Leuthold's Midterm

Earnings

In December, Leuthold saw corporate profit margins falling somewhat this year, but remaining close to record levels. He hasn’t changed his mind, but raises an unsettling question: If earnings are doing so well, why isn’t the economy doing better? His prime suspect is “increased globalization of U.S. companies.” Instead of plowing their profits back into the United States, many American corporations are investing abroad by outsourcing and building factories overseas.

 

Inflation

He was right in saying it would ease early this year, but now he’s boosted his year-end forecast for the Consumer Price Index (CPI), which charts the changes in the prices paid for certain products, increasing it to 4 percent from 3 percent. And he’s lifted his year-end outlook for the Core CPI, which excludes the costs of food and energy, to 3 percent from 2.6 percent—significantly higher than Federal Reserve Board Chairman Ben Bernanke’s comfort level.

 

Oil Prices

Last December, Leuthold foresaw crude oil prices fluctuating from $52 to $90 a barrel and averaging $71. The ups and downs have occurred, and the price was $69 at midyear. But Leuthold notes that the peak of nearly $80 early this year was still below the inflation-adjusted highs of nearly $100 in 1980–81. He believes crude prices will top that adjusted level in the next year or two, putting prices at the pump closer to $4 a gallon than $3. Leuthold suggests oil companies could ease the situation if they put more of their capital into research instead of stock buybacks aimed at jacking up their share prices.

The Dollar

At midyear, it cost $1.34 to buy a euro—the same as in December, when Leuthold said the price would drop to $1.20 by the end of this year. He now sees the rate staying at $1.34 through year’s end. Why did he see a stronger dollar in his December forecast? Leuthold believed then that President Bush would follow the suggestion of the Baker Report and begin pulling U.S. troops out of Iraq. He says the fact that Bush didn’t do that has damaged the confidence of foreign investors in the United States.

 

Federal Budget Deficit

Leuthold expected the federal budget deficit to rise sharply over the fiscal year ending September 30. It climbed, but not at the rate he anticipated. In fact, by July the deficit was down to 1.3 percent of gross domestic product from 4.4 percent in 2003. Here, he gives Bush’s fiscal policies some credit, saying a fairly strong economy boosted tax revenues. “This looks like our biggest miss,” he adds.

But don’t be too relieved. Leuthold predicts that a lack of fiscal discipline and the massive future costs of entitlement programs now on the books eventually will come home to roost. He points to a chilling article in the March/April issue of the Financial Analysts Journal: “Do the Markets Care About the $2.4 Trillion U.S. Deficit?” The article argues that improper accounting methods badly understate the deficit.

Leuthold says the tumult in the global credit markets, which erupted in early August, could alter his outlook by leading to higher rates on high-yield bonds and lower short-term rates. Generally, though, he’s sticking with his year-end forecast.

Actually, Leuthold’s biggest blooper may have been last year’s Super Bowl forecast. Leuthold picked the Baltimore Ravens. They didn’t even get past the final eight.