Economy, stocks look set for a happy new year
At times, 2006 seemed like one of those I Love the '70s episodes on VH1, except more depressing. A far-off war going badly, an unpopular president, higher oil prices, creeping inflation-not to mention a pungent whiff of actual stagflation as the economy slowed. There was even another Rocky film. The recent passing of two '70s notables, Nobel Prize-winning economist Milton Friedman and former President Gerald Ford, only added to the sense of deja vu.
But don't look for 2007 to be a rerun, at least as far as the economy goes. "The inflation scare of 2006 is over," declares Kenneth Beauchemin, U.S. economist at Global Insight. Now Beauchemin, who expects inflation to drift lower this year to 2 percent, is admittedly being a bit sarcastic. He never really bought into the notion that higher oil prices by themselves spawn an economywide price surge. "Oil shocks are never the proximate causes of inflation," Beauchemin says. "They are by definition short-term. But they set the table for a scare, and then the media [play] it up."
Yet in the minds of many people, at least those who remember the '70s, higher oil prices do equal inflation. "The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence to what would otherwise be a transitory increase in inflation," Federal Reserve Chairman Ben Bernanke told Congress last summer.
Stable prices. Although the Fed hasn't raised rates since June, it hasn't cut them either, despite a slowing economy (growth in gross domestic product fell to 2 percent in the third quarter from 5.6 percent in the first) and a sharp downturn in the housing market.
Making Bernanke's job easier in 2007 is recent good news about energy and housing, the main villains behind much of the stagflation talk. Oil prices are down nearly 25 percent from their high last summer, and even the latest core consumer price index report-the one excluding volatile housing and energy prices-was flat, showing that higher energy prices have failed to infect the rest of the economy. Over the past six months, the core rate is up just 1.1 percent on a yearly basis.
The worst might also be over in housing. Existing-home sales have risen in back-to-back months, and the damage seems to be relatively contained. Although the economy has grown at just a 2.3 percent annual rate in the past two quarters, according to First Trust Advisors, it has expanded at a brisk 3.3 percent rate excluding housing. There is "little evidence" that the ongoing weakness in the housing sector is spilling over to the broader economy, Simon Kwan of the Federal Reserve Bank of San Francisco noted in a recent report, and there are tentative signs that the housing sector may be stabilizing.
Consumers still seem to be digging deep into their wallets. The recent 1 percent jump in monthly retail sales was "a game-changer for those positioned for an imminent hard landing for the U.S. economy," says Mike Englund of Action Economics.