Global Trend

The U.S. Economy Keeps on Booming

When a natural disaster practically wipes a major city off the map ? at least temporarily ? it should be expected to have a catastrophic effect on a nation¡¯s economy. But although there was a Katrina-induced fourth-quarter lull, there is no question that the economy is once more surging.

Three broad themes are at work here:

First, growth in productivity, encouraged by sound tax and fiscal policy, has driven this boom and will continue to do so this year.

Second, labor costs will remain manageable because of productivity growth, allowing the cycle to continue with low inflation.

Third, wage incomes will rise, making strong consumption growth sustainable.

To begin with, housing starts are still strong after peaking at a 30-year high in January. However, as the Associated Press reported on March 24, ¡°a 10.5 percent drop in new home sales in February followed a 5.3 percent decline in January and was the biggest drop since a similar 10.5 percent fall in April 1997.¡± Sales of new homes fell in three of the four preceding months to an annualized sales rate of 1.08 million units, the slowest pace since May 2003.

But this negative was largely offset by the positive news, March 23, that sales of previously-owned homes actually rose by a stronger-than-expected 5.2 percent in February, reversing five straight monthly declines. Consistent with forecasts by the Trends editors, it appears that ¡°sales of both new and existing homes peaked at new all-time highs in 2005; a fifth consecutive annual record.¡± Based on this data and other factors, the Trends editors now forecast total home sales will decline this year, as the housing boom slows, and essentially plateau for the next several years.

However, the message from the housing market is: there¡¯s no reason to panic. As explained in prior issues, a reversion back to trend-line appreciation will primarily have the effect of making housing more affordable. Consistent with this forecast, the Associated Press also reported that, ¡°The slowdown in sales was putting pressure on prices. The median price of a new home sold last month dropped to $230,400, down by 1.6 percent from January and off 2.9 percent from February 2005.¡±

The Trends editors expect home prices nationally to fall 10 percent from the 2005 peak by 2010. But, with the average house affordable to just 6 percent, 4 percent, and 2 percent of the consumers in New York City, San Diego and Los Angles, respectively. this price drop should hav a positive impact on home ownership prospects for many. In the three hot spots mentioned above, as well as others like Miami and Boston, this might involve a price pull back of up to 20 percent. Speculators and recent buyers in some markets may have to deal with several years of negative equity.

Furthermore, taking the air out of the speculative bubble in the hottest housing markets will cause more investment dollars to flow into stock, reinvigorating that investment sector.

The Trends editors will examine these implications more deeply in an upcoming issue.

Personal incomes rose 0.7 percent in January, while the rise in monthly retail sales tripled the expected growth, rising 2.3 percent in January alone. Similarly, the personal consumption index rose by 0.9 percent in January after moving up 0.7 percent in December.

Moves like these throughout the year add up to real growth. This suggests that people are spending their extra income on both long- and short-term needs. And this is just one reason that fourth-quarter real GDP growth was revised upward. This all seems to refute any fears about what the weak fourth-quarter 2005 numbers meant.

More encouraging news comes from the new Consumer Price Index figures, which increased 0.7 percent in January after a deflationary dip of 0.1 percent in December. Energy prices surged 5.0 percent in January, the first increase in the last four months. Food and beverage prices rose 0.5 percent. However, inflation in energy and food costs can be misleading. Excluding food and energy, the ¡°core¡± CPI was up just 0.2 percent in January.

That means that ¡°core¡± consumer prices are up 2.1 percent in the past year ? a deceleration from December¡¯s year-over-year gain of 2.2 percent. This indicates that inflation remains under control. And with oil down 15 percent from its high, and gasoline prices off 26 percent, we should see the headline inflation moving down even further, leaving more room for other consumer spending.

Likewise, suggestions that the real cost of labor has risen are similarly misguided. The brief productivity drop in the fourth quarter, due primarily to weather-related disruptions, created a 3.4 percent rise in labor cost per unit output. But this does not reflect in any way on the entire economy, nor on the future.

In fact, if you look at 2005, the rapid growth in productivity made up for a 5.2 percent overall rise in wages, making the correct figure for the rise in labor costs closer to 2.4 percent. That is essentially the increase needed to keep pace with overall inflation. In other words, it represents no increase at all in unit costs of labor relative to the value generated.

In fact, the most recent report from the Bureau of Labor Statistics, quoted in the New York Post, shows no threatening figures and many very encouraging ones.

For example, in December and January, the federal government actually collected more in taxes than it spent, creating a cash surplus. Meanwhile, unemployment, at 4.7 percent, is approaching historic records lows set in the late 1990s. In fact, unemployment compensation is at a five-year low, with weekly initial claims remaining below 300,000 for more than two months now. That extra employment, in turn, will push total wages up yet again.

