Institutions have been buying recently on the anticipation that earnings growth will begin to materialize in five to eight months, when the market believes the current recession will end. However, it looks like the recovery may take longer than that, and could potentially be sidetracked by increasing geo-political tensions and terrorist attacks. One key question as to whether the recession will be short or weak is whether the interest rate cuts by the Fed will effectively jump-start the economy.
The current monetary stimulus is likely to have a hard time kick-starting capital spending, which has declined roughly 20% over the past year and a half. Corporate America is not going to be rushing into any new investment programs, as the psychology is simply not right and there remains an overhang of capital from the binge in capital spending that occurred at the turn of the millennium. At the most basic level, corporations will not be increasing capital spending while they are making layoffs. We need to see a decrease in unemployment before we see an increase in capital spending. People do not buy goods and services when they are worried about their jobs.
Additionally, corporate America is well on its way to taking a record $125 billion in restructuring charges this year. Charges are due to write-downs in excess inventory, plant, capital, people, and over-valued acquisitons. In the short-term, this will cause pressure to be put on the market, though historically there has been an upturn in corporate earnings following major restructurings. The sector with the largest dollar amount of restructuring charges this year is the tech sector. The recent rally in tech is based on the belief that, following these restructurings, the tech sector will experience an earnings up-tick.
Currently, based on volatility analysis, the market is pricing the terrorist threat and the Afghanistan conflict as much less risky than the Gulf War. During the periods leading up to the 1991 Gulf War, volatility stayed high for months after Iraq invaded Kuwait, only falling after the U.S. began its military response. In the current crisis, market volatility has been decreasing since peaking on September 20th - this suggests a degree of complacency compared to the Gulf War experience. I believe the market has not fully discounted the disruption on the U.S. economy that additional terrorist attacks will have. |
