Bears, listen up....this article questions the prevailing wisdom that the economy (and the markets) are heading South. In fact these may be your last days!!
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Economic Pessimism Is Overdone
By Marc Chandler
Special to TheStreet.com
Originally posted at 9:08 AM ET 10/9/00 on RealMoney.com
It seems clearer than ever that what happens outside the U.S. may have a profound effect on the performance of the U.S. economy. The global financial crisis in 1997-98 prompted the Federal Reserve to cut interest rates not once, but three times in rapid succession. Most recently we've seen many companies warn of earnings disappointments because of either the weakness of the euro or weakness in demand in Europe. Here at the start of the fourth quarter, it may be helpful to take a look at the macro-economic picture for the U.S., Europe and Japan.
It makes sense to begin here at home. The earnings warnings and soft economic data in the summer have sparked concern in some quarters that the U.S. may be headed for a hard landing. Anecdotal evidence and a cursory examination of the fed funds futures strip suggests that, on balance, the market's bias is to look for the next move from the Federal Reserve to be a rate cut.
Yet there's good reason to be suspicious of such pessimism. The September jobs report was much stronger than expected, with the private sector adding 288,000 jobs and a still-respectable 204,000 increase when special factors, such as the laying off of census workers and the return of strikers, are excluded. Modest revisions also helped reduce the loss of jobs seen in July and August.
In addition, the rise in September auto sales, coupled with the employment report, bodes well for the retail sales report due for release next Friday, Oct. 13. Roughly speaking, retail sales account for about 40% of U.S. personal consumption. Personal consumption, as is well known, accounts for about two-thirds of the U.S. economy. It rose 7.6% in the first quarter, when retail sales rose an average of about 0.8% a month. Personal consumption rose 3.1% in the second quarter, when retail sales were flat. I expect the average monthly gain in the third quarter was around 0.5%-0.6%, which would be consistent with 4%-5% growth in personal consumption. Of course, the performance of retail sales does not tell us very much about how the shares of any particular company, or even the industry, will perform.
It is also interesting to observe that consumption remains fairly strong despite the weakness in stock prices this year and the concerns about the impact of the wealth effect from share prices. At the end of the day, I continue to believe that the wealth effect from job creation is much more significant for consumption habits than the performance of the stock market.
Like the Federal Reserve, the European Central Bank, or ECB, sees the rise in oil prices in the context of inflationary implications. For the Fed this might make sense, given that it's trying to slow the economy to a more sustainable pace and the oil drag may assist such efforts. In Europe, there still seems ample excess capacity. Many econometric studies suggest that the rise in oil prices is a larger drag on European economies than on that of the U.S. It is reminiscent of the 1997-98 global financial crisis. As the Federal Reserve and the Bank of England responded quickly and decisively to cut interest rates, Europe denied that it would be adversely affected and later had to scramble to cut rates.
European officials suggest that the decline in long-term interest rates and the fiscal stimulus, including tax cuts starting in January, will offset the economic headwinds, including the rise in energy prices. On the eve of the recent ECB rate hike, top European officials were still suggesting that eurozone growth will outpace the U.S. next year. Most private-sector forecasts seem to disagree.
Recent economic data from Europe have generally been reported below market expectations. The day after the ECB raised rates and the market was assured that eurozone growth would not be adversely impacted, the French statistics office INSEE cut its forecast for French growth this year from 3.5% to 3.2%. It's not the size of the revision, but rather the direction that I think is telling. The recent rate hike by the ECB could very well be the last one for quite a while.
To read Chandler's view on the Japanese economy, click here
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Marc Chandler is the chief currency strategist for Mellon Bank. At the time of publication, he held no positions in the currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to send comments on his column to Marc Chandler.
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