Vollmer: The Goldilocks Economy

The Goldilocks Economy

By: CHARLES J. VOLLMER

The famous "Three Bears" rule seems to be in effect in the economy, according to the early projections: "Not too hot ... not too cold ... just right."

In 2005, the U.S. economy chugged along at an estimated annual growth rate of 3.8%, which makes economists quite happy. Historically, an economy that is growing in the 5%-plus range annually is heading for a cliff. And an economy whose growth rate falls much under 3% is beginning to raise concerns.

The early view of our analysts at Stanford Equity Research is that the moderate growth rate in the real Gross Domestic Product for 2005 is "just right," and should continue in 2006.

While economic growth stalled to an annual rate of just 1.1% in the fourth quarter - post-Hurricanes Katrina and Rita and surging energy prices - the consensus is that fundamentals still support a growth rate of greater than 3%.

Stanford analysts, as well as policy analysts at Stanford Washington Research Group, support the broad view that the Federal Reserve Bank will continue the program of quarter-percent hikes in the Fed funds rate through the first meeting for new Fed Chairman Benjamin Bernanke and then possibly take a breather.

The campaign of rate increases by retired Fed Chairman Alan Greenspan over the past three years has been focused on preventing inflation. And it seems to have worked. Core inflation (increase in the Consumer Price Index minus the effects of fuel and food) during 2005 was 2.1%. Chairman Bernanke is on record that his "comfort zone" for inflation is up to about 2%, suggesting he might make one more quarter-point turn in the rate at his first meeting this spring and then wait and see.

Moderately positive on bonds

High-yield corporate bonds took a bit of a beating in 2005, beset by a combination of rising interest rates and re-allocations to equities. Ken Weeden, fixed-income manager for Stanford Financial Group, points out that investors' confidence in the once-hot sector began to wane as long-time favorites such as Ford and General Motors experienced credit downgrades. Overall, this group underperformed for the year, finishing just over 2% including interest.

In comparison, investment-grade corporate bonds were up slightly, with tight spreads over comparable U.S. Treasury bonds. High-grade and high-yield corporate debt could continue to feel downward pressure early this year, according to Weeden, but if inflation remains controlled and the Fed ceases its tightening cycle, prices may gain support during this year.

Fixed-income investors may find attractive areas in defense and energy. Utilities have been able to climb out of the debt that hindered them a couple of years ago. And the entertainment/recreation field has stayed surprisingly strong despite some polls reflecting lagging consumer confidence. That could change if continued high oil prices seriously cut into disposable income. But if consumer spending remains strong, the spending should include this industry. As a general rule, fixed-income investors are advised to keep an eye on where consumers are spending.

Trading in Treasuries should remain volatile as managers begin to measure when and how to adjust portfolios in an environment that seems to be conducive to higher stock prices.

Juan Villamil of Stanford Research projects that Latin American bonds overall should extend their positive 2005 performance into 2006, albeit at a significant lower pace. He views the fundamentals in the main countries of the region as excellent and their creditworthiness "unquestionable."

Energy - the ride

The roller coaster of energy costs is projected to continue at least through the winter. Cold weather demand for both heating oil and natural gas is expected to pressure prices upward, even as full oil and natural gas production capacity in the Gulf return.

However, the economy seems to have done a good job of absorbing steep increases in both the price of crude oil and the price of gasoline and should do the same on into 2006.

Two generalized effects of the volatility in the energy market could be a slowdown in consumer spending in some areas as household funds are redirected to heating and transportation and also an overall positive picture for energy-related investments.

Re-building hope and confidence

Stanford Washington Research Group senior adviser and former Federal Reserve Governor Dr. Lyle Gramley looks for a stimulus provided by the massive reconstruction of Florida and the Gulf Coast as a result of Katrina, Rita and Wilma. While projecting 3% growth in consumer spending for 2006, he cautions that factors such as volatile energy prices and a larger than expected cooling of the housing market could dent consumer confidence.

Finally, as we saw last year, it is impossible to account totally for the weather. And the geopolitical situation is, to quote a public figure, "unknowable," and could affect every phase of the economic outlook for 2006. Those factors aside, the consensus of most economic watchers is that 2006 will follow the growth curve for long-term performance favored by economists and Goldilocks: not too hot, not too cold ... just right.

Charles J. Vollmer is managing director at Stanford Group Co., Longboat Key. For additional information, call toll-free 877/387-2800. The opinions expressed above are those of the writer and may not reflect those of Stanford Group Co., Stanford Financial Group or any of its affiliates. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. ©2006 All rights reserved, Stanford Group Co.