2007...Part 4...The Stock Market

In a 1/20/06 post on the stock market, I opined that the
market had the potential to rise significantly in 2006, with
the SP 500 reaching 1380-1405. We are up through that level
and did see some closing prints slightly above a revised
projection of 1425. All in all, it was a good call.

I also indicated I thought the market could rise into January
of 2007, before a nasty and substantial correction of 15-20%
ensued, primarily as a result of an acceleration in economic
growth and concerns for higher short rates and inflation.

At this point, the economic outlook is more muddled than I had
hoped. The inventory corrections that follow a slowing of final
demand may not yet have run their course, and the improvements
to real consumer incomes I anticipated as inflation waned may
not yet have boosted confidence and spending as much as I had
hoped. In fact, my macro profit indicators have clearly flattened
out as of late, and are not confirming general expectations for
final quarter 2006 earnings.

I am cautious about the outlook for stocks in general over the
first nine months of 2007, but I am not in any position now to
lay out a strong case for a 15-20% decline. So, rather than
push the conjecture, I am now content to forego the decline
projection and track developments as they move along until
I get a better sense of fundamentals and emerging trend.

I would say at this point that my caution extends well into 2007
because It is still early to say how good the balance between
economic supply and demand may turn out. In this cycle, growth
of productive capacity has proceeded slowly relative to output,
and even with recent modest upticks in growth, capacity is still
trailing output growth potential, which gives the economy an
inflationary bias.

There is another difficult issue which concerns me regarding
corporate profits and the stock market. This has to do with
the US trade position which has recently improved. If the trade
deficit is set to level off, as may occur, then the flow of
dollar liquidity abroad will flatten out, and this could
eventually stunt the profit growth of US multinationals as
the global economy adjusts.