In light of this AM's posts re the economy, one man's view of where we are going.......sorry couldn't cut and paste charts but they were very cool. LOL
B. Reynolds is a certified financial anaylist and an economist at David Babson & Co. in Cambridge, MA.
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Is This 1990 All Over Again?
By Brian Reynolds
Special to TheStreet.com
9/27/00 12:32 PM ET
Lately, James Cramer has been wondering if this year's surge in energy prices has changed the outlook from a 1994-type soft landing to one more akin to 1990's hard landing. That's a scary thought for investors. As Anirvan Banerji pointed out a few weeks ago, we have never had an oil-price rise of this magnitude without having a recession. With that in mind, it's probably a good idea to take a look at some of 1990's major trends, and then overlay the current situation to look for similarities and differences.
In the charts that follow, the red line covers the period from 1989 to 1991. This encompasses the 19-month period leading up to the August 1990 invasion of Kuwait by Iraq, the subsequent six-month recession that technically ended in March 1991, and the first nine months of what began as a slow economic recovery. The blue line represents the current environment, starting in January 1999 and going through August or September (depending on data availability) of this year.
Looking first at the behavior of oil prices, it's clear that the events of 1990 were a complete surprise. Prices had been hovering in a $17-$22 range until Iraqi troops crossed into Kuwait, causing oil to skyrocket immediately. Operation Desert Storm, headed by the U.S., then pushed prices back down.
The most recent year-and-a half has exhibited a much different pattern. There has been a continual, but larger, rise in prices. This year's climb means that there should not be as much of a shock to the economy this time, but clearly some damage to the system has been done. Even if we have hit a peak in prices, there is no imminent military action to bring them down quickly, and the fact that refineries are running flat out ensures a difficult winter heating season.
Oil Prices
West Texas Intermediate; $/bbl.
<CHART>
Source: FRB St. Louis
The impact of energy on inflation can be seen in the next chart. Before the Gulf War, the Consumer Price Index had been fairly steady, fluctuating around the 5% level. As oil surged, the CPI jumped 1.5% in a matter of months before falling back with energy costs.
In the current period, by contrast, we have seen a smaller, more gradual rise from just under 2% to just over 3% despite the larger percentage change in oil. This better inflation performance can be largely attributed to intense global competition, good productivity gains and a lesser dependence on energy than we had a decade ago. Due to the lags involved in the system, it would not be surprising to see the CPI hit 4% later this fall, but inflation should still be more modest than in the last cycle.
CPI Inflation
Year-to-Year % Change
<CHART>
Source: FRB St. Louis
The current environment's big surprise has been the strength of consumer spending. In 1990, real consumption (after inflation) quickly fell from +2.5% to -1.5% following the jump in energy prices. This year, overall spending has slipped a little from last winter's minisurge, but is still very strong and is growing at the same rate as it was in early 1999, despite the near tripling of oil prices during that time.
Real Personal Consumption
Year-to-Year % Change
<CHART>
Source: FRB St. Louis
However, the current headline numbers mask some worrisome trends. Spending on services such as electricity has increased, leaving consumers with less to spend in other areas of their budgets. In recent weeks, many Northeastern utilities have filed for 10%-20% rate hikes with their regulators. If these increases go into effect soon, this could be a disappointing holiday season for many retailers. As the fourth quarter represents the bulk of annual sales for many stores, marginal retailers could be pushed into Chapter 11. The resulting going-out-of-business sales could pressure even healthy retailers.
What can the Federal Reserve do about this? Probably nothing, in the short run. If it was to ease now, they could be seen as validating the inflationary impact of the energy price rise. In 1990, it began easing after oil declined and, if we have seen the peak in oil now, it could ease in a few months if the economy were noticeably deteriorating.
Federal Funds Rate
Monthly Average
<CHART>
Source: FRB St. Louis
Long-term bond yields, set by the forces of supply and demand, are more important to capital formation than are short rates. On this front, there is good news. Corporate bond yields are much lower than they were in 1990. In addition, yields have fallen sharply since this spring. This decline is a sign that fixed-income investors have confidence that the Fed will not let inflation get out of hand.
Corporate Bond Yields
Moody's Seasoned Baa Index
<CHART>
Source: FRB St. Louis
In an earlier column , I pointed out that the real cost of funding long-term capital projects is the lowest in years for investment-grade companies. This low level of financing costs could help to support investment spending and, if the economy weakens further, investors could expect more declines in yields.
The continuation of capital spending could be the crucial determinant as to whether or not we will have a significant downturn. The emergence of technology spending is perhaps the biggest change in the economy over the past decade.
Equipment & Software Spending
as a % of GDP
<CHART>
Source: BEA
Not only is our technology industry bigger than in 1990 but it is better. Our whole technology sector was then thought to be second rate, but has since evolved into a global powerhouse. The Internet, for most practical purposes, didn't exist 10 years ago, but is now being used in countless ways to boost productivity.
So it seems that, while the economy seems certain to deteriorate somewhat this fall, let's hope the drop-off will not be as bad as it was the last time energy costs soared. Regardless of how intense the decline is, it seems this would be a good time for investors to take a look at their portfolios to see if they are taking the right amount of risk for their own situation. A look at the equity markets of a decade ago shows the damage that oil can do:
NASDAQ Composite Index
1989-1991
<CHART>
Source: NASDAQ
Even if the next economic downturn isn't as bad as the last one, stocks today are priced for perfection. If a decline like the one above would wipe you out, it might be a good idea to take advantage of any quarter-end window dressing that occurs this week to, as Cramer would say, take some off the table. |
