Kudlow on the Market:
Keeping Faith With the Bull Market: Lawrence Kudlow (Correct)
New York, April 8 (Bloomberg) -- There are a number of white noise-type obstacles which have temporarily slowed the stock market advance -- Kosovo, the beef and bananas trade dispute with Europe, OPEC oil-price increases and the Justice Department settlement with Microsoft. Throw in rising bond yields. The newspaper headlines are not too promising at the moment; there is a lot of uncertainty in the air.
In times like this investors shouldn't get too distracted over the headline du jour. Keep your eye on the basic fundamentals that have fueled the long wave of bull market prosperity that has been in place since the early 1980s. Namely, disinflation, deregulation, moderate tax rates, a low capital gains levy, historically low interest rates, a strong dollar and expanded trade. It's all still in place. The bull market is not over. Neither is the economic expansion.
Add to this the transforming effects of technological innovation and investment, which have reduced costs, increased productivity and generated growth. Remember Joseph Schumpeter's dictum: Periods of rapid technological advance produce more goods, with better quality, at lower prices. It's a metaphor for the new economy. More good news.
Disguised Profits Strength
In today's business pages there's a lot of talk about declining profits. The government's latest GDP report for last year's fourth quarter shows a 2.6 percent yearly drop in profits adjusted for changing inventory values and capital consumption. But this earnings decline actually masks a lot more strength than commentators seem willing to allow.
For nearly two years commodity prices across-the-board have been deflating. This has done some damage to the earnings of commodity producers, raw material makers and the energy sector. It's forced them to downsize, cut costs and restructure. In rapid response, manufacturing output-per-hour rose 3.9 percent last year. For the overall non-farm business sector, productivity rose 2.7 percent.
The rest of the economy has benefited from commodity deflation. Think of it as a big tax cut, stimulating 75 percent to 80 percent of the economy, even while the commodity sector loses ground. For example, in the GDP report, total profits excluding commodity-based metals, petroleum, food and chemicals actually increased 10.7 percent over the past four quarters. So, while one fourth of businesses lost money, three-fourths were quite profitable.
Gains Excluding Energy
Similar story for the S&P 500 companies. Overall, the four quarters of 1998 produced a respectable 4.8 percent profits gain. Behind this headline number, however, 91 percent of the companies actually generated an 11 percent earnings increase when basic material and energy firms are excluded. Big gains were reported for computers and software (22 percent), durable goods (20 percent), telecommunications (36 percent), and health care (24 percent).
So, reports of the death of profits have been greatly exaggerated. Actually, the post-World War II profits trend, through nine recessions and nine bear markets, is an inflation- adjusted 3.5 percent growth rate. Really, abstracting from the recent commodity slump, U.S. profits are still rising above trend.
When combined with virtually zero inflation and historically low bond rates, this explains the spiffy rebound in share prices since the Russia/Long-Term Capital bottom last September. From early October 1998, the Nasdaq index has increased 76 percent, the S&P has rebounded 35 percent, the Dow has improved by 27 percent, and even the Russell 2000 is up 29 percent. Note how the ''new economy'' Nasdaq leads the pack.
Continued Prosperity
These stock market gains foreshadow continued prosperity. Even as Y2K-related technology investment slows, and the testing process begins, look for this year's economy to grow by roughly 3 percent, a downshift from last year's 4.3 percent pace (measured fourth quarter to fourth quarter). This ''reversion to the mean'' (the post-war growth trend has been 3.3 percent annually) will reduce real interest rates in the bond market, bringing Treasury yields back to 5 percent before too long.
Meanwhile, the temporary ''dead-cat'' oil bounce to $16 will not re-ignite inflation (meaning no disrespect to cats). A year ago oil was $15.50 per barrel, and in late 1996 it was $25 per barrel. What's more, people must distinguish between individual, or relative, price increases, and a broad-based rise in the overall inflation rate. Without excess money, a price increase in one area will crowd out spending elsewhere.
Recurring inflation comes only when the value of money is compromised. That is, when newly created money by the Fed exceeds
the domestic and global demand for it. Then, all prices in the economy rise. If this were so, then the U.S. dollar index wouldn't be so strong (it just moved back to 100 after falling almost to 92 in October), and gold wouldn't be so weak (barely hanging on at about $280).
Commodity Prices Down
What's more, the CRB commodity index is still 16 percent below its year-ago level, and the new Dow Jones/AIG commodity index is 23 percent below last year's level. These price rule indicators point to rising real rates as the chief culprit behind the move-up in Treasury bond yields to 5.65 percent late last week, not rising inflation expectations. The Fed won't raise the overnight fed funds rate. Bond traders may be rattling their Phillips curves, but the Greenspan Fed will not be rattled.
As for the oil-price spike, it won't last long. Higher prices will promote greater production supplies which, in turn, will lower the future price. New technologies have lowered the production cost of oil to somewhere between $5 and $9 per barrel. Absent world inflation, the selling price will converge toward the production price.
In the end, markets, not cartels, set prices. And, by the way, wouldn't it be nice if the U.S. government quit attacking Microsoft, which is producing more software at lower prices, and started criticizing OPEC, which is producing less oil at higher prices? Just a thought.
Speaking of attacks. The politicians may bungle, but the American men and women fighting in the Balkans, and those supporting our military forces at home, will prevail. Bet on it. Keep the faith, faith is always the spirit. |
