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A Fork in the Road
New York:
By John R. Stephenson


Earnings have been solid, interest rates remain low and there is some decent economic data spewing out of New York and Washington and yet stocks, as measured by the S&P 500, are down some 4 percent year to date. The question is "why?" Some investment strategists such as National City Corp's Tim Swanson think that the problems with stocks can be summarized by the six "e's": the election, energy, the economy, earnings, employment and extremists. For my money, the most significant of these "e's" is the state of the global economy that is weighing heavily on the market.

For starters, this week saw some disappointing data in the form of a record monthly trade deficit (exports less imports) for the U.S. of $55.8 billion. The culprit? The surging cost of crude oil and slowing growth in Japan and Europe which curbed demand for U.S. products overseas. Crude oil futures (September contract) finished the week at a record close of $46.58 which was up $1.08 and has been driven by concerns over the stability of oil supply and concern surrounding this weekend's presidential recall election in Venezuela, the fifth largest oil exporter in the world.

Although growth appears to be reasonably strong in the U.S., America isn't getting much help in expanding the global economy from either the Euro Zone or Japan. On Friday, the Japanese economy reported slowing economic growth as consumer spending weakened and the overall economy grew at an annualized pace of 1.7% in the second quarter which was less than half the median forecast of 32 economists in a Bloomberg survey. The Euro zone appeared to be even more anemic as the region's gross domestic product grew at 0.5% in the second quarter which was down from 0.6% in the first quarter.

Japan, Europe and the United States make up the three largest economic blocks of the world economy and with two of the three engines starting to sputter and the third waning a little, there is real concern about the sustainability of the global economic recovery. Recent cautious comments by the chief executive of Cisco Systems Inc. and profit warnings from other technology companies, including Hewlett-Packard Co.have been unsettling to investors.

In fact, the strength in the global economy can be attributed to one source — American consumers who through a policy of fiscal and monetary stimulus (record low interest rates, tax cuts and government spending) have been encouraged to go out and spend. So strong has consumption been that in the years between 1996 and 2001, the U.S. contributed fully 96% of the cumulative increase in global GDP — a staggering figure.

American consumers have been willing to carry the burden of the world's economic growth on their shoulders for some time because they have been given incentives to do so. The danger is that U.S. consumers are fully tapped out now and need to start to put their own house back in order before they consider spending again. With interest rates climbing, it is unclear how much longer American consumers can continue to add to and service the record amount of debt that they have been piling on. But if there were to be a sharp slowdown in consumer spending, it could spell disaster for both the world economy and that of the U.S.

There is some recent evidence that U.S. consumers may be less willing to spend in the future. The reason? Overall consumer confidence appears to be waning somewhat as measured by the most recent University of Michigan index of consumer sentiment. The index, which measures the U.S. consumers' overall confidence level about their economic prospects, fell to 94 in August, from 96.76 at the end of July. If consumers are less confident about their futures, they are less likely to continue spending on goods and services, particularly big-ticket items.

With oil prices remaining stubbornly high, consumer debt levels at stratospheric levels and consumer confidence starting to wane, perhaps it is time to think about taking a little money out of the stock market for a short while. In particular, the overheated tech sector is probably most poised for a fall where its average P/E multiple is 23 times next year's earnings compared with the market as a whole which is trading at just 15 times future earnings.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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