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Will the Momentum Continue?


Last year was marked by a surge in investors' appetite for risky assets. The S&P 500 added 28.7% last year after declining in each of the previous three years. However the NASDAQ 100 gained almost 50% and Russell 2000 added 47%, which was its best year since created in 1978. The short index I created last year surged just over 50%. The first week of the New Year is a continuation of this trend. While the S&P 500 has already added 1.3%, the Russell 200 is up 3.2%, as wall as the NASDAQ 100.

We have discussed how the manufacturing sector has started replacing the consumer as the source of economic growth. Last week's release of the manufacturing ISM survey offered more evidence that the manufacturing sector is rebounding. The December survey jumped 3.4 points from November to 66.2. This was also the highest reading since December of 1983 when it hit 69.9. These surveys do not measure the magnitude of growth, but the breath of companies experiencing increasing activity. Of the twenty industries represented in the survey, 17 reported growth. New orders and production were key drivers driving the survey. Production increase 4.7 points to 73.0, the highest level since 1983, while new orders jumped 3.9 points to 77.6, the highest since 1950. Of the 20 industries that report in the survey, 18 reported an increase in production while 16 reported an increase in new orders. Employment increased 4.5 points to 55.5, which is within 0.2 points of the previous peak set in December 1999. This also marked the second month showing job expansion after 37-months of contraction. Evidence that it is a global economic recovery is that export orders reached a fourteen year high in December. Inventories remain lean, dropping 2.7 points after jumping up to 50 last month. Customers' inventories are reported even leaner as the December reading matched the low set in May 2002 of 39. The increase in demand has also pushed the prices. The prices paid component rose 2 points to 66.0. The report included the following paragraph detailing which commodities have experienced an increase in price:

"There are no reports of commodities in short supply. Commodities reported up in price are: Aluminum; Aluminum Extrusions; Beef; Brass; Chemicals; Copper; Copper Cathode; Ethylene; Freight; Natural Gas; Nickel; Plywood; Polyethylene Resin; Stainless Steel; Steel; Steel Plates; and Steel Tubing. The only commodity reported down in price is Corrugated Cartons,"

Similar to last month, the non-manufacturing survey revealed that the service sector continued to decelerate in December. The ISM non-manufacturing survey dropped 1.5 points and was 2.4 points below expectations. Looking through the components of the survey, it is difficult to how it declined - new orders increased 0.9 points, backorder rose 3.0 points, inventory was up 0.5 points, prices increased by 2.0 points. The only parts that fell were: deliveries, employment, and imports, by a cumulative 2.4 points. Nevertheless, a 58.6% reading is nothing to get concerned over. It still represents a healthy expansion.

This week, I spoke with a sell side analyst this week that covers diversified industrial companies. During the conversation he said that his channel checks at distribution centers found that October and November where average, but saw a big increase in orders in December. At this point, it could be related to year-end budget flushing and not indicative of sustainable growth so there is little being done to increase capacity. But, if this continues for the next couple months, then there will be more hiring to handle the increased workload. This fits with what has been happening with the economic data lately. We have seen a dramatic increase in manufacturing activity, but little job growth. Too many businesses have been promised a "second half recovery" too many times that they are leery that the economic recovery is sustainable.

Currently, the rebound in the manufacturing sector appears to be sustainable, at least for the near future. Since the manufacturing sector had been extremely weak for several years, a robust rebound would be expected off the bottom. Economists have spent the past years hoping that consumers would shoulder the economy until the manufacturing sector started expanding. It appears that has happened. But consumer spending is over four times greater than business spending, so consumers will have to continue spending if the economy is going to grow faster than 4%, which are what economists are now expecting.

Auto sales will be an important factor for consumer spending. Vehicle sales closed out 2003 with the second best month of the year. Vehicle sales jumped to an 18 million annualized rate in December, 1.2 million higher than November sales. For the year, auto sales were 16.7 million units. While this was another good year for automakers, 2003 was actually the fourth consecutive year of declining sales. The cycle topped in 2000 with 17.4 million vehicles sold. In each of the past five years, there has been more than 16 million units sold.

The economy seems poised to keep rolling along now the manufacturing has started to rebound. Consumers will benefit from higher tax refunds during the first and second quarters. One big question will be if homeowners will be able to continue to tap home equity to fund consumption. The easy answer is that the record amount of refinancing and home equity loans in 2003 cannot be replicated. But that was also a popular misconception after the 2001 refinancing boom. It will be important to closely monitor housing prices to see if this source of funds remains available in 2004.

Here is the stat of the day. In searching for something that might show future economic weakness, I found myself on the census website. I generally find demographic data interesting and I never would have guessed this number. In the 2000 Census there were 1,388 people that were 110 years old or older. There were over 50,000 that were over 100, with 80% being female. I'm sure there is a marriage joke in there, but my wife reads this column.

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