January 21, 2004
What a difference a year makes. Last year, uncertainties about Iraq and North Korea and the
oil strike in Venezuela and oil field disturbances in Nigeria created an
unusually large amount of uncertainty. A
weak stock market and job declines only added to forecasting risk.
This year, by contrast, is a yawner.
Corporations have experienced an 18 percent gain in after tax operating
profits. They are beginning to
purchase capital (investment rose at a deflation adjusted 17 percent annual rate
during the summer) and take on risk. Employment
remains hesitant, mostly temporary workers, but a few more months of revenue
growth and that will improve.
However, there are risks in this forecast.
The dollar's weakness coupled with the increasing competitiveness of
China could lead to global instability. High
prices for industrial materials, including petroleum, could drain purchasing
power from households.
Although another $65 billion of reduced tax liabilities
will offset some of this, most of those gains are going to the higher income
households that have capital gains or dividend income.
They might not spend as vigorously as liquidity constrained households.
Also, the falling dollar may lead to international demands
of a yield premium to offset the dollar risk.
When corporations begin to borrow for capital expansion, this premium
might raise long term interest rates. The
Federal Reserve might be forced to raise short term targets to reduce
distortions created by such a wide spread between short and long term rates.
Of course, higher interest rates could undermine stock
values. And there are always those
terrorist and geopolitical issues that proved to be less compelling than we
thought last year.
Having made all my possible excuses, I must admit that most
of them are possible but not likely. Every
decade or so, the consensus forecast for a year is correct.
This may be one of those years.
As I will judge myself on the accuracy of my forecasts, I
need to present some specific targets. This
also encompasses a list of some of the more important variables that an annual
forecast should contain.
First, economic growth should average about 4.5 percent.
Slightly stronger gains are expected in the first half of the year than
toward the end, when housing may be stalling and consumer spending could be
Second, the Federal Reserve probably will declare its
independence by raising short term rates in August but wait until 2005 before
raising rates another 1.5 percentage points.
Thus, the prime rate should end this year at 4.5 percent.
Third, long term interest rates should rise from their
first quarter lows for the remainder of the year.
About three quarters of a point increase in mortgage and 10 year
government yields are expected by the end of this year.
Fourth, core inflation, currently 1.1 percent for the past
year, will gradually rise to 1.7 percent by the end of
2004. Energy and food
prices, which added almost a full percentage point to core inflation in 2003,
should subtract slightly from core inflation in 2004.
Thus, the inflation rate will subside to only 1.5 percent gains for the
Fifth, equity values should rise about 13 percent from the
beginning of January to the end of December for the Standard and Poor's 500.
That means an S & P index of 1250 at year end.
Furthermore, this year's peak should be reached, following a spring
correction, near the very end of the year.
Sixth, the dollar will continue to fall against most major
currencies until late in the year. The
trade weighted index, currently about 111, should decline to 105 before
rebounding at that time. This means
a $1.40 euro, a $2 pound, and a 100 yen all will occur this year
Seventh, employment growth will remain anemic.
Job growth will average only slightly more than 100,000 per month
although seasonal factors might put the bulk of those gains in the next few
months. In Atlanta, another 60,000
jobs will be created, and these will be higher paying than the temporary
employees who got the bulk of the job gains in 2003.
Eighth, after tax operating profits will expand another 18
percent on average for the year.
The deficit eventually will matter, but not a lot in 2004. And, except for those who lose their jobs or discover that the value of their skills no longer is what it once was, most people will consider this performance acceptable enough to preserve the current administration in the White House.