2005 Economic Outlook

Summary: 2005 is most likely to be a year of moderate expansion for the U.S. economy, as is typical at this point of the economic cycle. Sector by sector, however, this is an atypical expansion, which increases the risk of both an early end to the cycle and surprising strength.

The housing market is currently marked by high prices along with a high level of new construction and turnover of existing housing. Increases in prices, construction, and turnover will moderate this year from the combination of high prices and rising interest rates. The effect of the housing market on the expansion will be neutral to slightly negative. A pronounced effect will be the decline of speculation in the housing market; this cash will have to go elsewhere. Much of it will be used to unleverage positions.

Despite the gradual increases in interest rates controlled by the Federal Reserve, on the whole government policy will be very accommodative. Most of the accommodation will come from federal debt growth from the grossly unbalanced budget. Problems created by these fiscal and monetary policies will not appear until the next down cycle.

Consumer consumption increases will pause during the 1st quarter as debts are paid down, but this will set the stage for solid spending increases later in the year, especially if employment recovers enough to spark wage increases, as is likely due to a recovery in production.

Production is recovering as is typical at this stage of the cycle. The fallen dollar will slow the loss of manufacturing and services jobs to overseas. China's interest in normalizing its global relations should benefit companies with intellectual property assets, particularly software companies and, to a lesser extent, chip companies. It should be a very good year for the farm economy if the weather is good, although soybeans will be under pressure from Brazilian production.

China will continue to be the engine of the world's economy, which will benefit all the Asian economies and U.S. manufacturers focused on the export market. In particular mining companies will continue to prosper, as well as heavy equipment makers. Europe will continue to muddle along, hurt by the high euro.

The low dollar should benefit the stock, bond, and real-estate markets, as it makes US assets more attractively priced. Tourism (to the U.S.) should be good as well.

The recent runup in the stock market, plus an increase in short term interest rates and CD's (which seniors are heavily invested in), will build consumer confidence, once some debt reduction is accomplished.

So I see 2 phases of this expansion: first, an increase in manufacturing and services that coincides with consumers (as a whole) paying off debt, followed by a consumer-driven second phase based on reduced debts, lower unemployment, and higher wages. How long and high this virtuous cycle will go is not predictable based on current information.