The case in short is for the soft-landing economy that lands on a gusher of $2 trillion of corporate cash and another $2 trillion of investable cash, sitting in consumer money markets and cash equivalents.
My crystal ball shows the following occurring in 2006:
• The Fed done at 4.75%-5% short-term rates.
• Historically low REAL interest rates (relative to 2%-ish inflation).
• Steady oil and energy prices (oil at $52-$62 and natural gas at $9-$12).
• Tame inflation and unit labor costs (under 2.5%).
• Productivity growth around 3%.
• A cooling of the housing boom, which tells the Fed it finally has teeth to keep demand inflation (where too much demand chases too few goods) at bay.
• Speculative cash moving back into the market from the spec/flip condo and housing markets.
• Pent-up demand for corporate IT spending, dividends and acquisitions from its $2 trillion in cash that takes over for lower rates of consumer spending growth from the cash infusion from home equity financing.
• 10%-20% reductions in home values in the "ultra-overheated but now cooling to reality" residential real estate markets.
The $85 per share of S&P 500 earnings in 2006 puts us in the 14 P/E range — Yes, that includes energy earnings. (Don't they count, too?) Energy and power is a $1-trillion-plus industry in the United States — bigger than technology and more important to our everyday lives. And those earnings will be the strongest EVER in 2006.
BUT THERE COULD BE TROUBLE AHEAD
So what are the potential market killers for 2006?
• An inverted yield curve — the dreaded harbinger of oncoming recession.
• A housing price collapse.
• $100 oil and $25 natural gas.
• The Fed overcooking interest rates.
• Energy price spikes that we'll hit in the next week.
But let's take out the inverted yield curve fear right now, as the jury is split 50/50 on whether an inverted yield curve means recession.
My take is that unlike the six times in the past when the inverted yield curve DID portend oncoming recession, 2006 is very much like 1966-67 and 1998 — times when the inverted curve FAILED to forecast a recession.
The reality today, unlike those false alarms, is that REAL interest rates (Fed funds minus core personal consumption expenditure deflator) will be around 2.25% — NOT the 4.5% real rates that were in place in the six times the inverted curve was right in predicting a recession.
Real interest rates of 2.25% are still accommodative AND make dividends from stocks look great. Buying back gobs of stock make P/E ratios compress to even lower ratios — and make stocks cheap relative to other assets that compete for investment capital.
Tune in this weekend to our Business Block, Saturday beginning at 10am ET, for more with Tobin Smith and the entire FNC business team.
Tobin Smith is a ChangeWave research editor and regular FNC business contributor.