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Stock Markets to Rally?
by Ivan Gelfand

The stock market for the year 2005 has been very erratic. This has resulted in an approximate 4% decline in the markets, year to date. I still am convinced, though, that my original forecast of an approximate 10% increase for the year will stand up. This is despite the many negative economic statistics that have been released so far. The economy has slowed, as indicated by the first quarter GDP (Gross Domestic Product) of only +3.1%. The second quarter GDP is expected to be weaker at about 2.6%. However, the full year GDP should be in the area of 3.3% to 3.5%, indicating a much stronger 2nd half of the year. There continues to be an abundance of problems. In any event, we are not heading for another recession. Most of the bad news has already been released. We should then see a modest stock market rally beginning mid-year.

With that being said, stock investors should continue to be cautious, mainly due to the volatility of the markets. Investors should continue to look at the larger capitalized companies or the “blue chip” stocks; and within that group of stocks, those companies that are undervalued, or at least valued properly to the price of the stock. Continue to look for companies, not industries.

In the past, I have said – To have a good stock market, you must have low inflation, low interest rates, and good corporate profits. Although we have seen a modest step-up in the consumer price index, the core rate (which excludes food and energy prices) continues to be below 3%. For 2005, the annual rate is expected to be about 2 ½% from 2.2% in 2004. The rate for 2005, including food and energy, should be in the area of 2.8%. Therefore, inflation rates remain at a satisfactory level, for the present. As to year-end Federal Funds Rate, it is expected to be in the range of 3 3/4% to 4%. The long shot would be 4 1/4% to 4 1/2%. Corporate profits for the year, so far, have been increasing steadily despite a few disappointments by some major companies. This trend in good profits should continue through the balance of the year, primarily in the last two quarters. The stock markets didn’t take too kindly to the weak showing of General Motors and the subsequent downgrading, to non-investment grade, the credit ratings for the auto industry in general. In the past few years, corporations have not been able to pass on higher manufacturing costs to their goods sales prices. However, companies, now, are finding that price increases are beginning to hold. As a result many companies will begin, once again, making capital investments for plant and equipment purposes.

The high cost of energy (oil) seems to be settling in at about $50 per barrel. This should not only stabilize manufacturing costs but allow consumers to begin spending again. In addition, job growth is also contributing to the recovery. In April, employers created an unexpected 274,000 jobs, while the unemployment rate dropped to 5.2%. It is expected that this rate should continue to drop to about 5% by year-end. All of this is a greatly needed boost for the economy. Home sales continue to move at a positive pace. Mortgage rates have not moved up in relation to short interest rates. In fact these rates have actually come down. Because of low home mortgage rates, sales of homes and refinancing continues to be strong.

The Treasury Department is considering issuing 30 year bonds once again. They stopped issuing them in the 90’s when the country was in a surplus position. I thought that was a mistake at that time. Why not lock-in some lower rate, long term bonds, when the opportunity presents itself? Rates are lower now, but the country is in a huge deficit position. By issuing 30 year bonds now, it is an indication that the U. S. is anticipating deficits for many years. The positive, of course, is that issuing 30 year Treasuries now; it will lower the government’s borrowing costs. Speaking of deficits, Congress approved another $82 billion for the Iraqi war. That puts the current cost of the war at better than $200 billion. It is quite obvious that there is no way that our huge national deficit will be cut in half during the next 3 or 4 years. As I said back in late summer of 2003, these deficits will come back to haunt us in the next few years. Mr. Greenspan, Chairman of the Federal Reserve Bank, is now warning that the deficit will increase our inflation. It is for this reason that we will see increases in interest rates through the balance of this year, whether the economy continues to grow or not.

The consumer is not dead. Retail sales for April moved up an unexpected 1.4%. The increase was across the board in the retail area, which would include autos, gasoline, department stores. It is expected that retail sales will continue to be positive, but at a slower pace, to hold up its end of the economy during the last 3/4s of the year.

The short maturity bond markets continue to march in tune with the increase in short term interest rates. I may sound like a broken record, but I would continue to invest in short maturities, no longer than 5 years. Also, continue using the ladder approach, or equal dollar amounts in each year. This will not only preserve the principle in a rising interest rate environment, but will provide higher yields than in money market instruments or even Treasury Bills. The one “negative” to this approach is that your bond performance will not compare favorably with the bond indices. This is only paper performance, however, and easily explainable. Continue to invest cash that is set aside for stock investments in 3 or 4 month agency issues. This will produce approximately ¾% greater yield than money market funds or instruments.

The new bankruptcy law has been enacted and signed by the President. This will tighten the rules for individuals filing for bankruptcy. There is a 6 month grace period in the bill, which means individuals can continue to file for the next 6 months under the old laws. Watch for legal firms throughout the country to be swamped with bankruptcy applications during these 6 months.

Finally, it looks like there will be no changes in Social Security coming out of Congress this year. It has become a political football for everyone to kick around. Prediction – Nothing will be done to change the Social Security until a year or two before it runs out of funds. At that point everyone will be scrambling and blaming each other as to why nothing was done sooner. I probably won’t be around for that, but where ever I am, either looking down or looking up, I surely will get a laugh out of it. The sad part - this is not funny.

Copyright Ivan Gelfand. All Rights Reserved.

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