Thoughts on US, Europe & Japan
from Morgan Stanley's economic team. Long, but a good read.
Like I said to Blondie the other day, job one is keeping current on the big picture. After that, the market, industry sectors and finally individual stocks selection all fall into place.
This "top down" approach has worked best for me over the years.
Good post on the Caspian. Thx.
And, of course...GO LOILY!<g>
Regards,
Isopatch
"United States: No End to the Inventory Overhang?
Richard Berner (New York)
Corporate America liquidated inventories massively in the first quarter for the first time in nine years. Nonfarm inventories plunged by $25 billion at an annual rate as Detroit slashed vehicle production to the bone, and the swing from inventory accumulation to destocking lopped three full percentage points from growth in first-quarter real GDP. Inventories have actually been a drag on growth for four of the past five quarters, and the ratio of nonfarm inventories to final sales of goods and structures at the end of the first quarter fell back to 3.58 -- a tiny basis point shy of the all-time record low set in the first quarter of 2000. On the surface, at least, it appears that New Economy inventory management techniques have produced a lightening-swift response to a slightly excessive inventory backup, virtually eliminating it in three months. With vehicle demand remaining surprisingly resilient -- May sales of light vehicles appear to have slipped only fractionally from April's still-healthy pace -- it may appear that the economic spring is coiled tightly for a snapback.
Does that housecleaning set the stage for a strong economic rebound?
Our answer: Far from it. In our view, the worst of the inventory decline is over, but more liquidation lies ahead. New data show that stocks are still out of line with sales in manufacturing and wholesale trade. Most fundamentally, capital goods demand is still declining, if anything, at a faster pace than earlier in the year. Bookings for nondefense capital goods excluding aircraft plunged at a 32.5% annual rate in the three months ended in April, a decline every bit as steep as in the 1990-91 recession and about 75% of the intensity in the 1981-82 recession. In our view, this profound weakness more than offset the relative resilience in consumer demand and construction activity. In addition, despite the Fed's aggressive easing moves, the real cost of carrying inventories is still unfavorable. Nominal short rates stand at 4%, but prices are falling in a variety of industry segments, raising the real carrying costs. Consequently, we anticipate that in the next few months, companies will continue to cut production and payrolls in an effort to get stock-sales ratios and costs under control.
How big is the overhang?
The aggregate inventory-sales ratio cited above masks problems in manufacturing and wholesale trade. New data, collected under the North American Industry Classification System (NAICS) and benchmarked to the latest census, show that manufacturing and wholesale inventory-sales ratios were higher in March than previously thought, and rocketed in April to a 33-month high. Ironically, inventories in technology products as of April were still way too high in relation to sales; especially in computers and electronic parts. On a more timely basis, Shelby Fleck, Morgan Stanley's electronic manufacturing services (EMS) analyst, suggests that EMS inventory-sales ratios stopped rising recently, but have a long way to go before they are comfortably in line with sales. Likewise, the new data show that wholesale I/S ratios jumped to a two-year high in April. Our estimates suggest that companies will have to liquidate stocks through the fourth quarter to restore the old low ratios, let alone establish new lows.
The upshot: Trimming stocks to get them back in line with sluggish sales will require further production cuts. This is a familiar theme for us (see for example "Stocked Out?" Global Economic Forum, May 4, 2001). Moreover, the inventory cycle will shape, as it always does, the profile of the coming recovery. We believe that companies may wait to step up production even when sales begin to pick up, preferring to draw down inventories. That will moderate the early stages of recovery.
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Japan: Deep Roots
Robert Alan Feldman (Tokyo)
Investors have been giving the new Japanese government a vote of confidence, despite economic data that are mixed at best. And yet, there is still a vigorous debate over whether this confidence is warranted. Can PM Koizumi win his battle against the anti-reform forces? Can he keep the voters happy, when his program will inevitably cause much economic pain? I think that the answers to both questions are yes, because the forces contributing to change go far beyond the personal popularity of the new prime minister. As the strength of these forces is better understood, the fears of a reversion to old politics and thus of a stock market relapse will likely subside.
The fundamental reason for optimism about Japan is simple: The changed incentives now faced by politicians and bureaucrats will lead to changed behavior. The reasons for the changes of incentives are varied, but are broad and deep. First, changes in Diet procedures, introduced a year ago, now require party heads to debate in public. The Diet has become high theater, and popular interest in politics is soaring. As a result, the type of leader who can be successful is no longer the back-room compromiser such as former PM Obuchi, but rather the popular leader who can articulate a vision. Second, the minutes of government meetings are now mostly available to the public. This practice was started by the Bank of Japan, which has been releasing minutes of its Monetary Policy Board meetings, but has spread to many other agencies. Insiders can no longer influence decisions without fear of scrutiny. Third, the introduction of a sunshine law on government actions -- whereby citizens can gain access to government documents -- has brought a number of new revelations from investigative reporters. These changes boil down to greater power of public opinion over government actions, a change that the Koizumi administration has put at the heart of its economic strategy.
With this increased role for public opinion comes an increased emphasis on economic justice. In the Japanese popular mind, economic justice is no longer defined as everyone getting an equal share of the pie. Rather, after ten years of stagnation, economic justice means baking and slicing the pie by rules based on efficiency. In short, public opinion is willing to accept the bankruptcies of inefficient firms, because to do otherwise would shrink the pie. The corollary to this notion, however, is that a better social safety net must be woven for the innocent victims of the transition to a more efficient economy.
Weaving such a net is a key element of the new government’s plan. At the mid-May meting of the Council on Economic and Fiscal Policy (CEFP), which the PM himself chairs, Economics Minister Heizo Takanaka emphasized that the safety net was a key part of the program. Such a role makes both political and economic sense. On the political side, the new government’s strategy relies on using public opinion to surround and suppress insiders and vested interests. A better safety net would prolong the ability of the new government to keep public opinion strong in support of reform, even in the face of a worsening business cycle and dislocations from structural reform. On the economic side, the safety net is relatively cheap. For example, if the government paid one half of the average level of GDP/worker to displaced workers, each 1% on the unemployment rate would cost about Y2.5 trl. (=0.5% of GDP). A substantial portion of this amount would be saved if public spending to support unsustainable firms were cut off. In short, national income might be cheaper to maintain though job destruction than through job maintenance or capital injection. Moreover, the elimination of excess supply would also mean stronger pricing power for remaining players, and thus could help end deflation.
Who would pay? The answer is suggested by an exchange between BoJ Governor Hayami and Economics Minister Takenaka, at the May 18 meeting of the CEFP. Hayami: "The decisive monetary policy easing of March would be more effective if indeed structural reform starts to move the real economy." Takenaka: " The more structural reform progresses, the larger is the role to be played by monetary policy. I wish to paint a scenario in which there is harmonization between structural policy and the monetary policy pointed out by Gov. Hayami." In short, the BoJ would pay, if the structural reforms are actually carried out. This is the clearest statement yet that the BoJ and the government are trying to form a cooperative strategy.
The forces of the change that brought PM Koizumi to power are deep. It remains to be seen whether these new forces will conquer the old ones. Investors and analysts believe the answer to be yes. All that is lacking is proof." |
