Riding The Strong Economy Higher

We received good economic news this week, and that sent the S&P; 500 and our portfolio up every day.

On Wednesday afternoon, the Fed said that “labor cost pressures were little changed” and that “prices at the retail level increased at only a moderate rate.”

Of course, investors are looking for signs of an end to inflation or at least of a leveling off that might stay the Fed’s rate-raising hand. Wednesday’s report dispensed a drop of hope that maybe there will be just one more rate hike. That hoped lasted all week, as stocks finished solidly positive. It was hard to miss the “Indices At Five-Year Highs” headlines that dominated the week’s financial news.

Then, on Thursday, the consumer price index for last month came in at a modest 0.1% rise. It was expected to be 0.2%, so the report was good news. Prices rising more slowly than expected? Hmm, could that mean the end of rate hikes? Just the whiff of such a possibility created a light mood on the street. In fact, the data don’t change the situation much yet.

Finally, this morning’s industrial production report showed a 0.7% increase in February. That puts production up 3.3% in the last twelve months and into historical highs.

That’s a big thumbs-up on the economy. A lot of people think the U.S. has no industrial base anymore, having ceded it to cheaper nations like China and Vietnam. Part of that misconception is that U.S. manufacturing employment doesn’t grow anymore. However, that’s due to gains in productivity. It simply takes fewer people to make more stuff than it used to. Every year, output goes up while payrolls stay constant.

Production is up 10% from three years ago, and looks set to climb another 3% this year.

We face a classic on-the-one-hand set of data. On the one hand, the economy is strong and that’s always positive for business and stocks. On the other hand, if the economy looks too strong, it may bring further rate hikes and that’s negative for business and stocks.

Which is why Warren Buffett’s approach is generally the best: ignore the greater economic picture, ignore the market, and just focus on your own portfolio. If a stock is cheap and has good prospects, then buy it regardless of what’s happening in the bigger picture. In the end, good companies come out on top. Good companies bought at good prices are the mother lode in this business, and they turn up in every economic environment. In fact, The Kelly Letter bought one just today.

Let’s take a look back at the week.

Monday
We received confirmation that our tech recovery plan is on track when several analysts confirmed our rationale. Reports from last week’s Intel Developer Forum were widely circulated and shared this general overview:

  • Intel (INTC) will narrow or close the current price/performance gap against Advanced Micro Devices (AMD).

  • New Intel products coupled with Microsoft’s (MSFT) new Vista operating system in November will boost PC revenue in the fourth quarter and into next year. PC unit growth will track at 12% this year and climb to 14% next.
  • While all PC vendors will benefit from the improved performance and lower prices resulting from the Intel/AMD rivalry, Dell (DELL) is likely to see the best incremental improvement. That’s due mainly to its heavy reliance on Intel’s chips. Dell arch-rival Hewlett-Packard (HPQ) will benefit less because it sells a broader array of AMD chips.

We own Investments are shown only to KELLY LETTER subscribers. Click to try the letter for one cent.. We’re firmly at the heart of this story.

Tuesday
At last, some stimulating news from our brewer. The stock rose 1.7% after Deutsche Bank and Bear Stearns upgraded it, saying sales and prices appear to be rising.

Wednesday
Some bad news for Sony (SNY) was good news for Microsoft.

Sony postponed the release of its PlayStation 3 until November due to delays in its new disk platform. The game console was scheduled for a spring launch. It’s currently the dominant brand, controlling around 60% of the market.

Microsoft has been trying for years to gain market share for its Xbox, and this may finally be its chance. The new Xbox 360 debuted last November. Long-time readers may recall my report from Tokyo about the Xbox Cafe and signs outside major train stations. It was an impressive launch here in Japan.

What the Xbox has always lacked is a deep library of games. All developers still focus their efforts on the market share leader, leaving Microsoft and Nintendo behind. Now, though, there should be some shift to making Xbox games on the theory that publishing games that can be played today will provide a lot more revenue than publishing games that will sit in boxes until November.

Thursday
Needham recommended overweighting the Internet sector for four reasons:

  • recent stock performance has not reflected fundamental performance and has been driven by fear

  • based on historical trading patterns, now is a seasonally good time to build positions in the group
  • the fundamental outlook remains solid, with key advertising and e-commerce indicators pointing to continued robust growth
  • valuations generally look attractive, particularly relative to expected growth

The firm says that large-cap stocks such as Yahoo, Google (GOOG), eBay (EBAY), Amazon.com (AMZN), Monster Worldwide (MNST), and IAC/InterActive (IACI) are likely to benefit the most from strong earnings and improving sentiment.

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We’re seeing more activity at our electronics retailer. It restructured management by promoting four executives to executive vice president. The company said the move will simplify reporting, narrow accountability, and make for faster decisions.

The company also hired Wal-Mart (WMT) executive Cara Kinzey as senior vice president of information technology. Wal-Mart’s inventory management systems are legendary. Maybe Cara Kinzey can infuse some of that magic into our retailer, and improve margins.

Friday
The week’s upbeat tone continued on lower oil prices and the lingering good mood from good economic reports. For the week, the Dow rose 1.8% while the S&P; 500 and Nasdaq each rose 2%.

In the wake of Needham’s Thursday report on the Internet, I delivered to subscribers an in-depth look at Yahoo. If you’d like a look at that, along with the rest of my portfolio, please try my one-cent, one-month trial. There’s no long form to fill out, and I don’t need your credit card number. All you do is enter your email address and your name, then click.

Enjoy the weekend.

Oh, and don’t forget to check out my one-cent, one-month trial.

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