<font color=green>Barron's Just Beginning
Barron's Features
November 20, 2000
Just Beginning
Economist sees business growing "weaker .. everywhere"
An Interview With Nancy Lazar. She's a gal from Kalamazoo who would
never boast, but Lazar deserves a toast (with apologies to Glenn Miller) for
her economic strategy and forecasting at International Strategy &
Investment Group, a firm she founded nearly a decade ago with fellow
economist Ed Hyman. In July, amid the hand-wringing of the multitudes
over the prospects for escalating inflation, Lazar warned clients of an
impending slowdown in corporate profits and the overall economy. She can
claim long experience tracking the economy; she began her career working
with Hyman in 1981 at C.J. Lawrence. That, combined with the confidence
that comes from the proprietary surveys of key segments of the economy
she and Hyman collect weekly, keeps Lazar at the cutting edge and makes
her calls all the more cogent. The scope and scale of ISI's research made
folksy by the personal annotations of the economists in the margins-led the
former New York Post scribe Maxwell Newton to brand the team "the
lynx-eyed Ed Hyman and the diminutive but dynamic Nancy Lazar,"
something they've never lived down. We met recently with Lazar in the
firm's midtown Manhattan office to hear why she expects the U.S.
slowdown not only to continue, but to result in a severe global downturn.
Read on to learn what she sees as the bright spot in an otherwise bleak
outlook.
-Sandra Ward
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Lazar: "It's not just the Fed" that has tightened.
Barron's: While others were worried about inflation in July, you
predicted the current economic slowdown. What do you see on the
horizon now?
Lazar: The slowdown is here. The question now becomes how prolonged
and how deep and how pervasive will it be. Is it just a U.S. issue, or does it
end up being global? On all those questions, we lean toward things being
weaker, longer, everywhere.
Q: What leads you to that conclusion? A lot of people are still very
sanguine about overseas economies.
A: The level of activity is definitely fine right now, no question. But at turning
points on the downside it is always fine. Instead of growing 6%, U.S. and
world GDP growth is now about 5%, and six to 12 months from today it's
going to be weaker. These forces we have on the economy tend to lead
economic activity. It is classic textbook stuff in which it takes roughly 12
months for central-bank tightening to impact the economy. Central bankers
started to tighten in the summer of 1999, which means the slowdown so far
is due to the tightening of last summer.
Q: Yet so many thought the Fed would have to continue to tighten and
that remains its bias.
A: Absolutely. That is not unusual. The economy seems to have so
much momentum that it's like trying to slow a big tanker ship. It's hard
to know when enough is enough. But it's not just the Fed that has been
tightening. It is global central bankers that have been tightening, and that
may have shortened the amount the U.S. Fed needs to do. Even though the
Fed stopped tightening in May, these other guys have continued to tighten.
The European Central Bank just tightened in October. Over the past 17
months, we've counted 150 central-bank tightenings and the U.S. Fed
accounts for six of those. On a GDP-weighted basis, we are one of the
bigger influences, but our Fed has had lots of company during this tightening
cycle. That increases the odds of a more prolonged slowdown here and
ups the odds of a global slowdown. We are likely to see the effects of these
tightenings well into 2001, through the third and fourth quarter.
Q: What's the next move from our Fed?
A: There is still a good case to be made for the economy continuing to be
okay, and therefore the Fed doesn't want to jump the gun and move to help
the economy too quickly. My inclination, however, is that the next major
move on the part of the Fed will be to ease as it becomes clearer things are
slowing on a more prolonged basis. We're heading in that direction. Growth
is slowing. Inflation seems to be peaking. But any easing will come a
little later rather than sooner.
Q: What are the factors that may be masking the extent of the
slowdown?
A: Consumer confidence is still high. Given the hit to the stock market, I
would have thought consumer confidence would have gotten hit also, but it
remains amazingly high.
Q: Yet retail numbers are going south?
A: Yes. There are plenty of signs the economy is slowing, but it's not
falling off a cliff. Typically, when you go into a recession, consumer
confidence has rolled over very, very dramatically.
Q: Besides the tightenings, what are some of the other forces affecting
the global economy?
A: The other big drag on global growth is the oil-price increase.
Historically, there is a high correlation with changes in oil prices and
changes in the economy, with changes in oil prices leading by one year. A
good example is 1986, when you had the crash in the price of oil and the
economy continued to deteriorate before lifting off the next year. The same
thing occurred in 1998: Oil prices were down and the economy stayed
weak but it helped lift the economy in 1999.
Q: The U.S. has enjoyed 10 years of strong growth, and so a
slowdown may not be surprising. But you can't say that about foreign
markets, and everyone has relied on them to pick up the slack if the
U.S. faltered.
