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 struggling. 

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 year. 

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. 


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