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2005 economic outlooks remains strong

Although there are still a number of economic clouds on the horizon - oil prices, interest rates and the ever present threat of global terrorism -- there is ample reason to believe that 2005 may be a good year for the economy and the financial markets.

"With the negativity of the presidential campaign now behind us, it was likely that consumer confidence would rise," said Jerry Thomas, CEO of Decision Analyst, a marketing research firm.

After three months of declines, the company's Economic Index rose in November, the result of rising investor and consumer confidence.

"What remains to be determined is if confidence can be sustained over the coming months. If it can, then we should see business activity increase more rapidly," Thomas said.

Corporate spending has been the missing link in the economy ever since the turn of the century and Y2K. According to the Bank of America annual CFO Outlook survey, that could be changing in 2005. Chief financial officers say that capital expenditures will rise by 41 percent in the 2005, compared with 32 percent in 2004.

And, 77 percent of the CFOs surveyed believe that the nation's economy will grow in 2005, the highest percentage of optimism in the seven year history of the study.

"These results are consistent with what we are seeing in the marketplace," said James Connolly of Bank of America. "Borrowers have strong balance sheets and are prepared to execute growth plans and remain competitive through merger and acquisition activity and increased capital spending when appropriate."

If -- and it is still a big if -- corporations step up to the table and join consumer spending at the check out counter, it could lead to the economic expansion that has the Federal Reserve Board fretting over inflation. More than 60 percent of CFOs expect their product pricing to increase in 2005, compared to only 37 percent this year.

Of course, CFOs by their very nature are usually very optimistic. But, the same cannot be said of academia. "(The new year) will see rising interest rates, some weakness in housing and consumer durables and a bit-off-normal GDP (Gross Domestic Product) growth of 2.8 percent in the latter part of the year," reads a report from the University of California at Los Angeles Anderson Forecast. It goes on to say that the California economy in 2005 will be "solid, but not spectacular." The report anticipates a drop in personal income growth and sales tax revenues.

The UCLA reference to weakness in the housing market gathered the most attention. It's one thing for East Coast media to bash the West Coast residential real estate market, but negative comments from a Southern California institution was a bit of a surprise. The California Association of Realtors, as you might imagine, couldn't disagree more with the UCLA forecast.

"We expect the economy in 2005 to generate modest growth in jobs both nationally and here in California, while productivity gains and competition will likely keep inflation in check next year," said Leslie Appleton-Young, chief economist for the CAR. "While the increase in interest rates will be enough to moderate the pace of home sales in 2005, population and household growth will continue to put pressure on home prices, resulting in greater price appreciation in California compared with the nation."

The Realtor group predicts that the median home price in California will increase 15 percent to $522,930 in 2005 and sales will reach 603,700 units, down 2.5 percent from this year. The appreciation in housing values has rekindled a long-standing debate: Which offers the best potential for profit, stocks or real estate?

Historically, a portfolio of quality stocks has provided the best hedge against inflation, while residential real estate has appreciated at the rate of inflation.

However, if the CAR is right and home prices go up by 15 percent in 2005, it is hard to imagine that stock prices will keep pace. And, housing wealth may have been the salvation for the U.S. economy in the years following the Sept. 11, 2001 terrorist attacks. "Housing produces a quick lift to the economy while home price growth provides lasting benefits," said David Lereah, chief economist for the National Association of Realtors. "Homeowners are more confident of gains in housing wealth, so they spend more readily and quickly when they occur."

While a larger segment of the U.S. population owns homes compared to stocks -- 67 percent own a home, 52 percent stocks or mutual funds - the balance between the two assets is critical.

So, wouldn't it be nice if stocks and real estate rose in tandem in 2005?

"The market is clearly ready to break out of current trading ranges; don't bank on the market to decline by much," said Harry Dent, author and publisher of the H.S. Dent Forecast Newsletter. "We think the Dow is likely to break out of the current range between December 2004 and January 2005. Depending on trading patterns, investors could see targets ranging from 22,000 to 30,000 on the Dow."

Just in case you haven't been keeping score, the Dow Jones Industrial Average currently trades near 10,500. Dent, as you might expect, leans to the extreme of bullishness. Others, while not quite bearish, feel caution in 2005 could be appropriate.

"Potential risks to our core outlook include overly robust economic growth, an unexpected rise in inflation, or surprisingly weak growth, which crimps profits," said Michael Geraghty of Citigroup Smith Barney. Geraghty forecasts the Dow will close 2005 at 11,700.

"Conversely, some developments could prove our outlook too cautious, such as a major drop in oil prices, or a decline in bond yields with still strong economic growth," Geraghty added. Whether it's the economy, real estate or the stock market, 2005 should be anything but dull.

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