A: That is a key issue right now. Unfortunately, we're so tightly linked
that if the U.S. slows, Japan will slow, and the same is true for Europe. In
Japan, domestic GDP is virtually zero. The growth in Japan has been in
exports, which have been growing at double-digit rates. Lots of those
exports are coming to the U.S. Throughout Europe, retail sales are
relatively sluggish, vehicle sales are declining because of the increase in
energy prices. Exacerbating the decline is the depressed euro and a higher
system of taxes. And again, European exports have been very strong. The
domestic economy doesn't seem to be strong enough to withstand a
slowdown in the U.S.; if we slow, Europe slows. This oil shock is a bigger
deal, if not more so, outside the U.S., particularly where currencies have
declined. I've been to Europe several times in the past several months, and
they are really hurting over there. In Europe there is one difference:
They're cutting taxes, and that will be a cushion for European economies.
Thank goodness, because these other drags are so significant they're going
to offset the tax cuts. But the cuts help.
Q: What was the case in 1998?
A: Europe got hit harder than we did from the Asian crisis. German GDP
growth was 0.6% in early-1999, whereas U.S. GDP growth slowed to
around 3.9%. Europe is more heavy-industry-oriented than we are, and so
they are more vulnerable to these shocks. We're more service-oriented.
Q: Do you see any safe havens?
A: This is a global slowdown, and that's the surprise. But -- and I'm
struggling with this -- I don't think this is necessarily a bad outcome. Just six
months ago we were all worried about inflation getting out of control. The
thought was the Fed would have to continue to tighten and there would be a
very, very high probability of a hard landing. But the economy has slowed
by the skin of our nose and inflationary pressures have eased. In that sense
this is a good scenario. Once it's acknowledged that growth is weaker than
expected, the Fed is going to ease and that will be good news for the stock
market.
Q: So it's a matter of how quickly this is acknowledged?
A: Near-term, earnings expectations are still too high. As global growth
slows, those expectations will have to come down more and more, and that
is going to create indigestion for the stock market.
Q: What are you forecasting?
A: We see S&P 500 operating earnings increasing 8% in 2001, with risk
on the downside. We have odds of a recession at 40%; if these odds
go up, you will see a sharper drop in profits in 2001.
Q: What are your most important measures of economic health?
A: There are some key things we look at on a timely basis to gauge whether
or not growth is stronger or weaker. One is our company survey. We
talk to 150 companies every week and ask them how business is this week
versus last week. Our index has clearly rolled over. Our companies confirm
the slowdown is here. This is a good coincident indicator to watch
going into 2001 for any signs of pickup in activity but, right now, it shows
growth is still slowing.
Q: What industries do you survey?
A: Retailers, manufacturers, technology companies, banks, homebuilders
and auto dealers are the six key ones that are critical to our survey.
Q: What's another gauge?
A: Commodity prices. Commodity prices are a simple, timely gauge of
global economic activity. Two of my favorites are lumber, a good leading
indicator, and scrap-steel prices, which is a favorite of Greenspan's. It's a
good cyclical indicator. It tends to catch swings in business cycles. It's
surprising, because it is so Old Economy oriented. Lately lumber prices,
after declining sharply, have stabilized. But scrap steel has broken out
on the downside and prices are the lowest in 14 years.
Q: And gold?
A: Gold, I think, is still very useful. The fact that gold moved below $270
and stayed below $270 is a signal that inflationary pressures have receded.
Q: What about consumer spending?
A: Consumer spending has started to slow, and the extent of the slowdown
on the consumer side, I think, will be determined by swings in stocks. If the
stock market remains sluggish, then consumer spending will remain sluggish.
There is a very high correlation -- 99% -- between stocks and holiday
sales. We've been tracking this since 1995, so it's a relatively short
period of time. Capital spending is the other side of the equation that will
also slow. Consumer spending and capital spending have certainly been the
strongest parts of the U.S. economy.
Q: Is it troubling to you when executives at companies that have
disappointed -- say, Eastman Kodak and Hewlett -- Packard can't
seem to pinpoint the source of their problems?
A: It's been 10 years since we've had a real sustained economic slowdown.
Someone once described the three stages of a business cycle. There's the
prosperity stage. There's the crisis stage. Then there's the reliquefaction
stage. We've had lots of years in the euphoric stage, and now we are
probably in the crisis stage. Lots of things are cracking. Junk-bond yields
are hitting new highs. Nasdaq is down 41% from its peak, the biggest drop
since 1974. The good news is, the next stage will be the reliquefaction
stage. That will in part be determined by the Fed stepping in.
Q: Do you think there is also a denial stage in business cycles?
