Could it be recession?
The 'R' word is dreaded on Wall Street,
but some signs are pointing that way
By Staff Writer M. Corey Goldman
November 22, 2000: 8:51 a.m. ET
NEW YORK (CNNfn) - Could it be? After chugging along faithfully for almost 10
years, could the U.S. economy be poised for a recession?
Judging strictly by the economic numbers, far from it. The U.S. economy is
poised for a slowdown, a gentle easing of growth prompted by the Federal
Reserve's series of interest rate increases over the past year and a half. The job
market remains robust, inflation remains contained and consumers, while more
wary, still are relatively confident about their future prospects.
At least that's what the economic data say. The financial markets, however, tell
a much different story. They have priced in doom and gloom as far as the eye
can see. Corporate bond yields are at their highest levels since 1998. Bank
lending has dried up. Venture capital firms are keeping a tight fist on their
check books. And the S&P 500 spells recession, with the index on track to
post its worst annual performance in more than two decades. To date, the S&P
has dropped 8.3 percent; it fell 9.7 percent in 1981.
So who is right? Have the markets ridiculously overreacted by pricing in the sad
end to the longest economic expansion in U.S. history? Or are the experts who
dissect all those different numbers that foretell the progress of the economy
and the direction of interest rates simply missing, or arguably ignoring, the
writing on the wall?
"That really is the trillion-dollar question," said Steven Slifer, chief economist
with Lehman Brothers in New York. "The markets are pricing in extremely
negative news and the forecasters are talking about not-so-bad but
not-as-positive news. I suppose the truth lies somewhere in between."
The sharp shrill of the television set
Judging from newspaper headlines, magazine headlines and the sharp note of
TV announcers' voices as they recount the play-by-play triple-digit downfall of
stocks, the U.S. economy is not doing particularly well. And that is certainly
true: Concern about declining stock prices, whether it directly affects them or
not, has made people think twice about spending their hard-earned cash on
things like new cars, computers and vacations.
Add to the mix the uncertainty as
dot.com businesses go belly-up
almost daily along with more stringent
lending among banks and venture
capitalists and it does not paint a
promising picture for the economy
going forward -- at least not to Main
Street. Unlike 1999, when gross
domestic product growth averaged an
annual 5 percent, GDP expansion is expected to ring in at about 4 percent in
2000 and around 3.5 percent in 2001, according to the International Monetary
Fund -- good numbers by any measure, but not the heady growth American
consumers and businesses are accustomed to. By contrast, the textbook
definition of recession is two consecutive quarters of contraction.
And those growth forecasts assume a lot: that employment will remain
bountiful, that inflation will remain under wraps, that interest rates will remain
stable or even come down, that international demand for American-made goods
will continue and, as some analysts wryly say, that a U.S. President will be
elected. But no matter how confident, no economist is willing to predict with
certainty that all those things will happen in the magical order that will keep the
economy on the road of continued prosperity.
"A lot of people are starting to come to the conclusion that we are in for a hard
landing, based on the downturn in stocks and higher yields and spreads in the
bond market," said Kim Rupert, a markets analyst with Standard & Poor's
MMS in San Francisco. As for the prospect of a recession, "Things are never
out of the question," she said. "It is not a zero percent possibility, but I think
the probability is still extremely low."
The bond market is bracing for recession
Not according to the corporate bond market.
There, where companies with more-risky prospects borrow money, things are
looking pretty grim. The average yield on a 'BBB'-rated corporate bond is
currently 13.3 percent, up from an average 10.3 percent demanded by investors
back in September 1998, when the collapse of hedge fund firm Long Term
Capital Management seized up the corporate bond market and prompted the
Fed to begin cutting rates. Because a bond's yield moves inversely to its price,
as the price, or value of a bond goes down, the yield rises. In that regard, yields
in the double digits typically spell prices much lower than where they started.
For some economists and market
watchers, the downturn of the
corporate bond market and the lack of
lending among financial institutions
could spell big troubles for companies
going forward -- something that could
kick the economy in the gut a lot
harder than many currently are
predicting.
That has some serious implications for companies that have borrowed in the
corporate debt arena to finance their operations -- firms such as Amazon.com
(AMZN: Research, Estimates), whose 10-year 'CCC+'-rated bonds currently
yield 13.83 percent, or Global Crossing Ltd. (GX: Research, Estimates), whose
10-year 'BB'-rated bonds yield 10.13 percent. And Xerox's (XRX: Research,
Estimates) 'BBB' 2-year bonds that yield 9.12 percent.
