Commentary; Posted: 6/16/04

U.S. economy is in a flat-out boom

Dave Purdy
Guest Columnist

While financial markets remain focused on negative news from Iraq, high oil prices, terror threats and fear of Federal Reserve interest rate hikes, I see the main thrust of forces that will ultimately drive the market as positive.

I think the U.S. economy is in a flat-out boom. For example, the Institute for Supply Management (purchasing managers) May survey was recently released. Experts closely watch it because it provides an early, accurate read on the cyclical stance of the economy.

The survey shows booming growth in production and orders with low inventories and slowing deliveries consistent with suppliers unable to keep up with sales. In addition, the survey of the change in employment hit the highest level since 1973! So much for the jobless recovery.

Also, as I expected, company earnings rose sharply in the first quarter. For the S&P 500, after-tax reported earnings rose 15.6 percent from the fourth quarter and are up 28 percent from the same quarter last year. Operating earnings were up 6.7 percent from the fourth quarter and 27 percent from the same quarter last year.

The Wall Street analyst consensus estimate was way too low. When the dust settled, 359 out of 500 companiesí earnings were above their estimates, 63 companies came in on target and only 78 ìmissedî (came in low). On average, companies beat the estimate by 7.9 percent - a record.

Make no mistake, there are a lot of companies making a lot of money ñ a record high $141 billion in earnings reported in the first quarter. And, the new tax law largely benefits companies through depreciation accelerations that reduced reported earnings by about $50 billion.

So, the ìrealî earnings number is very likely higher ñ a switch from the fraudulent earnings reports back in 1999.

Well, you say, thatís nice, but how come the stock market is doing so badly this year?

It is not as bad as it feels - itís about flat, with the Dow down 2.4 percent, but the S&P 500 up 0.8 percent year to date.

It feels worse because of all the worries about Iraq, high oil prices, rising interest rates and the continued threat of terrorist attacks.

Certainly all of this bad news is not good for stocks, but I think the positive news on the economy and earnings front will dominate over time.

For now, I am watching the combination of flat stock prices coupled with booming earnings driving widely watched Price/Earnings ratios down. The P/E on the S&P 500, using trailing earnings, started the year at 29. Now it is down around 20.

Using first quarter 2004 earnings for the rest of this year (which assumes earnings are flat for the rest of the year) the P/E is down around 17. That is the average over the last 30 or 50 years. There was a lot of worse news over those time frames.

So, while I am frustrated by the lack of advance in stock prices, I view the continued advance in the economy and earnings as providing better valuations while the other risks are sorted out.

I continue to recommend a well-diversified portfolio that is not overly defensive in this environment.

Writer David Purdy is president of Wealth Management Midwest, Forest Lake, and offers securities through Linsco/Private Ledger, Member NASD/SIPC and an investment advisor.

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