October’s thunder came from the clamor and anticipation of November’s elections which were predicted to move many contested offices into Democratic hands; top issues included runaway federal spending, illegal immigration, crimes in Iraq, and national security. Other populace emotions were mixed as relatively low gasoline prices boosted consumer sentiment while near record US troop deaths delivered a somber mood. Expect a renewed Congress to successfully push through their mandates over the next two years.
US third quarter corporate earnings are up more than 20% over last year – better than the expected mid-teens growth rate – with exceptional profit margins near peak levels. Based on such robust performance, analysts are increasing their 2007 corporate earnings forecasts and security target prices. Such strength augurs well for both the economy and the markets. Expect to see stock prices continue to rise and corporate investment grade and high yield bond spreads to remain tight.
Inflation questions still pester the market. The Fed is practicing a combination of behavioral and numerical economics. Behaviorally, the Fed hopes that low inflation expectations will help restrain actual inflation. Numerically, the Fed believes that a weak housing market and current interest rates will curb economic growth (and inflation). On the other hand, some Wall Street economists fundamentally believe that falling unemployment and rising wages will advance inflation. These pundits surmise that as long as employment remains strong, consumer optimism and buying power along with invigorated corporate balance sheets will keep advancing growth. For now, expect the Fed to keep US interest rates level at least until they see the results of the upcoming holiday shopping season.
Technology and technology companies are entering investors’ portfolios with fresh vigor. Funding for Web 2.0 (next generation Internet companies that promote online collaboration) startups has doubled over last year and recent high profile acquisitions have grabbed headlines including Google’s recent purchases of YouTube, Upstartle, and JotSpot and News Corp’s acquisition of MySpace. Anticipate Google’s competitors, Yahoo, America Online and Microsoft’s MSN to ink some high-profile deals of their own.
Across the Atlantic, expect the European Central Bank to lift rates at its next meeting on December 7, from 3.25% to 3.5%. As unexpectedly robust European economic results arrive, analysts will increase reported and forecasted GDP for the stalwart Eurozone economies. Remarkably, inflation remains low (1.6%) with unemployment stable, albeit a little high at 7.8%. On the other side of the globe, Japan will see gradual hikes in interest rates although its current production growth is one of the slowest in Asia. Japan should perform better now that vast billions of non-performing loans have been wiped off of the books. Overall, global economies should continue to perform well, boding nicely for international and emerging market fixed income securities.
Michael Ashley Schulman, CFA
Hollencrest Capital Management