That's because the amount of interest they are required to pay their bond
holders is far greater than they ever anticipated, noted Richard Berner, chief
economist with Morgan Stanley Dean Witter in New York. Paying more in
outstanding interest means less on the bottom line -- a signal for stock
investors that even a company like Amazon that has seen its stock price fall
almost 80 percent in the past eight months still might not be fairly valued.
Banks are tightening their lending
One institution that most believe certainly can save the day is the Fed. Back in
1998, when lenders refused to nibble on corporate bonds at almost any price,
the Fed swooped in and lowered short-term interest rates three times in as
many months to ease investors' fears about a credit crunch occurring, and
restore calm to jittery financial markets.
Many believe the Fed would do that
again if it sees concrete evidence that
buyers are truly afraid to commit
capital to sellers -- at any price. The
Fed opted to leave rates unchanged
at its Nov. 15 meeting, holding its
influential fed funds target rate at 6.5
percent. Its next and final meeting for
the year is Dec. 19.
But few are willing to bet the farm --
even on the Fed.
"The U.S. stock market is pricing in a
hard landing, an acceleration of
inflation and a Fed that may or may
not come to the rescue," Berner said.
"Part of that message is emanating
from the bond market and part of it is
coming from some thick smoke
signals that the banks are sending."
Indeed, U.S. banks have all but closed their vault doors on lending cash to new
ventures. According to figures complied by MSDW, commercial and industrial
lending in the past three months has slowed to a 4.4 percent annual rate from
14.4 percent during the summer months -- the greatest reluctance among
banks to lend cash since the 1991 recession.
Loan application? Denied
Even the Fed under the leadership of the seemingly omnipotent Alan
Greenspan has taken note of U.S. banks' recent unwillingness to loosen their
purse strings. In its November Senior Loan Officer survey of bank lending
practices, the Fed found that 44 percent of domestic banking institutions
"reported tighter lending standards on their commercial and industrial loans to
large- and medium-sized firms," the highest percentage since 1991.
With the initial public offering market
all but shuttered, with the corporate
bond market demanding the highest
premiums on debt since the early
1990s, and with banks keeping their
cash in their vaults, "That leaves
companies with no choice but to pay
more for financing and development,"
Berner said. "And it's not just tech, it's a lot of different sectors.
"Take a look at where some of the defaults are on a sector-by-sector basis –
health care, shipping, auto parts -- some have been in industries which have
been in legal wrangling such as Owens-Corning (OWC: Research, Estimates)
-- which filed for bankruptcy because of asbestos claims. But many of these
are more 'old economy' companies feeling the heat here," Berner said.
All that is going to have an impact on the economy going forward, said Sherry
Cooper, chief U.S. economist with brokerage BMO Nesbitt Burns Inc. As the
stock market wavers, consumers will be less confident. As confidence wanes,
spending will falter. As spending falters, companies will have more trouble
selling goods and services. And as companies have more trouble selling, their
profits will falter, prompting investors to further shun their stock.
Sounds an awful lot like a recession, no?
If it looks and smells like recession...
It may sound like it, says Lehman Brothers' Slifer, but it certainly doesn't look
like it.
He points to a 30-year-low unemployment rate, solid gains in disposable
income, strong consumer confidence and mortgage rates that actually have
declined more than a point and a half in the past six months, triggering
renewed interest in the housing market. Even government spending is expected
to rise, no matter who ends up in the oval office.
"The American consumer feels good, he has the money, he's not worried about
losing his job and yes, the stock market has fallen, but that's way down on his
list of concerns," Slifer said. "I think that growth is going to slow a bit but it's
not going to fade into the sunset."
Certainly other Wall Street notables agree with Slifer, and almost no one is
claiming the economy will come anywhere close to a recession. On the
contrary, most are bickering over whether the economy will hit the runway hard
on its way down or, as it did back in 1994-1995 under Greenspan's careful
stewardship, glide back down for another soft landing.
"It really does come down to whether the economics profession is right or
whether the markets are right, and I really think the markets are building in a
huge amount of unnecessary fear," Slifer said. "From my own viewpoint, I sit
here and I go through the various sectors of the economy and I try to figure out
where all this alleged weakness is going to materialize -- and I really can't." |
