Politics & Policy

Taking Stock of 2003

The White House and Fed deserve some praise.

The stock market ended the year on a positive note for the first time in the decade, loudly proclaiming that the three-year equity losing streak is now history. For the year, large-cap stocks as measured by the S&P 500 increased 26.1 percent and small-caps as per the Russell 2000 posted a 47.61 percent return. When all is said and done, irrespective of size, style, and/or location, 2003 was a very good year for the stock market.

And while there may be some dispute as to the origins of the resurgence of the market, there is no mistake as to the timing and the acceleration of the pace of economic activity. Real GDP grew at a 1.9 percent rate in the first quarter, 3.1 percent in the second, and 8.2 percent in the third (the latter was the fastest rate in 20 years). In spite of this acceleration, the U.S. inflation rate came in at a modest 1.8 percent while core inflation at 1.1 percent was the lowest in 40 years.

So, what’s behind the turnaround? In short, the White House and the Federal Reserve.

The policy mix concocted by the Bush administration and the Greenspan Fed has brought about the ideal outcome of a strong economic recovery with little or no inflation. Kudos to both. From most all angles, this is a very good recovery.

Just look at these other indicators: The November industrial-production index had its strongest increase in 4 years. Accelerating capital goods investment lifted the Institute for Supply Management’s index to a 20-year high. And business investments are turning progressively stronger.

Muscular productivity gains are partially responsible for the slow employment recovery, yet all indicators point to gains in employment during the coming months. A fourth month of payroll gains after a six-month string of declines is consistent with employment increases and an improving economy. Also, the unemployment rate has fallen to 5.9 percent from its June peak of 6.4 percent.

It’s worth noting that the surge in confidence in the economy and the stock market coincided with the decision to go into Iraq last March. The early success of the campaign reduced the terrorism premium on equity valuations, and as a result stock values rose. Since the U.S. suffered a disproportionate burden of the terrorist attacks of 9/11, it seems logical to assume that we would get the bulk of the benefits of the lower risk premium — U.S. equities outperformed the rest of the world.

Then, in May, Congress passed the Bush dividend tax-rate cuts, after which real GDP continued its acceleration as did market valuations.

Historically, a low inflation rate coupled with a strong and sustained worldwide economic expansion has been a good environment for global investing — 2004 should be no exception. The cause of the recovery is something that economists love to debate, but it is clear that the Iraqi war and the passage of the Bush tax-rate cuts were integral to the economy’s rebound. Capturing Saddam Hussein and Libya’s agreeing to surprise nuclear inspections should further reduce the terrorism premium in the coming months, again tilting the balance in favor of U.S. stocks.

— Victor Canto, Ph.D., is the founder of La Jolla Economics, an economics research and consulting firm in La Jolla, California.

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