Industrial production posted its fourth gain in a row, rising 0.7 percent, as reported by Lawrence Kudlow and John Park. Manufacturing showed 5.4 percent growth in the fourth quarter and was churning along at 4.7 percent as of mid-February. Since this number moves in lock-step with the Gross Domestic Product, it shows the track the economy is on for 2006. Moreover, the high-tech sector boasted a lively output increase of 32 percent year-over-year.

The Institute for Supply Management¡¯s manufacturing index rose as well, hitting 56.7 in February, an increase of almost two points over the January level. This translates to annual GDP growth of more than 5 percent. And this is just one in a long list of indicators. For example, 10-year Treasury yields rose to 4.69 percent in response to the broad economic strength shown in other indicators.

Similarly, the employment component of the CEO Economic Outlook Survey reached a new high. Since growth in one area fuels growth in other areas, we expect the first quarter numbers for 2006 to show an astonishing annualized rise of 5.5 percent in real GDP.

With the healthy growth in demand, double-digit corporate profit growth, and companies rich in cash and light on loans, we can expect more new investments in plants and equipment, and continued growth in production capacity. This will further drive growth, even as it boosts employment and wages.

Another indicator of where the economy is heading comes from the U.S. Senate, which extended President Bush¡¯s tax cuts. According to Lawrence Kudlow, it¡¯s significant that Senator John McCain voted for the tax cut extensions, since he voted against the tax cuts in 2003. Apparently, he now sees the positive impact of those tax cuts.

In fact, during Fed Chairman Ben Bernanke¡¯s recent appearance before Congress, he credited those tax cuts with the current good health of the economy. That¡¯s because the Bush tax cuts have inspired new entrepreneurial activity and business investment, which in turn has helped rebuild the economy. Specifically, after nine quarters of decline before the tax cuts, we¡¯ve now seen 11 consecutive quarters in which business investment has risen, at an average annual rate of 8.4 percent.

Bernanke¡¯s realization of the importance of tax cuts tells us that we¡¯ll be seeing strong supply-side leadership at the Fed. Another positive signal was the unanimous approval of Fed board appointees Kevin Warsh and Randall Kroszner by the Senate Banking Committee. Warsh brings valuable professional experience as an investment banker and lawyer to the table, and Kroszner helps move the Fed toward a more supply-side, free-market footing.

In light of these encouraging signs of the economy¡¯s health, we offer the following five forecasts for your consideration:

First, with the new Fed board members and renewed tax cuts in place, expect the economy to continue to boom throughout 2006 and very likely through 2009. Barring an enormous surprise in the mid-term elections, pro-growth policies should remain in effect at least through mid-2009.

Second, expect to see healthy levels of growth in productivity through that timeframe. A tightening labor market will encourage companies to make ever-larger capital investments. Newer, more efficient plants and equipment, as well as the latest technologies, will cause the labor cost per unit output to drop with each new advance.

Third, while labor costs may rise, they will not outstrip inflation. Since that means no real effect on profits, expect corporate profits to continue to rise over the next few years. This will be reflected in robust stock market activity.

Fourth, the number of jobs will increase at a pace of 1.5 percent this year, and, as in 2005, the larger number of people being employed will push real household income up. As stated earlier, wages were up 0.7 percent in January, and the most recent ¡°flow of funds data¡± from the Fed showed household net worth at a record high of $51.1 trillion in the third quarter of last year. So, consumers don¡¯t have to spend the equity from their increasingly valuable homes to fuel the expanded consumer spending that will further boost those corporate profits.

Fifth, all of these factors, taken together, will yield a self-reinforcing cycle that will continue to produce strong economic growth, with low inflation. Profits will rise, and companies will spend more on capital investment. Jobs and wages will rise, as those companies, needing workers, will hire more people. Those workers will spend more, causing increased aggregate demand, which in turn will raise corporate profits and inspire even more capital expenditure. There is no reason that this virtuous cycle shouldn¡¯t continue for the foreseeable future.

References List :
1. Associated Press, March 24, 2006, ¡°New Home Sales, Median Prices Fall in Feb.¡± by Martin Crutsinger. ¨Ï Copyright 2006 by The Associated Press. All rights reserved.2. To access Milton Ezratis commentary ¡°Productivity, Costs, and Consumer Spending,¡± visit the Economic Insights on the Lord Abbett website at www.lordabbett.com/usa/home.jsp3. The New York Post, February 17, 2006, ¡°Undeniable Boom,¡± by John Podhoretz. ¨Ï Copyright 2006 by NYP Holding, Inc. All rights reserved.4. To view Lawrence Kudlow and John Parks commentary ¡°Affirm,¡± visit the American Skandia website at:www.americanskandia.prudential.com5. To view Lawrence Kudlow and John Parks commentary ¡°A Good Beginning,¡± visit the American Skandia website at:www.americanskandia.prudential.com