Column: Economic Musings
Signs that the business cycle may have reached its trough strengthened as inventories were again reduced in the second quarter at a yearly pace, estimated by JP Morgan, of $162 billion. After 10 consecutive months of decline, replacement demand alone can be expected to support manufacturing activity ahead. Just as importantly, U.S. worker productivity in the second quarter rose at an annual rate of 6.4%–the best quarterly figure since the country emerged from the last recession in 2003. It should be noted that this gain resulted from hours worked declining by 7.6% against a drop in output of 1.7%.
Another tentative sign of stabilization and recovery can be found in the price action of base commodities which are a good measure of anticipated industrial demand. For example, the price of copper has risen over 100% year-to-date. After falling from a peak of $4.00 in 2008 to a trough of $1.40, it has now rebounded to about $2.80.
With increasing evidence of a bottoming of the U.S. economy and a slow recovery ahead, the dollar has gained some strength against the euro. This reflects the E.U. countries being behind the U.S. in dealing with their banking problems and their GDP growth revival. Russia is recovering thanks to higher oil prices. China and India continue to move ahead with China becoming aggressive on locking up mineral, oil and gas supplies around the world. The latest such activity being a $17 billion bid for Repsol’s stake in YPF, its Argentine unit. This would be the biggest overseas investment China has made to date.
China is working to build an international currency bloc with other Asian powers and perhaps such nations as Brazil. The object would be to limit the use of the U.S. dollar as a world reserve currency. Their holdings of more than a trillion dollars of U.S. Treasury bonds have them a bit nervous as to a fall in the dollar’s value. Such a fall would also affect their profits as their product prices are denominated in dollars.
While substantial problems remain in the U.S. and international banking and finance systems, the Fed and Treasury as well as foreign central banks have had a good deal of success in stabilizing the situation.
Crude oil again reached $73/barrel on an intraday basis and has pulled back to approximately $70. This is normal profit-taking in a trend that still appears to be up. Economic recoveries in the U.S., China, India and Brazil mean higher demand for oil and therefore the tendency will be for prices to work higher rather than lower. In addition, alternative energy such as wind power and solar as well as the new deep water oil finds offshore Brazil and Ghana all need approximately $80 oil to be profitable.
On August 12th, the Federal Reserve Open Market Committee issued a statement suggesting that “economic activity is leveling out.” Despite this change from previous, more cautious assessments (for example June’s statement read: “economic activity is likely to remain weak for some time”), the Fed signaled that it would keep rates unchanged for “an extended period” in an effort to assure sufficient liquidity as we emerge from recession. Few economists expect the Fed to raise rates at all before 2010 and many expect present rates to remain into 2011.
In another sign of confidence, the Fed signaled it would phase out its program to purchase up to $300 billion in U S Treasury securities. As these and other efforts to shore up the nation’s financial house are eased, market reactions will require close scrutiny to assess the pace and success of these efforts.
From the March 6th low to the August 12th high, the Dow Jones Industrial Average rose 2,960 points or 46%. While many solid companies enjoyed strong rebounds from over-sold conditions, much of the recent upside action has been concentrated in sectors that performed poorly during the sell-off, particularly securities of financial, housing-related and consumer discretionary companies. With over-sold conditions now largely behind us, future gains can be expected to correlate more with long-term earnings prospects. Therefore, well-selected equities will continue to do well.
Fred Ruopp is the CEO of Chelsea Management Company and was named one of the Top 20 value-oriented managers in the U.S., according to Kiplinger’s. .
A well-grounded and thoughtful Catholic, Los Angeles-based founder and CEO of Chelsea Management Company, Mr. Fred Ruopp, Sr., is ranked by Kiplinger's as one of the... MORE »