A: There is a sense in the investment community, in general, that if the
economy slows, Greenspan will save the day, and earnings may slow, but
not by much. We fear there is too much complacency, which makes us
more concerned that activity will come in weaker than expected.
Q: What about the dollar?
A: It's possible the dollar could weaken, but the argument against that is the
slowdown will be global. Maybe the dollar doesn't go up much, but I have a
hard time getting too cautious on the dollar as long as this looks like a global
slowdown. Another part of the story is Japan. Japan has been doing better.
There is some talk that Japanese corporate profits have clearly recovered.
My inclination is that's old news and that they are very late to the global
economic environment. Domestic finance is very weak, vehicle sales are flat
and department-store sales are declining. There is still deflation.
Government spending is declining. If global growth slows, Japan slows,
just to reinforce this notion.
Q: There's already concern that Japan is slipping.
A: The recent data from Japan are weaker than expected. The Economic
Planning Agency lowered the GDP outlook, the economic assessment for
Japan, for the first time in two years. And the stock market has figured it
out, with the Nikkei and the Topix breaking down. So, are there any safe
havens? I guess not.
Q: What about emerging markets?
A: The developing countries are also at risk. If anything, they're going to get
even more severely hit by these drags on global growth. They, too, are very
dependent on exports. Here, I would specifically focus on the Pacific Rim,
where exports have been the strongest part of the economy. If global
growth slows, they slow. Domestic demand is already slowing. We just got
a chart on Thai auto sales, and the growth rate has slowed significantly.
They were up 80% last fall and now they're up just 5%. It's not just
Thailand. I'm amazed at the breadth of the slowdown in the Pacific
Rim. Singapore tech activity has clearly slowed, as measured by the
Singapore PMI index, all of which highlights this slowdown in capital
spending around the world.
Interview, Part 21
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Interview -- Part 2
Q: But having just emerged from hard times, do these economies
have far to fall?
A: They rebounded pretty sharply and some of their GDP growth rates
surged. The Pacific Rim leading indicator moved from negative to plus
15%. Now the indicator has gone back to zero, and that suggests the
stock markets are figuring out what's going on. The next leg will be for the
economic data to more clearly show it. Every part of the world right
now is vulnerable and the PacRim is still fragile.
Q: This sounds so bleak. Are there any bright spots?
A: From the standpoint of economic activity, probably not. The good news
is inflation is probably plateauing, and so it's probably the sun at the end of
the horizon.
Q: I've noticed your charts show we've hit a fifth peak in inflation
over a 25-year period and the peaks are getting lower. Have we
mastered the art of taming inflation?
A: We are in a secular disinflationary environment, and the quickness of
these inflation numbers -- these leading indicators of inflation -- to roll over
highlights that we are still in this disinflationary environment. If anything,
there are signs of deflation on the horizon. Some of the leading indicators
on inflation, like PPI core crude, is negative on a year-over-year basis. U.S
import prices, excluding oil, seem to be plateauing. Why? What's helping to
contain inflation? Certainly global competition, which is as intense as ever.
Global deregulation. Maybe even higher on the list would be the
technology boom. All of these commingled result in a productivity boom.
Here in the U.S., you have the dollar helping to contain the rate of inflation.
If there is one golden nugget in this global slowdown, it's that inflationary
pressures seem to be easing.
Q: Are you concerned about labor and wage costs?
A: The global slowdown is helping to contain labor costs and productivity
is containing wage inflation. Unit labor costs around the world are
declining. Globalization, productivity and now the slowdown have helped
contain wage inflation.
Q: Would you characterize the runup in tech stocks as a bubble?
A: I don't know if I would call the tech boom a bubble, but I believe very
strongly that we are experiencing a cyclical slowdown in tech, which will
last longer and be potentially deeper than expected. A simple point to
make is that tech is cyclical.
Q: A point people seem also to have forgotten.
A: If anything, technology is more cyclical today than in the past.
Q: Why is that?
A: It's a bigger share of capital spending. If companies have to cut back on
capital expenditures, it is more difficult today not to cut back on tech. In
the old days, when tech was 5%-10%-20% of your cap-ex budget and
you had to cut back, you could leave tech alone. Today, tech is
approaching 50% of cap-ex and that makes it more vulnerable to a cyclical
slowdown, not less. Also, a lot of the boom in tech has been financed by
debt. Nonfinancial corporate debt has been growing very rapidly for two
years, 13% for two years. I can't prove this is all tech-related, but a good
chunk of it is.
