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Integrity
Performance Service
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The domestic economy is strengthening after an apparent lull stretching from the spring through mid summer. In particular, new jobs creation has turned positive. October saw the creation of 337,000 new jobs, and the numbers for September and August were revised upward. The sharp deceleration of new jobs in the spring, brought about by the sudden rise in energy prices and hesitant response of businesses to new hires, appears to have run its course. Surveys support the view that businesses generally are again in a hiring mood, and formerly discouraged job seekers are returning to the labor force. Other signs of stability and consumer health are not hard to find. Wages and hours worked grew modestly in the latest period, pointing to rising personal income growth heading into the important holiday season. The improved consumer picture is reflected in retail sales trends through the fall that, other than for automobiles, have been surprisingly positive. Overall, the consumer segment of the U.S. economy is on a firm footing. American consumers remain resilient spenders, but a return to the free spending years of the late 1990’s and early 2000’s is not likely to occur. The mortgage refinancing boom is winding down and consumer debt levels have continued to rise. A moderate, undramatic rate of consumer spending growth is likely going forward. At the same time, business spending is climbing and promises to be the key economic driver of the U.S. economic progress for the foreseeable future. Business equipment spending in the third quarter Gross Domestic Product report showed equipment spending rising at a 14.9% annual rate. Moreover, conditions exist for a continuation of a high growth rate. In particular, corporate profits are surging and corporations are flush with liquidity. Standard & Poor’s reported that aggregate cash on the balance sheets of companies in the index stood at $590 billion at the end of September, equal to more than 38% of their long term debt. There are, of course, many potential uses for this liquidity. We believe, however, that a meaningful portion will be used for business investment. In fact, non-defense capital equipment orders have been in a strong uptrend. The recent "American Jobs Creation Act of 2004" which, among other provisions, lowers the income tax rate on broadly-defined manufacturing activity to 32% from 35%, holds substantial economic benefits for American industry. Corporate cash flow is meaningfully benefited by the reduction in taxes, further augmenting the healthy corporate financial picture. Hopefully the intended increase in manufacturing employment will also become a reality. Just as the components of the U.S. economy are transitioning to corporate spending from the consumer, the fulcrum of foreign economic growth is increasingly shifting to the Far East and away from Western Europe. The economies of Japan, China and India are expanding at near record rates while Western Europe stagnates. These countries contain the largest and most rapidly growing populations, and development promises to be a multiyear phenomenon. Other countries, such as Russia and potentially Brazil, have ambitious growth agendas. With varying levels of enthusiasm and occasional retrogression, all are generally following private sector initiatives to economic growth, and/or raising the living standards of their populations. Unlike the United States where consumers have enjoyed a high standard of living and an extended spending spree, pent up consumer demand in developing nations is very high. We do not pretend to be experts on foreign economies or on currency movements. However, the significance of such broad scale expansion in very large population centers should not be overlooked. Economic development overseas is accelerating and will last for many years. Unlike the decade of the 1990’s, when the United States economy was the sole engine of growth, growth today and in the future looks to be broadly based and more balanced. Increasingly it will be a global affair. This dynamic will create its own tension in terms of trade, currency exchange policies, and protectionism. The potential for raising living standards and lifting deserving people out of dire poverty, however, is real. The whole world benefits from rising living standards, including the most advanced nations like the U.S. Certainly there may be other variables that will impact the future course of the financial markets. It is not our intention to comment on them, nor are we capable of divining their ultimate effects. At the end of the day, however, the financial markets will respond to economic conditions. A sound, growing economy is the healthiest precondition for the financial markets, assuming inflation remains calm and excesses do not develop. In the present circumstances, we believe inflation is likely to creep higher but remain moderate. Competition around the globe remains intense and the excess capacity and resources are characteristics of the global economy. We believe that the transition now underway in the domestic and global economies hold great potential for the financial markets, especially for equities. Investment Policy Committee Alfred A. Lagan, CFA, Chairman November 22, 2004 The opinions expressed herein are those of Congress Asset Management and are subject to change without notice. 2 Seaport Lane Boston, MA 02210 www.congressasset.com
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