Portfolio strategy update

A hard landing at the Federal Reserve

David Gottstein

Editor’s note: The following portfolio update is from David Gottstein’s monthly Dynamic Research Group’s newsletter. It was compiled in early January.

The Federal Reserve has always had the tricky task of orchestrating monetary policy in a manner to achieve good long-term economic growth with low inflation. Even through such a prolonged period of economic prosperity, it has been tenuous at best.

Now it appears they may have waited too long to lower interest rates. It is true that one hundred quarters in a row of foreign trade deficits could catch up to the dollar and weaken it enough to spur a round of inflation.

Now with twenty-five dollar oil, even as opposed to thirty-five, this too will add to the inflation fires.

However, the cost of such a significant economic slowdown is too high a price to pay when overall inflation still appears to be somewhat tame. Only when wage pressures get ahead of economic output, should the brakes have really been put on to this extent.

This has not happened yet. However, the Federal Reserve will likely give in and loosen at the end of the month, helping to reduce the deceleration in economic growth, but not enough to reverse it.

We are in for a period of higher unemployment, lower consumer confidence and spending, significantly reduced corporate profit growth, and personal income. Whether we get back on a growth track soon largely depends on the Fed, the new Administration and also what happens in foreign economies.

The Fed will act, Bush will likely get some kind of tax relief, but the rest of the world, already a bit sickly, is going to get sicker from our cold.

The bottom line looking forward is that we should expect 1-2.5 percent economic growth and 5-10 percent corporate earnings growth at best, instead of 3-4 percent and 10-15 percent respectively. At least until better conditions present themselves.