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Outlook 2006:
Consumer Spending
by Paul J.
Nolte, CFA
December 19, 2005
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Winter solstice, the longest night of the year and a prelude to the Christian holiday season marks the beginning of the long cold winter for those in the northern climes of the US. It is also what gets the traders excited about buying natural gas futures. Gas prices are way up, inventory still is running ahead of the five year average and on par with year ago levels, yet traders are concerned that we won’t have enough to weather the winter. What makes the prices are up or down? Just have a trader go outside, if he is cold, buy – if warm, sell. In more mundane economic news, inflation fell as oil prices fell last month, industrial production and capacity both rose, indicating the economy continues to “produce” well ahead of our initial estimates of a year ago. So what about the future? We will focus on the spending figures released next week for an indication of how the consumer is actually doing. The key to our outlook for 2006 is how engaged the consumer is in their spending habits. Or will the rapidly cooling housing, higher gas/oil prices and higher interest rates finally put a dent into the very strong habit of spending – no matter what. Although there will be a bunch of economic news next week, we expect the investor to have pretty well bagged the year by mid-week. We are seeing indications of rising sentiment and an expectation that 11,000 will be hit on the Dow by yearend. All pointing to a “too confident” investor in the continued good times ahead. We cite a still historically high valuation (we use trailing 12 month earnings), although cheap vs. the past eight years, still very expensive vs. historical norms. Investors have bailed on “short funds” (those that gain when the market declines) and piled into the high volatility technology funds. Our sentiment indicator is getting to a “sell” that was last hit in December last year, prior to the early ’05 sell-off. However, (and there is always at least one) our longer-term momentum indicators are toward the lower end of their ranges, indicating we are closer to a rally than a decline. If we are to draw up the year next year, we expect it to follow historical trends, a weaker first half to three-quarters before yet another yearend rally. However, we don’t expect the market to get too much above breakeven by yearend. After three years of gains, the sledding may get tougher yet in 2006. For the first time in a couple of months, the bond model finally flashed a buy signal, indicating interest rates may decline in the months ahead. We generally like to see a couple of weekly buys before getting more aggressive; at least the decline in both short and long rates is welcomed. While the language changed with the Fed hiking interest rates for the 13th time last week, we believe that it allows Ben Bernanke, the next Fed chair, room to maneuver when he takes over in March. Further, we expect the Fed to be done raising rates by mid-year and by this time next year, we will be discussing interest rate cuts in 2007. We will be watching the “core” inflation reports in the months ahead to assist us in determining whether the Fed is done or will continue the hiking cycle.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
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