Saturday, April 28, 2007

News Letter 4/28/2007

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The Economy:

There were three negative economic indicators and two positive indicators at the end of Q1, 2007. The economy grew at a slower rate of 1.3% in Q1/07 compared to a growth rate of 2.5% in Q4/06 indicating slowing growth. Inflation rose to a higher rate of 2.2% in Q1/07 compared to 1.8% in Q4/06 indicating rising prices. Oil prices have gone higher to $66.50/bl compared to the low 50’s at end of Q1/06. This does not bode well for inflation in the near term. Gas prices have also gone higher to $2.95/gallon due to high demand and inventory shortages. The housing industry continues to suffer from low demand and lower prices. Housing starts dropped 17% from last year on an annualized basis. On the other hand, there was good news on the unemployment front with the latest unemployment rate at historic lows of 4.4% in March. There was also good news on the corporate earnings front in Q1. Earnings came in higher than expected pushing the stock market to all time highs with the DJIA reaching 13,000. See market index performance year to date in the chart below.

Future Outlook:

Going forward, there are two camps out there. The optimists like Jim Cramer state that we have just started to go higher and the Dow Jones Industrial Average will reach 14,000 by the end of the year. Jim argues that in this bull market there is a shortage of stocks and anytime money managers buy large blocks of stocks they push stock prices higher because there is high demand and short supply for stocks. Morningstar’s Pat Dorsey believes that stocks are still undervalued and the Dow would be fairly valued at 14,000 meaning there is room for the Dow to go up another 7.7%. On the other hand, pessimists point to the negative indicators mentioned above arguing that we are due for a correction. They also argue there is a seasonal drop in stocks in the summer months and since the markets have reached all time highs, investors should sell their stocks and buy back in October after the summer correction. They point to the adage “sell in May and go away”. The seasonal effect is actually real and is related to some money managers taking summer vacations and taking their money temporarily out of the market. My view is that no one can predict the future. I believe that there is a good chance that the markets can go down. If you are nervous, taking your money out of the market during the summer months and placing it in a money market fund would be okay given that on average we have gone up 5.5% year to date. I have personally taken some money out of individual stocks that had large returns. My long term retirement money continues to be invested in mutual funds. I don’t believe in market timing and believe that in the long run markets continue to go higher.

Economic Risks:

As I pointed out in previous News Letters (see links on the left margin), the largest threat to the economy continues to be terrorism, Iran, and the weather. The news yesterday regarding the thwarted Al-Qaeda plot to attack oil installations and government officials in Saudi Arabia is a reminder of the real threat that terrorism presents. Iran’s seizure of British sailors in March drove the markets down because of the fear that the West may go to war with Iran disrupting oil supplies to the world. The hurricane season is upon us as well and any hurricane related disruption in energy supplies in the Gulf of Mexico will have a negative effect on the stock market. Oil is the most important commodity in the global economy and any disruption in its supply will have a dramatic effect on markets and economies world wide. Economies are globally connected. The proof happened in March when China’s central bank raised interest rates to slow down their economy. China had a 10% market correction in one day which immediately lowered markets in Europe, Asia, Latin America, and the US. The global economy is a very delicate balance. Any disturbance anywhere will have a negative effect everywhere.


My favorite stock is Google. Google continues to blow away earnings and steal Internet search market share from Yahoo and Microsoft. Despite the stock price appreciation in recent times, Google will go higher. The analysts’ average price target for Google is $585. Google closed at $479 yesterday. The PEG is at 1.06 which means it is cheap. I think Google will go much higher than the analysts’ target.

Disclosure: I don't have any position in Google. I am a GM employee and own a small number of shares of GM stock.

Mike Katto
Registered Investment Advisor
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