Financial markets continue to be roiled by sub-prime mortgage concerns. And a number of doom and gloom prognosticators are saying we are in a recession or predicting recession. I continue to disagree with these gloomy assessments of the U.S. economy. I am confident we are not in a recession, and I do not expect a recession this year.
Yes, housing construction and home prices are down, but other sectors of the economy are taking up the slack – notably U.S. exports which are rising at an 8% growth rate in real terms and are 3½ times the size of residential construction. The consumer is hanging in there, behaving rationally. Real consumer spending excluding energy (taking out gasoline, heating oil and the like) rose 2.6% last year, while spending on energy slowed to 0.3% (and fell outright in the fourth quarter). Makes sense to me given outrageously high energy prices. Business fixed investment is chugging along at a steady 7.5% growth rate in real terms. Inventory investment was soft all year and fell in Q4, but I consider that to be a positive this year – no inventory glut to clear out. And government spending is doing what it always does – rising – at a steady 2.5% rate in real terms.
Income and interest rates look okay. Real after-tax personal income is chugging along at a 2.1% growth rate. The personal saving rate, while low, is in positive territory. Outside of these sub-prime related write-offs at a bunch of big, dumb banks, company earnings look pretty good. With 439 of the S&P 500 companies having reported, non-financial company earnings are up about 14% over the last four quarters. There were big gains in Technology (good volume, better pricing), Energy (sky-high oil prices), Healthcare (demographic tailwind) and Industrials (exports). And the Federal Reserve is cutting, not hiking, interest rates.
What I worry about are rising oil prices and/or further dollar declines. Another big rise in oil prices might do enough damage to tip us into recession, and further dollar declines would erode international investment in U.S. financial markets. And oil prices have moved back up to $90-100 per barrel range. Unfortunately, energy policy has not helped. Starting last September, with oil prices around $75, the Energy Department began adding oil to the Strategic Petroleum Reserve! Over the same time the private sector reduced inventories and petroleum use fell. So, on the margin, it appears that the U.S. government was the big marginal buyer helping push prices from $75 to $100. Not smart… However, the Energy Information Administration is forecasting a deceleration in global demand for oil and a rise in supply. So there are some grounds to expect lower oil prices.
I will continue to watch the economy and these data closely and report back to you. For now, I remain optimistic that we will avoid recession and return to faster growth and rising financial markets. As always, please call me with any questions or concerns.
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