U.S. Stocks Lackluster, Despite Buoyant Economy

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The U.S. economy remained surprisingly robust in 2005 despite the surge in energy prices. Inflation remained under control and home prices continued to rise. But income growth lagged and stocks turned in a mediocre performance.

STEVE INSKEEP, host:

The business news starts with a disappointing stock market.

INSKEEP: Stock prices crawled into positive territory yesterday. But stocks are expected to end the year with lackluster gains at best. NPR's Jim Zarroli reports on disappointing returns despite the fact the US economy fared well this year.

(Soundbite of factory noise)

JIM ZARROLI reporting:

At FALA Technologies, a worker is slowly cutting a hole in a large sheet of steel. The steel will eventually become part of a machine used to make semiconductors. FALA is a 60-year-old machine tool company located in the Hudson River Valley city of Kingston. The company has recently branched out, not just building machines, but designing them as well. Owner Frank Falatyn says business is strong, even if it doesn't always feel that way.

Mr. FRANK FALATYN (Owner, FALA Technologies): In the last two years or so, we've seen our business come back to the levels we were experiencing during those halcyon days of the Internet time. But it doesn't feel the same because, you know, back then it was like the sky was the limit. Everybody was investing. Everybody was building new technologies. Now it's--everyone's got a sense of more realism now. We're happy with the way things are progressing, but we're also very cautious.

ZARROLI: Falatyn worries about rising health care and energy prices, and he's very concerned about the long-term erosion of the US manufacturing sector. Such is the paradox of the US economy right now. Throughout much of this year, growth was strong and corporate profits were high. President Bush could boast in a July radio address that the economy was growing faster than that of any other industrialized nation.

(Soundbite from vintage July presidential radio address)

President GEORGE W. BUSH: The unemployment rate is down to 5 percent, lower than the average rate of the 1970s, 1980s and 1990s. We have created more than two million jobs in the past 12 months. More Americans are working today than every before in our nation's history, and home ownership in America is at an all-time high.

ZARROLI: This strong growth came despite a series of problems that pessimists warned would slow the economy down. Energy prices rose throughout the first part of the year. The Federal Reserve slowly lifted interest rates. Then in late summer came Hurricane Katrina, which devastated the oil and gas facilities in the Gulf of Mexico and shut down vital Mississippi River shipping routes. To economist Richard Berner of Morgan Stanley the fact that the economy could withstand these pressures is testament to its underlying strength.

Mr. RICHARD BERNER (Economist, Morgan Stanley): I think this economy keeps surprising the pessimists, and I think it will continue to do so because it's a more flexible economy than many people realize.

ZARROLI: Berner says part of the reason the economy is flexible is that US companies have been careful about spending. In past economic recoveries, many corporations overinvested in big capital projects, and when a slowdown occurred they were in over their heads. But Berner says that hasn't happened in recent years.

Mr. BERNER: In my view, people have been very disciplined in corporate America about hiring and capital spending, and that has created pent-up demand that is only now being satisfied.

ZARROLI: And Berner says that means there's plenty of room for companies to keep hiring and investing, and that augurs well for the economy in the months to come.

But that kind of optimism isn't shared by everyone. Despite high corporate profits, the stock market has been down or largely flat throughout much of the year. This week, long-term bond interest rates fell below short-term rates, a sign that many investors believe a slowdown is coming. To many investors, the good growth numbers this year obscure as much as they reveal. Gail Fossler, chief economist at The Conference Board, has some doubts about how strong the economy really was this year.

Ms. GAIL FOSSLER (Chief Economist, The Conference Board): 2005 is a really interesting year from a standpoint of growth, because while the growth numbers look pretty good--you know, 3 1/2 percent--a lot of that growth, particularly in the consumer markets, was acquired through very heavy discounting.

ZARROLI: Fossler says consumer spending was strong because a lot of companies, especially in the automobile industry, lowered their prices. But she says consumers won't keep spending at that rate forever. Wages simply haven't been growing fast enough to allow it, and the cost of health care keeps rising. And Fossler says there are other problems that should make 2006 a less robust year.

Ms. FOSSLER: There is a considerable opinion out there that somehow there's going to be a re-acceleration in 2006. I think this is wrong. The energy impact is going to be with us well into 2006, and I think that, generally, the consensus is underestimating the impact of these higher energy prices on the economy.

ZARROLI: And Fossler says higher interest rates will also dampen growth. Until now, higher energy costs have been offset by low rates for mortgages and home equity loans. But mortgage rates finally began to rise this year. Just how big an effect that will have on consumer spending is unclear, she says, but it's certain to have some impact. The US economy may have defied the pessimists this year, but as 2005 ends some economists say a healthy dose of skepticism is still in order.

Jim Zarroli, NPR News, New York.

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