Elections and the economy
Herbert London (archive)
February 4, 2004 | Print | Send
Some have argued that in 2004 the bears will be sleeping and the bulls stampeding. I have my doubts, but hope springs eternal.
Since 2003 marked the end of the longest lasting equity bear market since the Depression, the equity market was bound to improve. And it has done so in grand style in the new year. In fact, the combined third and fourth quarter growth rates in 2003 are at about 13 percent ushering in 2004 dramatically.
To the dismay of Democrats, the president’s tax cut is having a stimulative effect as capital spending has increased and consumer spending remains robust. Even more surprising is that corporate earnings have exceeded expectations due in some part to a weak dollar that has encouraged exports.
Alan Greenspan and the Fed have remained accommodative. But it is hard to believe that a 1 percent Fed Funds rate is sustainable even with the deflationary pressure of cheap Chinese manufacturing and a worldwide labor supply at low wage rates. The disparity between a growth rate of 5 percent and the one percent Fund rate is not likely to continue throughout 2004, albeit the rise in interest rates will be gradual until the growth signals are synchronized in green.
The equity market will probably outperform bonds in 2004, but those who see sugar plums dancing in the future of their portfolio should be wary. There is still a lot of leverage in the market and the potential for volatility remains unabated. Clearly a weak dollar and improved earnings as well as presidential jawboning about the “roaring economy” suggest a sound return on equities. But it is hoped that the average investor has gotten over his intoxication with the returns offered in the 1995 to 2000 period. A sound return in 2004 translates into 6 percent.
As I see it, capital will flow to quality, i.e. companies with real earnings and profitability. For speculators, enormous profits can be realized in commodities such as gold. Here is a commodity that has experienced underinvestment for years. Given a weak dollar and the possibility of reflation, gold is a superb bet. It will surely outperform bonds, equities and cash.
With a weak dollar, OPEC will try to control supply in order to maintain a high oil price. So far this strategy is working since oil prices have risen 20 percent in the last three months and oil companies have had resounding profits.
Last, I’m persuaded that President Bush will be reelected, and the Republican advantage in the House and Senate will increase. Despite all of the imponderables in politics, it is unlikely any Democratic candidate can win the presidential race with the economy growing at a 4 percent rate or higher, unemployment going down and the conditions in Iraq improving. If reelected the president will attempt to make his tax cut permanent, a point emphasized in his State of The Union address. He will also urge the Congress to consider the partial privatization of social security.
This Republican victory and likely presidential initiatives should translate into market boosterism. For one thing, the market is disrupted by a lack of certainty or a change of administrations and, for another, privatization of social security and a permanent tax cut could serve as an adrenalin rush for market slumber.
As a consequence, I am guardedly hopeful about 2004. Yet there are incalculable risks that could alter this scenario significantly. A terrorist attack in the U.S. could paralyze the economy. A political collapse in China or a spasmotic North Korean attack against Japan could lead to global fear and retrenchment.
The great “philosopher” of the twentieth century, Fats Waller, once said “one never knows, do one.” Alas, we never really know what the future holds in large part because the future changes each day and markets are a barometer of that change.
Nonetheless, the trend lines are more positive than negative for the first time in four years. Hope is bubbling to the surface. I pray, however, that the hope isn’t converted into “irrational exuberance,” but we’ve been there before and presumably have learned from the experience. Hope combined with forbearance should make for a reasonably successful season for investors.
Herbert London is president of the Hudson Institute and John M. Olin professor of humanities of the New York University, publisher of American Outlook and author of "Decade of Denial," recently published by Lexington Books. He's reachable through www.benadorassociates.com.
©2003 Herbert London |
