“The Three I’s" - Interest Rates / Inflation / Investment
by Abner, Herrman & Brock Asset Management

During the past several years we have witnessed the benefits of a global economy.  The United States and other major industrialized economies have experienced above average economic growth with low levels of inflation.  Emerging economies in the Far East and South America appear to be the driving forces helping sustain this strong global economic expansion.  Significantly, China and India’s large populations are providing both demand for products and services as well as low labor costs which are helping to keep inflation modest. Information technology and communications have enabled other countries to benefit from these globalizing forces.  The combination of innovation in technology and communications coupled with the availability of low labor costs has been a major factor in providing above average productivity gains over the last several years.  The net result has been strong growth in the global economy with modest inflation, an optimal combination.  Although prices for industrial materials and natural resources have experienced sharp increases during this period, they have been offset by significant gains in output per man hour and technological innovation (i.e. productivity).

The drivers of the global economic growth began to change about a year ago as productivity started to slow from a 4% rate to a 1% rate in the first quarter of 2007.  As productivity slowed so did economic growth in the U.S. and elsewhere. The U.S. economic growth was negatively impacted by the decline in housing as well as an inventory build up in the manufacturing sector of the economy.  As the U.S. and other economies slowed, the pressure on price inflation was eased.  Thus the slower gains in productivity did not negatively impact the inflation rate, and in turn, interest rates.

In the past several months we have witnessed an increase in interest rates both in the U.S. and other major economies.  These higher interest rates are coming at a time when most economists are projecting an increase in economic activity for the balance of 2007 and into 2008.  As economic activity increases it is possible that rates of inflation could rise.  In the past, inflation growth has been controlled during periods of economic expansion by above average gains in productivity.  Should productivity not rebound with the resurgence of the expected economic growth it is possible that interest rates could trend higher anticipating higher inflation rates.

The Federal Reserve during the past year has continued to caution about their concerns of the potential for higher levels of inflation.  In the May Fed minutes, the committee was quoted as saying that inflation has reached “uncomfortably high” levels and that inflation was the committees “predominant concern”.  With the high level of Fed vigilance in monitoring inflation, it is a possibility that the Fed may raise interest rates at some point to ward off the prospect of higher rates of inflation.

Abner, Herrman & Brock Asset Management
 

Founded in 1981, Abner, Herrman & Brock Asset Management manages portfolios individually structured to assist each client in achieving their investment objectives.  Stock portfolios are managed utilizing a Core Equity philosophy, investing in both large capitalization value and growth disciplines with an objective of long-term, after-tax appreciation and below market volatility. Portfolios are diversified across economic sectors, industries and companies.  Bond portfolios are managed to provide a high rate of current income.  Portfolios are invested in staggered maturities of U.S. Treasury, government agency and investment-grade corporate bonds and where appropriate, investment-grade municipal bonds. Portfolio managers are available to meet with clients upon request.

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