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The Bad Things That Didn't Happen


The data to date point to a "Goldilocks" economy, neither too hot nor too cold.

Note from Professor Vitaliy: The writer of this piece, Michael Conn, is a president and founder of Investment Management Associates, Inc. He is a Chartered Financial Analyst and has been in the investment industry since 1968. Michael and I work side by side and look at the world in a similar way, the only difference is he's been doing this a bit longer (OK, he has ties older than me).

Stock market gains in the third quarter were the best for a third quarter since 1997, pushing the Dow Jones Industrials to the high reached in January of 2000.

Going into the third quarter the headlines were predicting the worst hurricane season in history, oil prices continuing to rise to triple digits, and a bursting of the housing bubble which would bring consumer spending to a halt.

Oil prices did reach $75 per barrel and gasoline $3.00 per gallon, but with most of the gulf refineries back on stream thanks to a mild hurricane season, these prices have fallen and weakness in housing has resembled a gradually deflating soufflé rather than a balloon being burst.

Economic growth is slowing from a rate that might have caused inflation pressures, but the consumer has held up well in the face of fuel and housing concerns that are now lessening. High oil prices didn't push overall inflation much higher, and the inflation outlook now appears to be modest enough to preclude further increases in interest rates. Job growth certainly doesn't look like a boom, but income growth has been higher than inflation and the unemployment rate remains low. Growth in household net worth slowed in the second quarter, due to a negative stock market, but rose again in the third quarter. The home line of credit has been a piggy bank for the consumer, and is certainly a source of risk to consumer spending, but this risk is now mitigated by the estimated $65 billion benefit to household income in the fourth quarter due to the decline in the price of gasoline (Business Week 10/02/06). The peak impact on consumers due to gasoline prices and housing weakness was likely in the third quarter. As the US economy slows, foreign demand has been picking up, and US exports are benefiting. US corporations are in very good financial condition and corporate spending is unlikely to weaken.

The data to date point to a "Goldilocks" economy, neither too hot nor too cold. Future data on the economy, the consumer, and inflation may certainly put this outlook at risk, and this is the reason for continuing to keep an eye on the risk side of the investing equation. The DJIA at current levels is valued on reported earnings similar to January of 2000, dividends are 50% higher, but the biggest difference is the emotional environment. The risks to the market were much higher in early 2000 due to the mania surrounding the stock market at the time. This time the mania has been around real estate, and many investors are just now turning their attention to a stock market which overall is up for the last four years, but not to the extent of past bull markets.
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