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7.21.2003 2003 Second Quarter Client Letter
July 10, 2003
U.S. economy must now deliver
The recent stock market rally, the largest in four-and-a-half years, is greater than I expected. The rally is a result of the enormous fiscal and monetary stimulus by the federal government. The current stock market rally is being driven by liquidity. The Federal Reserve has been aggressively creating money. Literally, in the last six weeks the U.S. Government has created 120 billion greenbacks. This is an annual rate of $1.04 trillion per year, the fastest rate of money growth in history. These dollars are used to purchase goods, service and financial assets. This method of economic stimulus is called monetary policy. The government’s other means of spurring economic growth, fiscal policy, is the collection and spending of income tax. The recent federal income tax cuts will reduce the income tax bill for all income tax payers, providing more after-tax income and additional economic stimulus.
Though the government is going out of its way to revive the economy, there are no signs of economic growth. This was confirmed on June 25th when the Federal Reserve cut interest rates for the thirteenth time by another 1/4%. The economy has been growing at an annual rate each of the past two quarters at 1.25%. This is not enough growth to sustain the current levels of employment. Therefore, the U.S. Government has aggressively injected both monetary and fiscal stimulus.
There are three drivers of the U.S. economy: consumer spending on housing, consumer spending other than housing and business spending. During the past three years, consumer spending and housing spending have been strong. Business spending continues to lag from over expansion in the late 1990’s. Housing has been supported by low interest rates, which allow consumers to qualify for more expensive homes. Secondly, lower interest rates mean lower overall mortgage payments, which provide additional money for other consumer spending.
If the consumer can continue their spending until the business spending recovers, the economy can work through the excess capacity and begin to grow again. Contrary, if the consumer can’t continue spending before the business spending emerges, then the recovery will be short-circuited.
One of two things will occur: 1) the economy and corporate earnings will increase to justify the current stock market prices; or 2) if the economy doesn’t begin to show signs of life, the stock market is extremely vulnerable to another sell-off in this prolonged bear market. “Don’t Fight The Fed” is a famous saying in the investment world. If the Federal Reserve continues to create money, the market will continue to advance. We will monitor the Federal Reserve’s activities and the pending economic recovery. We look forward to reporting its progress in the coming months.
Trevor K. Holsinger, CFP
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