10-26-01 Merrill Market Comment
New Realities
The war against terrorism is in its early stages, and Americans are only beginning to see the
outlines of the new realities that we will have to deal with for quite some time. The
uncertainties we face are broad in scope, ranging from the details of day-to-day life to
questions that involve the extent of the sacrifices we will be willing to make to defend
ourselves against a ruthless, determined enemy.
Some of the new forces at work in the business world acted very quickly, tipping the
economy into a recession and causing the financial markets to re-assess what lies ahead on
the macro level and for individual industries and companies. A number of these
considerations are fairly straightforward, and their effects may fade soon; others are not, and
their influence will be felt over a long period of time. In the latter category, we think that the
safety concerns raised by the September 11 attacks and by the anthrax attacks that have
occurred since then could have far-reaching consequences for the economy. In particular,
measures designed to guard against the risk of further bio-terrorism could cost many billions
of dollars and extend permanently into virtually all aspects of business, the economy, and
regulation, much the way that the rise of environmental concerns did in the not-too-distant
past. Looking ahead, the open question is whether bio-terrorism-related economic “friction”
along a wide front – handling the mail, re-thinking transportation and logistical networks,
designing inventory systems, paying higher insurance premiums, breaking patents, dispersing
work forces, safeguarding public and private facilities – will be enough to hinder long-term
trends in productivity improvement and growth.
In the nearer term, chief economist Bruce Steinberg thinks that the immediate risks remain on
the downside, but that the massive amount of stimulus working its way through the system
“all but guarantees a powerful recovery by the middle of next year.” The stimulus could boost
GDP growth by 4.5 percentage points by the fourth quarter of 2002, in Bruce’s view. He
expects GDP to be growing at a rate of nearly 5% during the second half of next year.
Meanwhile, technology strategist Steve Milunovich recently studied the profit-margin
patterns of major technology companies for the past 20 years. His conclusion is that margins
probably will get worse before they get better during the current downturn. That, in turn,
reinforces his view that tech stocks are likely to “bump along the bottom” in the months
ahead, and that investors should have equal-weight positions, at best, in the sector. It also
ties in with something that we have said frequently: the capital allocation process is working
to shrink the tech sector, and that will take a long time to play out. For years, expectations of
very high returns fueled high levels of investment in the tech sector, eventually pushing the
industry’s capacity far above potential demand. Those returns didn’t materialize. As a result,
capital now is flowing elsewhere, and tech-related assets are being priced accordingly. This
isn’t the time for investors to abandon a cautious approach to the sector, in our judgment.
Andrew J. Melnick
Senior Vice President |
