"Are you sure we're going to have a rally?"
Well, I'm not so sure, at least not for a couple of months. Here is what I have advised my clients on the factors which can impact on a recovery:
INTEREST RATES AND TAX CUTS - As John Kenneth Galbraith pointed out in a recent article in the New York Times, mere changes in interest rates historically have been ineffective in stopping or reversing a recession, depression, downturn, or whatever you want to call it. The same is true for tax reduction, particularly to the extent that it favors those who do not spend, and thus do not add an immediate boost to consumer demand or to the sort of items on which a recovery depends. The Administration asserts that recovery can come with a tax cut, but only if it is the type and size advocated more than four months earlier, when economic conditions were considerably better. There is no economic justification for such claims, nor is there any accurate calculation of the dampening effect on a recovery from reducing budget surpluses, opening up the possibility of public debt increases. Neither is there any calculation (so far) of the impacts of increases in state and local taxes needed to offset reduced yields from traditional sources, or reduced federal transfers to states and local governments.
CONSUMER AND INVESTOR CONFIDENCE - Loose talk about an economic downturn, made in an effort to drum up support for a tax cut, has a way of setting in motion unanticipated results. People who fear they might lose their jobs, buy only essentials. Companies reduce orders for supplies and equipment and defer expansion plans. Eventually demand cools, companies start laying off workers, and what started off as fear about job loss becomes the real thing. The sudden reduction of new orders for durable goods, for example, has led to excess inventories, which in turn have caused firms to cut back on current production until inventories are brought back to more acceptable levels. Investors, meanwhile, are less than enthusiastic about holding stock in the technology companies that were mainly responsible for the greatest business expansion in U.S. history. Pulling out of tech stocks occurs either through direct sales or through redemptions of mutual fund shares, where a fund owns tech stocks. There is evidence, moreover, that the drop in stock prices both on the New York exchange and NASDAQ resulted in margin calls, which in turn created more selling pressures. Stock prices can be expected to recover only slowly, as the availability of investment funds is much less than it was six months ago.
ENERGY COSTS - Even though oil and natural gas prices in the U.S. are among the lowest of any industrial nation, the increase in those prices over the last two years is finally having an impact on consumer spending for durables or discretionary items not essential to daily living. There are no short term solutions to supply and demand for commodity fossil fuel products, other than energy conservation. Long term solutions, such as the use of alternative fuels, more energy efficient products, and changes in living styles that reduce transportation uses of fossil fuel require either higher prices for existing fuels (and corresponding life styles) or monetary incentives to change. There does not appear to be any interest in these alternatives, particularly at the political level.
JAPANESE BANK DEBTS - As many as 19 top Japanese banks may be near insolvency. A change in accounting practices in Japan now requires institutions holding stocks to value those holdings at market. The Japanese stock market is now at a 16-year low. Furthermore, banks which granted mortgages on overvalued real estate for several years in many cases own mortgages whose principal exceeds the market value of the properties, opening up the possibility of delinquent loans. The impact on U.S. markets comes from the fact that many Japanese financial institutions have large holdings of stocks and U.S. Treasury bonds. If the Japanese are forced to liquidate these holdings, Treasury bond yields will rise and stock prices will come under further pressure. The lackluster Japanese economy, moreover, depends on huge exports to the U.S. But if consumer confidence in the U.S. remains low and consumers buy fewer imported items, the Japanese economy will take another hit. The precarious state of the Japanese economy (with interest rates near zero) is a two-way street. They can't sell as much to the U.S., nor can they buy as much from the U.S., the only economy larger than Japan's.
CHINA'S ECONOMIC BOOM - Acceptance of a market oriented economy has led to an economic renaissance in China, with benefits for most developing countries in Asia as well. As an example, China expects to expand its wireless phone networks (the only phone networks available, since wired infrastructure is so primitive) by adding some 10 million new subscribers a year for systems that use QUALCOMM CDMA chipsets and patents. An initial expenditure of some $6 billion is planned for base stations and handsets. This may seem large, but in a country with a population near 2 billion, it is probably a conservative projection. One can only hope that the sagging Japanese economy does not interfere with China's ability to grow economically. But politics also plays a role here. The Chinese have shown that unfriendly political acts can affect trade relations, and the U.S. is not the only supplier of telephone equipment and other kinds of infrastructure. Failure to recognize the benefits of healthy economic gains in developing countries throughout the world could result in foreign policies that prolong the current domestic slowdown. Policies such as the anti-missile defense system and its impact on countries such as China can have unintended and negative impacts on economic recovery.
EACH of the above factors are necessary but insufficient conditions for recovery. The important point is that no single factor will work by itself. Assuming that a recovery is not impeded by counterproductive measures, this is not too early to buy or continue accumulating shares in companies that have low debt and high earnings prospects, even in a period of slower growth. The technology sector, which has dropped the most, contains most of the buying opportunities. One problem continues to beset the group. Investors often make no distinction between companies with good earnings prospects and companies with strong fundamentals. This means good stocks get no more respect than bad ones.
In short, it is premature to assume that a recovery might be just around the corner, following the Fed's lowering of interest rates next week, for example.
Art Bechhoefer |
