The year ahead
Ten forecasts to start the new year ...
our judgment on major issues shaping 2005.

1) New energy price highs in spring. Odds are prices for oil, gasoline, and diesel will hold about steady through the winter. But they’ll spike higher by Memorial Day, when high seasonal demand meets tight supplies and refining capacity that’s stretched thin. Look for $2.15/gal. for gasoline, on average.
And that’s the best-case scenario. Headed up to the Jan. 30 election in Iraq, large-scale terrorism could add $10 a barrel within days. That could also happen with civil unrest in Saudi Arabia, Africa, or Venezuela or other natural or manmade supply disruptions.

2) Modest economic growth, around 3% ... nearly a full point less than in 2004 ... as energy costs sap consumer spending power. Productivity will also grow more slowly, slipping from nearly 4% to 2% or so in 2005 and 2006. The silver lining: Accelerated hiring ... an average of about 200,000 new jobs a month as employers boost output.

3) A worsening situation in Iraq. Insurgent attacks will increase as the election draws closer, and they aren’t likely to let up after it. Insurgents will simply have a new goal: Disrupting a planned referendum on a new constitution, slated for late 2005. More allies will withdraw, and Iraqi forces won’t be ready to contribute much till the end of 2006. Plus the U.S. will have to work with a less amenable Iraqi government, dominated by Shiites who, in the near term, will tilt toward Iran.

4) A bottom for the dollar by spring, with the greenback’s value edging up through the rest of the year. In historical terms, however, the dollar will remain soft, helping to slow growth in the trade deficit. By year end, the deficit may even turn the corner, beginning to narrow.
China will finally budge on its currency, letting the yuan trade within a narrow range, probably by summer. But low Chinese labor costs mean imports from China will continue to swamp U.S. exports to China.

5) Higher prices for most items, but a lower inflation rate ... about 2% instead of 3%. That’s because even though energy prices will hit new highs, they won’t climb as much as in 2004. Meanwhile, the weak dollar raises import prices for many goods, letting U.S. firms follow suit. Even automakers and airlines will make price hikes stick.
That spells increased long-term interest rates ... roughly 5% for 10-year Treasuries by the end of 2005, up from just under 4% now. The Federal Reserve, meanwhile, will inch short-term rates to 3%.

6) A catch-up year for stocks, with better returns than in 2004. Total returns in the 12%-15% range, including 2% from dividends, will beat growth in profits of about 10% for Standard & Poor’s 500 firms. That’s in contrast to 2004, when uncertainty about energy prices held returns to only around 10%, while profits soared by more than 20%. Some likely strong performers in the coming year: Energy, defense, and biotechnology plus manufacturers of medical and electrical equipment. Likely laggards: Apparel, autos, and other consumer-dependent industries.

7) An even more contentious U.S. political arena. Bush’s move to renominate 20 judicial appointees already blocked once by Democrats plus the GOP threat to prevent filibusters mean compromise is unlikely. The take-no-prisoners approach probably dooms progress on tax reform and Social Security changes. But Bush has enough political muscle to hand victories to business on key issues: Shifting class-action suits to federal courts, some limits on liability, highway construction funds, new energy production incentives, and an overhaul of U.S. bankruptcy laws.

8) Employer health costs rising about 10%. Although that’s steep, it’s not as bad as it has been. Firms will dig even deeper for savings, emphasizing consumer-driven insurance plans, which coax employees to make more judicious use of health care. High-deductible coverage and tax-favored Health Savings Accounts will be pushed especially hard.

9) Burgeoning foreign investment by China, not just in China. Huge foreign currency holdings will allow China to snap up foreign firms, improving product quality and forming vast global distribution networks. China’s top interests in the U.S. are in electronics, IT, and telecom. The Asian giant also wants to secure more raw materials for its builders and manufacturers. It will try to buy up or buy into foreign companies with holdings in oil, natural gas, metals, and timber, for example.

10) Intense competition for telephone and Internet services, with providers rolling out new services and technologies and lower rates. Cable TV will offer Internet phone service. Baby Bells ... video service. Wireless phones will outnumber wired ones. Half of U.S. businesses will use high-speed Internet connections by year end. One year later, so will most households. And everyone will get everything cheaper.

The economy
The urge to merge is strengthening. Two years of strong profits and plenty of cash on hand are fueling many companies’ desire to acquire and grow. Banks are also more willing to lend this year and have the liquidity to help foot the bills for business nuptials. And, as concerns about accounting compliance wane, shareholders are eager for more growth and market share.

Lots of small acquisitions but few megadeals are likely this year. The value of mergers won’t come close to the $1.7-trillion peak hit in 2000. But the number of deals this year will approach the 11,000 mark, near the record.
Industries most likely to see consolidation: Cable TV and radio. Electric and gas utilities. Computer software and supplies. Plus activity in telecom, banking, and medical supplies and equipment will continue.

The potential for too much merger enthusiasm gives the Fed pause. It’s fretting that interest rates are still too low and may spur a wave of 1990s-like irrational exuberance, with attendant speculative deals ... business acquisitions and home buying. Add to that ongoing Fed concerns about high energy costs and the dollar’s softness igniting inflation.
So yet another quarter-point interest rate hike is likely in Feb.
Manufacturing will remain the job-growth laggard this year, curbing hiring amid intense global competition and high health-care costs. Look for total monthly job growth to average around 200,000 this year.

Business costs
Expect steel prices to edge up again by spring after a slight dip during the winter months as auto demand and construction ease. Costs of nickel, chrome, and other steelmaking materials will also rise.
Major steel users will pay about $760 a ton for hot-rolled steel, up $100, matching last summer’s peak. Cold-rolled: $830, also up $100. Stainless steel will fetch about $3,500 a ton, an increase of about $200. Manufacturers that buy steel in small amounts may have to pay even more.

Hotel rooms will cost you about 5% more next year, on average, versus this year. Luxury digs, up about 8%, and economy lodgings, 3%. Rooms in NYC and Hawaii will see the biggest gains ... 10% on average.
Looking for a bargain? Consider a hotel near the city airport. Room rates are lower than at downtown hotels, and parking is often free.

You’ll have to dig deeper to take a client out to lunch in 2005.
Restaurant prices will climb 3% or so. Higher energy costs are driving up food production expenses. Another culprit: Hurricanes that caused heavy damage to fruit and vegetable crops in Fla. and Texas.
Supermarket shoppers should also budget more for groceries.

© 2005 The Kiplinger Washington Editors, Inc.