Sunday, May 20, 2007

Happy Memorial Day

The summer months, which usually are considered the doldrums by those in the investment community, could provide some interesting outcomes as we head into the Memorial Day weekend and what many see as the onset of the summer season. This is also the start of the summer driving season, and gasoline is already hovering around $3.00 a gallon. As hurricane season also begins to heat up, I hope there are no direct hits on the oil infrastructure, or the possiblity of $4.00 a gallon gasoline I've read about could become a reality. Meanwhile, the Dow Jones Industrial Average continues to set record after record, and now the S&P 500 is is less than 5 points away from its all time record of 1,527.46 set in 2000. If the Federal Reserve holds interest rates steady at the FOMC meeting in June, they will have held rates steady for a year, something the Fed does not do often. The Fed has held its target for short-term rates at 5.25% since June 2006, after raising it steadily for two years to tame inflation. Banks use the rate as a benchmark for pricing consumer and business loans. These issues could be setting the stage for a very interesting second half of 2007.

For well over a year now, I've been writing about the dual concerns of a slowing economy and inflation. Fed policy has been concerned with remaining hawkish on inflation, while some economists, investors and journalists expected rate cuts as early as September 2006. The midcycle slowdown economists predicted seems to be exactly what has happened, with the bottom being symbolized by April's paltry retail sales figures. While many thought the housing slump would drag the economy into a recession, it seems the builders and subprime borrowers are the ones bearing the brunt of the pain. Most homeowners remain solvent and able to meet mortgage expenses. As long as the employment numbers continue to hold steady, consumers should be able to continue to meet obligations and make discretionary purchases.

Where the economy goes from here no one can predict with certainty, but there are reasonable hypotheses one can make based on the data. This economic cycle is in the mature phase of the current expansion and the mid cycle slowdown was like a breather, before growth picks up again. Expansions don't last forever, so at some point in the future we will have a recession again. With that said, it looks as if the second half of 2007 will be a time when growth reignites and inflation will continue to be the number one concern of the Fed. With the productivity of workers declining, and the pool of skilled workers drained, labor will begin to demand higher wages. Usually, when the economy slows down unemployment ticks upward, but that hasn't happened during the first two quarters this year. Some economists think this is because the slowdown in housing hasn't worked its way down to the employment figures. Others think there is a possibility the economy is actually growing faster than the GDP numbers indicate. As we head into the Memorial Day weekend, one thing is certain, gas is going to cost you about $3.00 a gallon. As far as interest rates are concerned, the jury is still out. Will the Fed raise, cut or hold? Will the S&P 500 EVER break 1,527.46? Time will tell. Enjoy the holiday!

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