The economic future is rosier than expected

We have been calling for GDP to average 3.0 percent real growth in 2010. This call was initiated in August of last year and the consensus (average economist view) of the annual growth rate at that time was 2.6 percent. Since then, we have not made any adjustments to the initial forecast.

Now, the consensus forecast is calling for the economy to grow by 3.0 percent. In other words, Wall Street has once again come to Kansas City.

Dogs are curious creatures and in some ways very human. Dogs tend to view the world as a static place. They have little capability, or desire, to look to the future. Many people are the same as dogs – they have little capability or desire to look to the future. We would place many economists into this mix.

Normally, economic consensus forecasts tend to be current weighted, with current data weighing heavily on forecasts. We attempt to stay away from this tendency by continuously looking forward in our economic and market analysis. We are noticing certain trends that lead us to conclude the following: It is time to adjust our economic and market outlook for the remainder of 2010. 

We are moving our expected economic growth rate from 3.0 percent to 3.2 percent. Additionally, we are lowering our expectations of inflation and interest rates by the end of the year. Make no mistake – we still believe interest rates will rise, on balance, for the majority of this year as the economy continues to gain traction and final demand trends firm. Additionally, we have raised our projected trading range for U.S. stocks by roughly five percent from our previous projection.

What has happened to drive us to the conclusion that the economy on balance should be stronger going forward than our previous thoughts? It is one word – consumer.

We have been, and still are, concerned about overall consumer spending trends. We believe in the long term that the consumer will not count as much toward overall economic growth than has been the case in the past. These beliefs are based on systemically high unemployment, massive wealth destruction and demographic trends. As we stated before, these macro trends still remain a concern. However, data which is now becoming more apparent (retail sales, housing data, discretionary consumption patterns, improvement in employment) suggest that the consumer, while not out of the woods, is showing signs of recovery.

As the employment picture continues to improve, we believe consumption will grow slightly more quickly than we had originally projected. Consumption still represents more than 65 percent of overall economic power within the U.S. Consequently, a little adjustment in this area translates directly to an overall healthy and powerful economy. In the face of this slightly better-than-expected economic performance, inflation appears to be very much at bay.

We believe the risks of rising inflationary pressure are still with us, and indeed may accelerate as 2011 unfolds. We continue to believe the current economic and market rallies may prove temporary in nature, as the nation’s balance sheet remains highly levered, with significant risks still present for interest rates and currency exchange rates. As follow-on to this slightly more positive economic outlook, we believe corporate profits will show substantial gains during the entire year. We now expect corporate profits to rise by 25 percent, a higher raw growth rate than has been seen in more than two decades.

 This is what should drive stock prices higher as the year continues to unfold. All of the issues mentioned above are in relation to the economy’s “income statement,” or overall economic growth rate. We continue to believe this rally in stock prices is wrapped within a secular bear market – one that may indeed return sometime in the not-too-distant future. For now, however, we believe the bull market for equities should continue as the economy’s growth profile marches forward.

The economy and markets appear to be experiencing a temporary return to a “Goldilocks” environment, in which the economy isn’t hot enough to immediately create a spike in inflation pressure, nor cold enough to create economic growth challenges. Additionally, the bears in the Goldilocks tale appear to be out of sight. We believe the non-sighting of bears will prove to be temporary, because eventually, investors’ focus will move from the nation’s income statement back to the balance sheet. This is a land where Goldilocks will not be found.

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