Living in Goldilocks’ zone

Of the 122 New York analysts interviewed by Bloomberg, all stated they believe that the Fed will raise the base overnight lending rate another 25 basis points (0.25%) to 5.25%. If the Fed does raise the rate, this would be the 17th straight rate increase.

Some may criticise that Bernecke talks too much, but he is clear about his understanding of the delicate balance regarding checking inflation without damaging the over buoyant housing market with its abundance of new jobs (something like 27% of the 5.5 million new jobs created) and high market values.

As we approach the end of the second quarter, it is appropriate to look at the performance of the global financial market indexes for the quarter with a view to the future, rather than provide just a weekly review. In the USA, the DOW was the best performer, only loosing 1% from April 1. The S&P was off 4% over the same period, but it was the NASDAQ that lost the most, giving back over 10% in the quarter. Across the pond to the UK and Europe, losses were less, but stocks were still off over the quarter, the FTSE down 5%, the DAX 8%, and the CAC 8.4%. The NIKKEI down 7.3%

Last week, we spoke of equities and the decline they have experienced over investor concerns regarding the impact of inflation on economic growth and corporate earnings. We have cautioned investors for some time about the legitimate concerns regarding building inflationary pressures and the central banks need to address this circumstance but this has been tempered by the solid fundamentals in employment, GDP growth and corporate earnings.

Consider, for instance, consumer spending. This has been the backbone of economic growth during this expansion cycle and we expect it to remain strong in the near term. Further, with more consumers coming into play with the expansion of large markets like India and China, it seems to us very unlikely that a dramatic reversal of this long-term trend will occur. The truth is, consumers continue to seek more material items and a better life style, thus driving GDP growth.

Another point the availability of money in the financial system to purchase products and services. Money supply is in a strong position, perhaps too strong. If it is that money is too much then interest rates should increase to dry up that supply. Hence, the rate hikes in many of the leading economies of late and the reasonable certainty that the US Fed will raise rates today.

Those that argue against further rate hikes say one should stop and see what the effect of those rate increases is before tightening any further. As investors know, there is a significant lag between the implementation of a rate change and when the effect trickles down into a measurable change in economic activity.

In reviewing the corporate guidance figures, second quarter earnings are expected to come in around 11% year over year. Given that this will be the 12th quarter in a row where earnings have grown at rates greater than 10%, we see earnings right in the Goldilocks zone.

The same is true for the Gross Domestic Product (GDP), the value of country wide production. With the USA leading the world in terms of economy size at over $US12 trillion annually, their growth is just over 3%, which once again is right in the Goldilocks zone. The globe’s other leading nations, with the exception of China, are also within a reasonable range for expansion.

Unemployment too is at or near the Goldilocks zone for many countries. Germany and England are producing positive figures and the USA is down to 4.7%, a very low rate of unemployment indeed.

Inflation rates near 2% is where you want to be. Even with the food and energy price moves, inflation is fine and core inflation (inflation excluding food and energy) remains within the 2% alert limit. The last two times stagflation occurred, GDP growth was negative. Thus for us, the likelihood of stagflation happening against the background discussed above seems to be very unlikely.