Fed Looks to Correct What Went Wrong
By Pierre Belec
Reuters
NEW YORK (March 2) - The 'Great Big Ship' that Wall Street gurus like to call the U.S. economy is nearly stuck on a sandbar and the rescue crew at the Federal Reserve may not have an easy time pulling it free.
What's happening is that the business part of the economy, notably manufacturing, is in recession, as opposed to the still buoyant consumer side. To make matters worse, the businesses, which last summer misread the handwriting on the wall that the economy was heading into rough waters, are now holding bloated inventories.
The manufacturing recession, which has hit technology companies the hardest, is forcing a lot of companies to cut back on new production until demand catches up with supplies.
The inventory glut could be around for a long time because there's no pent-up demand to soak up the stocks of unsold goods. The problem is that a lot of their customers are loaded up to their eyeballs with the latest technology and they have no need for more stuff.
''After nine years of economic consumption without interruption, it's possible that consumers' needs are pretty well satisfied in many important spending categories -- most important, possibly in the area of technology,'' says Greg Smith, chief investment strategist for Prudential Securities.
The point is well taken.
Why should a company buy more technology that uses the same old software? Since the semiconductors become cheaper every two years and their speed doubles every 18 months, what's the rush to load up on old tech now?
''Consumers may not buy more gadgets simply because they're new, as readily as they used to,'' Smith says. ''There will always be a market for new gadgets, but there may not be big markets for them until the gadgets are proven to be truly useful.''
Many people would agree that Greenspan threw a monkey wrench in the business cycle and caused the economy's growth to come to a screeching halt when the inflation-fearing central banker boosted interest rates by 1.75 percentage points, or 175 basis points, from 1999 to 2000.
The rapid-fire rate increases took a bulls-eye shot at the companies' capital spending on computers and software, which had fueled the information technology boom as well as the Greatest Bull Market in history.
THAT WASN'T SUPPOSED TO HAPPEN!
''Nobody seemed to pick up clues around the middle of last year that the tech industry had entered an inventory cycle,'' says Ned Riley, chief investment strategist at State Street Global Advisors. ''The technology companies were believing the salesmen and the salesmen were believing the high stock prices and stock prices were being driven higher by stock market analysts.''
The vicious circle was broken when people finally acknowledged that the fast-growing technology sector was just as cyclical as most other industries.
''Unfortunately, the cyclicality was manifested at a time when inventories were very high and there were expectations for a continuation of a perfect environment,'' Riley says.
Nowhere is the damage so horrific as on the Nasdaq market where the biggest tech names have gone over the cliff.
There's a lot of nail-biting over how long it will take the tech companies to clean out their huge inventories. Initially, Wall Street was betting that the de-stocking would last only one quarter but now, there's talk that the inventory correction may last for a couple of more quarters.
SUPPLY PENDULUM HAS TO SWING THE OTHER WAY
The problem is not one of demand but rather of supplies, which take a longer time to correct.
Almost a year after rocketing above 5,000 points on March 10, 2000, the Nasdaq composite index, which is 70 percent heavy with technology stocks, has plummeted more than 50 percent from last March's high and hovers at a two-year low.
Just in February this year, the Nasdaq had a bone-jarring drop of 22 percent and it has had its nastiest New Year start since 1984.
Don't look for the battered technology stocks to race back up as fast as they fell.
''The history of financial bubbles shows that when they burst, it can take a very long time before shell-shocked investors are willing to come back and bid prices back to their bubble peaks,'' says Ed Yardeni, chief investment strategist for Deutsche Banc Alex. Brown.
NO EASY FIX
Another big fear is that the negative mood on Wall Street may cancel out the benefits from the Fed's two interest-rate cuts that totaled 1 percentage point in January. The experts are betting that an additional reduction will come out of the central bank's next policy-setters' meeting on March 20.
Analysts have dramatically changed their expectations for the tech companies' earnings. High-flying techs, like Canada's Nortel Networks Corp., have seen their stocks get destroyed because the companies assumed that business was going to be as good as usual. What was not supposed to happen, did happen.
First Call/Thomson Financial expects the technology companies in the Standard & Poor's 500 index to post a 19 percent drop in first-quarter earnings. That's a big downward revision from the 4 percent gain predicted at the start of the year. A 16 percent drop is seen for the second quarter while a 4 percent slide is forecast for the third quarter, First Call says.
Based on the latest survey, the fourth quarter may turn out to be the year's only winner with analysts forecasting a 20 percent gain in earnings for the technology companies.
NOW THE GOOD NEWS
The good news is that the consumer side of the economy, which accounts for two-thirds of the nation's growth, is still holding up nicely.
Indeed, the key to the turnaround will be consumers' response to the interest-rate cuts by the Fed.
And, don't get carried away with all of the gloomy talk in the media about how bad things are. The economy has lost altitude but the fact is it's still flying, just not as high.
Example: The Consumer Confidence Index slumped 6.0 percent in January but the level is still consistent with economic growth.
While orders for costly manufactured goods plummeted in January, the drop was exaggerated by a dive in aircraft orders.
''There is a lot of information out there that would promote the negative argument that we are falling off the precipice and into the deep hole of recession,'' Riley says.
''What seems unfortunate is that we may be creating some of our own morass by believing that the drop in demand for things has been so dramatic. And it can only be associated with recession when we fail to realize that the growth we had in the last two years has been just spectacular,'' he says.
It helps to keep things in perspective. The Nasdaq may have crashed by more than 50 percent from its peak but it's easy to forget that the market was on a rocket ride of 130 percent from 1999 to March 2000.
For the week, the Dow Jones industrial rose 24.41 points to 10,466.31. The Nasdaq composite index dropped 144.88 to 2,117.63 and the Standard & Poor's 500 was off 11.68 at 1,234.18.
Reuters 16:29 03-02-01 |
