Friday, October 27, 2006

Slowing Economy, Rising Stocks

Friday's announcement of 1.6% GDP growth for third quarter is slightly weaker than I was looking for, and it is a very real indicator of just how weak real estate is. The good news is the inflation data in the release fell to 1.8%, much lower than the consensus estimate of 2.8%. That is very good news to the Fed. Even in the face of the slowing economy, I believe that the S&P 500 and the Dow Jones Industrials, which both contain blue chip multi-national stocks, will continue to perform well over the next year to 18 months. The slowing economy will not be good for smaller domestic stocks, and I believe their performance will likely lag that of the blue chips. I also believe that blue chip international stocks will continue to perform well. This divergence between stock market performance and economic performance will be the opposite of what happened in the previous 24 months, when the US economy was strong and US blue chip stocks were flat. The reason for the unfolding divergence is two fold: (1) The stocks in the major blue chip indices produce nearly 50% of their earnings outside the US, and for the first time in many years, in 2007, the rest of the world will be growing faster than the US. (2.) Blue Chips were poor performers in 2004 and 2005, even though earnings were strong, and because of this , they are underowned on Wall Street. As it becomes increasingly clear that the rest of the world is growing faster than the US, big money will pile back into US blue chips. Finally, according to S&P analysts, blue chip stocks are as cheap as they have been in years and 2007 S&P 500 Index earnings estimates are still expected to reach double digits. Markets seldom feel right because we human beings have a habit of projecting today's headlines onto tomorrows stock performance. Remember, the stock market is not a democracy. Prices move in the direction that big money pushes it. Fortunately, big money is normally rational and understands economic cycles and the power of the Fed to slow and speed up the economy. Big money has a problem. The places where it has been treated well over the past few years are all rolling over. Treasury bonds yield are under 5% in most of the major industrialized nations of the world. Bonds simply are not competition to stocks. Real Estate and commodities are no longer competing effectively for investors against stocks because they are now in downtrends. Blue Chip stocks, alone, stand out as a value now that bonds, real estate, and commodities have become over owned and over valued. Finally, blue chip stocks are in an uptrend. This positive momentum is a rarity in today's world's financial markets. As long as earnings growth holds near 10%, stocks will continue their strong advance. This blog is for information purposes only. Do not make purchase and sell decions on the basis on what is discussed here.