Kudlow's Money Politic$
Pro-growth, strong defense, virtuous values, business, and stocks
2.21.2005
Economy Revisited
I haven't blogged during the long holiday weekend, but here are a few brief thoughts on the economy and the markets.
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Citing strong profits,cash flows, and returns on equity, star money manager Bill Miller of Legg Mason is bullish on stocks for 2005.Mr. Miller has outperformed the S&P 500 index fourteen straight years. He is one of the best thinkers in the business. He is quoted in an AP story I found in the Pittsburgh Post-Gazette: " Valuations are not demanding, especially in a world of low inflation and low interest rates. Mergers and aquisitions should boom this year, providing windfalls for the shareholders of takeover targets."
I agree. Even after the much higher than expected producer price report, core inflation for the personal spending deflator watched closely by Greenspan should remain historically low.
In that PPI report,it was capital goods prices-- comprising 42% of the core PPI-- that really pushed up the basic index. This included outsized price jumps for railroad equipment, oil and gas equipment and mining machinery. But this is a healthy sign that the tradeable hard goods sector, long ignored during the hi-tech boom, is returning to strength.
Capacity is being enlarged to accommodate growing world demands. Higher prices and profits are attracting new capital. Soon increased production supplies will lower prices.It's part of the market process, a microeconomic application. Freely rising prices attract investment. That investment leads to more output. As supply then rises to meet demand, free prices decline back to a sustainably balanced level.
Markets work. Business works. Investment works. So does our flexible economy, which quickly moves capital and labor to their most productive uses. Contrast this with over-taxed and over-regulated Europe and Japan, which lack the market flexibility to respond to changing conditions. This is why America is growing rapidly and the others are not.
But capital goods investment should not be confused with persistent inflation. That can only occur with excess money creation extending well beyond the markets' demand for that new money.
Slower monetary base growth in the wake of Fed restaining moves is a positive sign for lower future inflation. Gold and the dollar are stabilizing. Treasury bond yields are low and the Treasury curve has been flattening over the past year. Bond rates and core inflation may drift slightly higher in the months ahead, but this will not be an obstacle to economic growth or stock market advances.
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Standard and Poor's research expects another record year for dividends in 2005 as payouts to investors increase 12% to $203 billion compared to $181 billion in 2004. Meanwhile dividend paying shares continue to outperform nonpayers. Over the past year the former rose an average of 0.64% while the latter fell by an average of 5.01%. After a 29% increase in 2003, the S&P 500 index rose nearly 11% in 2004.
Sceptics will never admit it, but the 15% marginal tax-rate on investor dividends (from 40% earlier) had an awful lot to do with these positive results. The after-tax cost of capital was significantly reduced while the post-tax return to investment was significantly raised. So? More dividends and more investment followed suit. Tax capital less, you get more of it. The entire economy doubled its growth since the Bush tax reform was implemented in mid-2003.
Meanwhile, these supply-side tax cuts are paying for themselves. The Congressional Budget Office admitted as much in their winter report. Taxing investor dividends and capital gains at lower rates is reducing the budget deficit (and growing the economy). The Laffer curve strikes again.
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Here's a neat bit of economic history. Since 1800, the ten-year Treasury bond yield has averaged 4.9%. The CPI has averaged 2%. The Fed's policy rate has averaged 4%. This from one of Wall Street's best and brightest economists, Michael Darda. Mr. Darda expects bonds, inflation and the Fed rate to move back to their long-run equilibrium averages over the next year or so. If so, it would be very healthy. And consistent with roughly 3.5% inflation-adjusted economic growth. If my memory serves me, Penn Prof. Jeremy Siegel found that inflation-adjusted stock returns averaged 7% since 1802.
Aren't these long-run performance data for stocks and the economy exactly why individuals should have the option to own and invest a portion of their Social Security taxes? |