If you look at the corporate financing gap, which is the difference
between corporate cash flow and capital spending, you have had this huge
deficit. The level of cap-ex has been rising faster than the level of cash
flow, which has led to a plunge in the corporate financing gap. And that
corresponds with this surge in debt growth. A lot of the junk-bond
problems are tech-related. So, the fact that tech cap-ex is now such a big
part of cap-ex and that a lot of it has been leveraged make tech a more,
not less, cyclical industry. It is cyclical to start with, it moves with the
business cycle, but it has just been a long time since we've had a
slowdown. The tech slowdown is here along with the global slowdown,
and the question there, too, is how prolonged and deep will it be.
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Lazar photo
Q: You mentioned that the Nasdaq is already down 40%. Do you
we have further to go?
A: The Nasdaq tends to lead cap-ex, and so the Nasdaq is foretelling
what is going to happen to the tech sector. But I'm not sure the markets
have fully discounted the duration of the slowdown. That would be my
concern.
Q: And once they figure it out?
A: Tech stocks will turn up before tech activity turns up. But for now, I'm
concerned the extent of the slowdown isn't discounted yet in the market.
You've seen some very dramatic moves on the tech side. DRAM prices
are down over 60% in just a four-month period. The growth rate in U.S.
semiconductor orders has slowed from 38% to 4%. We've counted over
500 dot.com company problems.
Q: Problems or total busts?
A: Problems. Some are just layoffs or IPOs pulled.
Q: In what time period?
A: In the last seven months. Again, this tech slowdown is global, and
certainly a lot of company news points in that direction, as do the data.
European semi sales are slowing, and Siemens' problems and Dell
suggesting that some of its problems were European-related point to a
global slowdown. It isn't just semiconductors. Telecommunications
orders have slowed from 40% to less than 20%. Every sector of tech has
slowed. The tech slowdown will continue as long as global growth
continues to slow.
Q: Any sectors showing resilience?
A: I would rather stick to the basic economic outlook. One thing I'll say,
just because I feel strongly about this point, is that there are certain sectors
of the market, like cyclicals, that look cheap. But if you look historically,
they typically don't do well or start to outperform until after you've had
some Fed easing. And we are not there yet. If growth does tend to be
weaker for longer than people expect, the cyclical sector is likely to
continue to get hit. There's a reason they're cheap, and near-term there's a
reason they could get cheaper. These guys get hurt the most in the kind of
economic environment we expect.
Q: What are your thoughts on credit quality?
A: It would be a classic economic-slowdown event to have credit
problems. I can't think of one business cycle where you've not had some
sort of financial crisis linked to too much leverage in the system. Every
major peak in interest rates, you have had a financial crisis in part related to
debt. So I would expect to have some sort of crisis related to too much
debt in the system. The question is, where is it going to be? And I don't
know.
Q: Is it likely to occur on the commercial side? Or the consumer
side?
A: I could guess, but that's a dangerous game. You've got Jamie Dimon of
Bank One saying credit was his biggest worry for the industry and pointing
to high-yield defaults. You've got high junk-bond yields, consumer-finance
stocks have taken a hit. There are lots of yellow flags. In Europe,
junk-bond yields are as high as ours.
Q: So cash is looking better and better.
A: I'm an economist, not a money manager. I'm sure there are some good
values someplace out there, but I am afraid there is too much complacency
and not enough recognition that things could be weaker longer than people
think.
Q: Do you see any aberrations that would set this cycle apart?
A: This is turning into a classic slowdown in global economic activity, led
by central-bank tightening and pushed further down by higher oil prices.
The last three recessions were caused by central-bank tightenings and oil
shocks and we've got them. Many people, myself included, have forgotten
what a sustained slowdown looks like or feels like-it's been 10 years!
That's why we're relying on these longer-term historical relationships.
Q: At what point are we at risk of depression?
A: Historically, the central bankers have done a nice job of cushioning
financial markets, something they didn't do in the Depression. The Fed
eased very aggressively in 1998, as did global central bankers. I do worry
that the one country in the world that is most vulnerable to a depression
--maybe that's too strong a word, but certainly a severe recession -- is
Japan. There, it looks as if you are at risk of seeing a triple dip.
Growth there, as I've said, has been export-oriented. There have been
policy mistakes. Money-supply growth is low and slowing. In Japan, there
is a very high correlation between swings in money supply and swings in
the economy. Fiscal policy is restrictive. They are cutting government
spending this year. They are still experiencing deflation. The banking
system is still sick. They have other financial problems, such as the
insurance industry. Of the G-7 countries, Japan is more vulnerable to a
severe slowdown. Right now, the economic data look fine, but the stock
market certainly smells something.
Q: Has the tightening been overdone?
A: The ECB overdid it. In hindsight, the last couple of moves related to
supporting the euro will be viewed as a mistake. The Fed stopped
tightening in May. We just can't point a finger at the Fed.
Q: Thanks a lot, Nancy.
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