8 trillion at the end of 1999. Employment rolls, meanwhile, declined by less than 0.2 percent per year from 130.5 million persons at the end of 1999 to a current total of 129.8 million. This relative stability in overall employment, coupled with consistent increases in compensation, helped drive the 3.7 percent annualised increases in spending seen in recent years. Consumption has also been strong due to the near-record levels of wealth created by rising values of real-estate, bonds, and cash holdings. Based on recent data by the US Federal Reserve, the estimated aggregate net worth of households in the United States is near $39 trillion USD, essentially twice the level seen in 1990. While it is true that mortgage and instalment debt has risen over the years as well, the size of that debt relative to overall net worth is manageable especially as interest rates and the carrying cost of that debt has declined. Today, debt is equal to 22.5 percent of total household net worth and 101 percent of income.

While these numbers appear high relative to history, they do not reflect the fact that the long-run lowering of interest rates and the more recent dramatic cuts in interest rates by the US Federal Reserve have actually helped lower the actual carrying cost of that debt for many Americans. While it is difficult to estimate the exact carrying cost of that debt, we estimate that debt loads are not any more onerous today than at other points throughout the last 20 years. While not a perfect measure since some debt is based on fixed rather than variable rates, the result shows us that current debt loads appear reasonable thanks to the lower attendant cost of money. Should employment rolls expand by one percent next year (a reasonable assumption), one could expect aggregate wages and spending to rise by roughly 4.5 to  5.5 percent in 2004. Given that personal spending accounts for roughly two-thirds of a nations economy, that rate of growth would add roughly 3 to 3 .5 percent to aggregate GDP growth. As a result, we would expect 5.5 - 6.25 percent growth in the US economy in 2004, against current economists’ forecasts of 5.6 percent growth. Real GDP growth should be between 3.5- 4.25 percent. Investment with an overweight position into equities, with consideration to the UK and far east markets should produce better returns than other asset classes for the medium term.

e-mail: darcy@investments-intl.com