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Economics: A rising tide?
New York: October 14, 2003
By John R. Stephenson

Over the last year, the stock market has continued its steady march upward. Last week the market surged on news that the jobless claims in the U.S. had dropped to 382,000 from 405,000 (see figure 1) and that the economy had generated 57,000 jobs in the month of September. This news took equity markets up and gold down. So is the economic recovery here to stay and can investors start celebrating again?

A careful review of the numbers leads to the conclusion that it might be a little early to break out the champagne or to take a luxury cruise. During an economic recovery, the economy expands and generates at least some price pressure. But last week’s U.S. producer price report showed only a .3% rise in prices (a 0.0% rise when energy and food were factored out). This lack of pricing pressure is particularly surprising when you consider that the Federal Reserve has adopted a policy of monetary stimulus, congress is turning more protectionist, the dollar is weak and there are negative real interest rates.

Figure 1: U.S. Unemployment Claims

It is difficult to believe that the world’s major economies are indeed improving and hence that equity valuations can be justified. Technology companies, for example, have had an incredible run-up over the last six months, but can you really justify buying Yahoo (YHOO) at eighty-eight times forward earnings? There are many skeptics out there including Merrill Lynch’s chief economist who, in response to the recent economic data, noted that “he’d never seen such a massive market reaction to…an employment number that was not statistically (different) from zero”.

The rest of the world (export markets for U.S. manufacturers) looks a little shaky as well. Japan, the second largest economy in the world, continues to prop up near comatose companies with loan guarantees and has been delaying the start of serious structural reforms. If the structural reforms (most notably of the banking sector) were to occur, then Japan could most likely return to a path of reasonable economic growth, say on the order of 3% per year, but that would likely take a decade or more to occur.

The principal reason why equity markets appear to be soaring is not the improving fundamentals but rather the lack of alternative investments that have the short-term potential to generate yield. The story in tech land seems to be one of survivorship bias, with the few decent remaining technology companies being the beneficiary of the available investment dollars.

If you remain skeptical on the “recovery” story, the prudent thing to do is to consider cashing in some of your chips if you’ve been at the table this year (particularly if you are a tech enthusiast) or to put down only a small portion of your savings if you are hankering to get in. With the dollar’s slide nowhere nearly finished, monetary tightening not yet on the horizon, and protectionist forces rallying around the flag in Washington it might get worse before it gets better.

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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