The commodity markets provide another source of information regarding price pressure faced by business and consumers. Although companies can and do offset the cost of rapidly rising goods purchased by operating more efficiently and/or by accepting lower gross profit margins, the cost trend applicable to commodities should not be ignored. Table 3 illustrates the monthly trend in the cost of key goods traded in the commodity market. Gold prices, which provide a harbinger of inflation, increased by 10 percent in May. Gold prices also respond to continued global terrorism, the mounting U.S. fiscal deficit, and expectation of modestly higher prices. After falling in April, oil prices increased by over eight percent in May trading. High oil prices cause severe operating problems for industries dependent upon petroleum, such as airlines and trucks. The all-commodity futures’ index increased by over five percent in the past month. The higher cost commodity costs are consistent with the high cost component applicable to surveys conducted by the Institute for Supply Management. Prices are behaving well; neither deflation nor inflation should inhibit economic expansion in the United States during 2003. Governmental policy remains stimulative.

Fiscal Tax Legislation Enacted 
Although the U.S. government posted a surplus of US$51 billion in April, the fiscal deficit posted through the first seven months of the year amounts to US$202 billion versus US$65 billion red ink a year ago. Governmental outlays have increased by 6.5 percent in the past year as defense-related spending mounts. Tax receipts have declined by 5.4 percent in the year. The U.S. federal government is on track for posting a deficit well in excess of US$300 billion in the current fiscal year. Congress and President reached compromise and approved a tax relief and jobs bill that is projected to cost US$350 billion over the next ten years. Key provisions and projected costs include (percentage of projected costs shown parenthetically):

• Cut the marginal tax rate applicable to both dividends and capital gains to 15%: (42%)
• Accelerate to this year and next lower marginal tax rates currently projected for 2004 through 2006: (32%)
• Increase the standard deduction and expand the 15% tax bracket for married couples: (10%)
• Raise the child credit from $600 to $1,000: (9%)
• Provide more generous expensing of investments for small business and more liberal depreciation for large business: (3%)
• Other factors related to alternative minimum tax and expansion of the 10% bracket: (4%) 

It is instructive to note that only US$10 billion or three percent of the $350 billion tax program directly encourages investment in equipment and technology by business. Economic stimulus will only occur if American taxpayers quickly spend or invest projected tax savings. The tax package also provides limited fiscal support for financially-strapped states. Deficit-reduction will soon top political agendas.

Not only did the Federal Reserve cut interest rates 11 times in 2001 and once in 2002 to stimulate growth, the central bank has increased the supply of funds. During April, the increase in the money supply represented one of three key components that led to a minuscule increase in the Index of Leading Indicators. The narrow money supply, M1, and the broad money supply, M2, both ballooned by about two percent in May. Further, free reserves in the banking system increased another US$100 million to $1.5 billion. The central bank clearly has indicated it will cut short-term interest rates again or begin to buy longer term U.S. Treasury debt to reduce capital market interest rates if needed. Although European countries are struggling to regain economic momentum, China is trying to contains SARS, and Japan is attempting to offset debilitating deflation, the U.S. should be able to achieve sustainable growth given the stimulative fiscal policy, a very accommodative monetary policy, another wave of mortgage refinancing and a depressed value of the U.S. dollar that should trigger more export activity. The U.S. economy needs a jump-start.

Weak Growth Projected

Index of Leading Indicators Barely Turns Positive 
The Index of Leading Indicators increased by .1 of one percent in April after declining the prior two months. A shorter workweek, higher unemployment gains and fewer firms reporting slow deliveries all held the Index down. Improved consumer expectations, increasing stock prices and rapid money supply growth turned the Index positive. Regardless of individual components, the Index suggests the tepid recovery will limp for at least another six months. The Institute for Supply Management’s monthly survey for the manufacturing sector declined from a weak reading of 46.2 in March to 45.4 in April. A reading below “50” suggests no growth. The purchasing managers reported weakness in production, employment opportunities and inventories. 

The manufacturing sector is unable to generate sustained vigor. 

• Factory orders increased by 2.2% in April; defense orders surged by 14.2%.
• Industrial production fell by another .5% in April after declining in March; the manufacturing sector contracted by .6% while both mining and utilities reported enhanced operations.
• Capacity utilization at the nation’s factories, mines and utilities fell to 74.4% in April compared to the 20-year average use of 81.3%.

Clearly, the industrial sector is struggling to reverse course and regain momentum.

The recently enacted tax legislation provides few new incentives other than the ability for small firms to expense US$100,000 of equipment in a year versus the prior limit of $25,000, and the ability for all firms to temporarily expense 50 percent of a depreciable asset rather than the 30 percent previously used. The change in depreciation will increase the rate of return on an investment by about three percent. Selected firms are benefiting from substantial increases in defense and homeland security spending by the federal government. 

