2007 Economic Outlook

What will the economy do in 2007? While there are some dangers, and unexpected events may change things, I think the U.S. economy will do just fine in 2007. The world economy will do better.

I have followed the statistics and the predictions of government agencies, investment banks, and assorted pundits. In 2005 I made a pretty good prediction (read it). For 2006 I was busy and wrote nothing down. If you are an investor you want to know not just how the economy will do overall, but how individual sectors will fare. Though I am a math guy and like to make models, I think the human brain, mine anyway, is still best for modeling complex systems like the economy. So this is what I think:

China and India will continue to boom. With increasing domestic consumption they will continue to be positive drivers for the manufacturing and intellectual property side of the U.S. economy. Electronic chip makers who can produce the best technology and get good prices for their chips will continue to do well.

The commodities boom as a whole is not so much over as adjusted to the market. New mines and processing facilities that were created in response to higher prices will keep a lid on commodity prices overall. Only specific goods where their are genuine global shortages that are difficult to rectify with new investments will see significant price increases. That said, petroleum is a wild card. Capacity seems adequate for now, but purposeful production cutbacks will probably keep oil well above $50 per barrel. A major war could send prices far higher.

The housing market in the U.S. is going to recover in 2007, but more slowly than predicted because prices have not, and probably will not, drop enough to accelerate the demand side. I would not look for significant increases in new house construction until the second half of the year.

Retail as a whole will have a modest year. One good thing about people not buying houses is that they tend to have more cash around to spend on other things, which will offset in part the decreasing wealth effect from people using their house appreciation as income.

Interest rates will stay in a narrow range. If housing does pick up in the second half and manufacturing and services stay strong, which is likely, look for rates of 6% and higher by the end of the year.

I think the bond market is wrong, at least for the short run. I am not known for being overly optimistic about the economy, but that is based on realism. I called the imbalances of the late 1990's. Now that things are more in balance, the fools who told you that the stock market had nowhere to go but up in 2000 are overestimating the chances of recession in 2007. Bond rates are mostly too low, not because inflation is likely to heat up significantly, but because the Federal Reserve will eventually raise rates to keep inflation at bay.

The stock market as a whole is not overvalued right now. Of course some individual stocks are. But there are plenty of stocks that are undervalued, too. This is an ideal field for picking individual stocks.