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Euphoria…Then Reality

Stock Market News

May 2007

Euphoria…Then Reality

The Dow soared past the 13,000 mark as April drew to a close, and the NASDAQ also dazzled, reversing March’s downward drift to gain almost 5 percent. But before investors could bask in the excitement of a series of a record highs, the Commerce Department injected a sour note, releasing data that showed economic growth during the first quarter of 2007 had slowed to its weakest pace in four years. For the most part, the market was able to withstand the somber news, ending the last week of April flat rather than in decline.

So what is an investor to do? The bad news is that the persistent slump in the housing market has dragged the economy down. The nation’s gross domestic product (GDP) the most comprehensive measure of economic activity expanded at a rate of 1.3 percent in the first quarter of the year—just over half the rate recorded in the same time period in 2006. Did this slow-down help put a halt to inflation? Unfortunately, no. The consumer price index (CPI), which excludes food and energy prices, rose at 2.2 percent in the first three months of 2007—a rate which continues to make the Federal Reserve a little nervous. More inflation and less growth is not a reassuring combination.

The dollar took a major hit overseas in response to the Commerce Department’s data, briefly falling to its lowest rate against the euro, as investors assessed the possibility of higher rates of economic growth and rising interest rates in Europe. The trade gap remains an issue, too. A weak dollar may help U.S. exporters, but it hurts importers.

The good news is – of course—that corporate earnings outstripped expectations. Analysts attribute this robust trend to corporations’ success in improving overall productivity. In other words, savvy management is allowing corporations to maximize earnings and profits. Business investment rebounded somewhat from its lackluster rate to show expansion of an annual rate of 2 percent during the first quarter of this year. Investment in information technology was a major factor in the rebound, with this segment contributing more than half a percentage point to the overall growth total—bringing in good news for Silicon Valley.

But back to the Fed’s concerns for a moment…just like Wall Street gurus, as well as individual investors, the decision makers at the Fed are struggling to make sense of contradictory signals regarding the nation’s economic outlook. This means the Fed remains in a quandary over interest rates. A slowing economy suggests cutting rates to trigger growth but inflationary pressures indicate a need for higher rates to inhibit prices increases. While the Fed ponders, rates are likely to stay where they are until the Fed gets a clearer idea of where the economy is headed.

Indecision Reigns
If the pros are mired in indecision, what should the individual investor be pondering? Well, don’t overlook the good news. Positive indications still remain. The corporate profit picture is a big factor. Likewise companies with significant overseas operations are reaping good profits from countries with stronger economies. Other investment experts see rosy prospects for people who stay committed to the equity markets, because they anticipate that the relatively brisk rate of buyouts and buybacks will continue. This means that, over time, individual investors should benefit from the effects of a dwindling pool of stock and the potential increase in earnings per share.

In a world where disparate data commands the headlines, perhaps the smartest approach is a wait-and-see stance. Remember that knee-jerk reactions rarely yield long-term success.
 

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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