Editor's note: The following review is based on the most recently available information as of January 12, 2007.

A slowing trend in the domestic economy became evident as 2006 ended. Third-quarter Gross Domestic Product (GDP) grew 2.2% annualized, according to the U.S. Commerce Department, contrasted with 2.6% in the second quarter of 2006 and 5.6% in the first quarter.

Federal Reserve chairman Ben Bernanke said in late November that inflation, driven by tight labor markets that could push up wages and prices, remains the predominant risk to the economy. He called growth (excluding housing and motor vehicle sales) solid and suggested that the Fed might be likelier to raise rates, now at 5.25%, than lower them. Core inflation at the consumer level remains above 2% annualized, which is the upper limit of the Fed’s comfort level. Some of Bernanke’s anxiety stems from a strong labor situation, with unemployment at 4.5%.

Corporate profit growth remained extremely healthy, increasing 4.2% from the second quarter of 2006 to the third quarter, according to the Commerce Department. When measured against 2005 third-quarter figures (which were negatively impacted by Hurricane Katrina), the year-over-year growth is 30.9%. Such sustained profit growth should be expected to be shared with labor, which in turn will provide a cushion to consumer spending and, thus, sustained economic growth.

According to the Office of Federal Housing Enterprise Oversight, sales prices of existing houses rose 0.86% (or 3.45% annualized) from the second quarter of 2006 to the third quarter, the smallest such increase in eight years. Falling bond yields should help the housing market as mortgage rates are pegged to the yields on 10-year Treasuries.

Crude oil prices topped out in the mid-$70s during the summer of 2006, and then dipped below $52 per barrel in mid-January 2007.

The U.S. dollar weakened against foreign currencies during the fourth quarter. A weak dollar has the potential to reverse this country’s trade imbalance, as our imports become more expensive and exports become less expensive. This, too, could fatten the bottom lines of U.S.-based companies that do a significant amount of business overseas.

FOURTH QUARTER INDEX COMPARISONS

Source: The Wall Street Journal

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