The equity markets reacted positively to the end of war-uncertainty, the expectation the central bank will retain an accommodative monetary policy and the major tax cut. Table 4 illustrates the monthly trend for key indicators of the broad-based Standard & Poor’s 500 Index. The Index gained about five percent during May, which is equal to the gain posted for the year-to-date. The Index remains 14 percent lower than year-earlier levels. The material monthly gain can be traced to both improved confidence demonstrated by investors who increased the price-earnings (PE) multiple assigned future earnings from 15.9 times in April to 16.3 times in May, and increased corporate earnings. PE ratios reflect earnings growth projections by investors and demonstrate the willingness of investors to accept risk in the market. Although dividend yields fell by five basis points in May trading to 1.76 percent, the cash returns on stock exceed U.S. Treasury bill yields by almost 70 basis points. Business Week reported that earnings of an all-industry index increased by over 30 percent from year-earlier levels. Auto, oil & gas, diversified telecommunication, and industrial conglomerates all reported significant gains in net income. The equity market gains have yet to translate to job growth and new employment opportunities.

Table 4
Monthly Equity Market Trends
Standard & Poor’s 500

Standard & Poor’s 500	May 2003	April 2002
Index	923.4	879.0
Price-Earnings Ratio
Trailing Year	29.5x	31.3x
Next Year	16.3x	15.9x
Dividend Yield	1.76%	1.81%

Source: BusinessWeek and Standard & Poor’s Corporation

More Jobs Lost
The Conference Board reported a very large gain in consumer confidence in April; the monthly index surged from a very low reading of 61.4 in March to 81 in April as prior concerns related to the war and cost of oil dissipated. Despite the monthly gain, consumer confidence is lower today than in the recession of 2001. Indeed, only 5.9 percent of the 5,000 households polled expect to purchase a car in the next six months which is the lowest proportion since 1996. The low confidence is directly linked to the loss of jobs in the economy.

• Another 48,000 workers lost employment and the unemployment rate increased by .2% to 6.0%. Over 500,000 Americans have lost a job in the past quarter.
• Despite the devastating loss of jobs, both personal income and spending increased by .4% in March and personal saving rate hovers near 3.6%.
• Consumer debt increased by a minuscule .6% annualized rate in March compared to the 3.6% growth posted in 2002 and 6.9% in 2001.
• Retail sales fell .1% in April but that poor month merely offset a 2.3% rise reported in March. Discount stores, such as Dollar General and Costco, report strong retail sales growth, while department stores, such as Sears or J. C. Penney, report declining sales.

The consumer sector is key to the U.S. achieving sustainable growth because it accounts for about two-thirds of gross domestic product. The tax legislation will increase disposable income for workers as early as July 2003. Many homeowners will again be able to refinance mortgages given the recent drop in 10-year U.S. Treasury rates of interest that affect home loan rates. Employed Americans will have more money to spend.

The economy would have remained in a recession, rather than the tepid recovery during the past year, without the robust residential real estate market. Long-term, fixed-rate mortgage rates fell to 5.3 percent in May compared to 6.8 percent a year ago. The one-year decline can reduce monthly payments by over 14 percent and save almost $150 per month for a mortgagor with a $150,000 30-year loan.

• Although construction spending fell by 1% in March, it remains 1.5% above year-earlier levels. Residential spending increased by .1% in March, non-residential fell by just .2% and public spending plummeted by 3.5% as states grapple with fiscal deficits. 
• New home sales increased by 7.3% in March to 1.012 million unit sales. Importantly, the supply of new homes fell from a low 4.4 months in February to 4.1 months in March.
• Existing-home sales declined by 5.6% in March as prospective home owners watched war news. Despite the monthly decline, home sales represent 5.53 million annualized unit sales.

The very low rate of interest for mortgage loans should provide more support for the residential market. Non-residential construction will remain weak as office vacancies exceed 16 percent and industrial vacancy rates rose to 10.1 percent in the first quarter of 2003 compared to 8.9 percent a year earlier.

Summary

The fighting in Iraq is over. Congress approved major tax relief legislation. The Federal Reserve has indicated it will retain an accommodative monetary policy. Stock prices are up five percent this year and long-term interest rates have declined to record low levels. Consumer confidence has improved but remains low. The U.S. dollar has lost over 20 percent of its value against the euro and almost 10 percent against the yen in the past year. Although the FOMC has stated concern with falling prices, gold prices, oil costs and the commodity futures’ index all increased in May trading. If the consumer sector spends tax savings, low mortgage rates encourage another wave of refinancing activity and home purchases, and the low value of the dollar props exports, the U.S. economy will enter the long-awaited expansion phase of the business cycle. Policy-makers have provided a framework to support economic growth. The financial markets do not project expansion until late in the year.