Investor: An insider's guide to the marketGrowth in the US economy has been decelerating during 2006, in contrast to the gradual acceleration in Europe. So far all the evidence is pointing to a soft landing for the US economy as it responds to the rise in official interest rates from 1 per cent to 5.25 per cent, engineered by the Federal Reserve over the past two years.
The US housing market has slowed sharply, with new house completions and starts running far below the levels of a year ago. However, housing weakness has not disrupted consumer expenditure, which has continued to grow, albeit at a moderate pace.
US leading economic indicators, released on Monday, rose by 0.2 per cent in October, indicating that slow growth will continue into the winter and spring. The leading indicator index for September was revised up to an increase of 0.4 per cent from the initial 0.1 per cent estimate. September/October was the first back-to-back increase in the leading indicators since last December and January.
Over the past six months, the leading indicators are down 0.2 per cent, with the housing permits component having the largest negative impact. The leading indicators are designed to forecast economic activity six to nine months ahead. In October, six of the 10 leading indicators rose, led by money supply, consumer expectations and stock prices.
The slower pace of growth predicted by the leading indicators will be welcomed by the Federal Reserve since it will have the desired dampening impact on inflation and inflationary expectations.
The improved inflation picture has received a major fillip from the recent fall in commodity prices, and in particular the fall in the oil price. US crude oil prices have hit lows of $55 per barrel in recent weeks, which is their lowest level in 17 months. Opec is now trying to agree a further cut in planned output from its members in order to prevent the oil price from falling further. The combination of slower growth and weaker commodity prices virtually guarantees much better news on the US inflation front in 2007.
The weaker oil price should also act to reduce inflationary pressures in Europe. However, recent comments from Jean-Claude Trichet, ECB president, reaffirmed that the ECB remained "strongly vigilant" in assessing inflation risks. This hawkish rhetoric must in part reflect the fact that euro-zone interest rates are much lower than those in the US and Britain. Therefore, euro-zone monetary policy is still relatively accommodative and probably requires interest rates in the 3.5-4 per cent range to bring policy into a neutral stance.
At the macro level, the lower oil price has clear beneficial inflationary implications. At the micro level, those sectors that are heavily dependent on oil are particular beneficiaries. Transport companies clearly fall into this category and their share prices have responded positively to the more favourable oil market.
On the Irish market, Ryanair and Irish Continental Group (ICG) have outperformed the overall market so far this quarter, with the Ryanair share price up 16 per cent and ICG's price up by 17 per cent. While stock-specific factors have also played their part in these share movements, a review of global transport sectors illustrates that the declining oil price has been associated with a generalised rise in transport company share prices. Global low-cost airlines have risen by an average of 7 per cent over the past month. JetBlue in the US rose by 29 per cent although Southwest Airlines, which was the pioneer of low-cost air travel, declined by 2 per cent. In Europe, Easyjet rose by 13 per cent over the past month and Virgin Blue is up 5.9 per cent.
Interestingly, the share prices of the full-service European airlines have enjoyed even stronger returns in recent months. European network airlines have risen by 12 per cent on average over the past month alone, led by Air France KLM with a gain of 22.6 per cent. British Airways is up 7 per cent on the month but has risen by approximately 47 per cent in the year to date. Airport operators have also joined in the overall rise of transport sectors with, for example, Fraport in Germany gaining 7 per cent over the past month.
Transport stocks are extremely volatile given their high level of operational gearing and sensitivity to external shocks. Adverse geopolitical events and sudden movements in commodity prices can have an immediate and large impact on the share prices of transport-related companies. Therefore, these are high-risk stocks relative to the average risk of the market and their share prices move in a highly cyclical and volatile pattern. However, with the futures market in oil pointing to lower oil prices in 2007, Investor believes that the current bull run in these volatile transport stocks has further to go.
