The Perfect Recovery
Nancy Lazar says the economy is far stronger than most people think
By Sandra Ward
Barron's Online
March 18th, 2002
In the summer and fall of 2000, when everyone else fretted about inflation and interest-rate hikes, economists at the International Strategy and Investment Group sensed a shift in the wind and took a different tack. The firm warned clients of a coming slowdown in corporate profits and a downturn in the global economy that would be more severe and longer lasting than anyone then imagined. They called it the Perfect Storm, and they were right.
This past autumn, with the U.S. reeling from terrorist attacks and outlooks for global economies at their grimmest, Ed Hyman and Nancy Lazar again saw the world differently. The worst was over, they said. The economy was likely to touch bottom in the fourth quarter and a recovery was getting under way. U.S. gross domestic product was going to be stronger than expected, their research showed. At the time, they forecast GDP growth of 3.5%-4% for 2002. The surge in the stock market, in October and November was a "classic end-of-recession" rally. They forecast the Perfect Recovery. They appear to have been right again.
ISI is renowned for uncompromising and comprehensive research, which includes a series of proprietary weekly surveys of industries, ranging from housing to autos to capital goods. The firm's work is always timely and uncannily accurate. It is the reason Hyman, who hired Lazar in 1981 when he was at C.J. Lawrence, has been ranked the No. 1 economist in each of the past 22 years in a poll of money managers conducted by Institutional Investor magazine. Hyman and Lazar founded ISI in 1991. A staff of 12 has since grown to more than 60.
"We're big fans," says Charles McCurdy, a portfolio manager at Veredus Asset Management of Louisville, with $1.2 billion in assets. "Their greatest advantage is they're willing to call things as they see them. They take a dispassionate approach."
"If you have Ed Hyman, what else do you need?" reflects Hersh Cohen of Citigroup Asset Management and manager of the Smith Barney Appreciation Fund. "He is the best."
Lazar: Growth will be stronger than expected and inflation will be lower than predicted. "The recovery is sprouting legs."
As is typical, Hyman was on the road meeting with clients last week, leaving Barron's to chat with his partner, Lazar. The "diminutive but dynamic" economist, a label assigned to her years ago by a wag at a New York tabloid, credits ISI's enormous emphasis on research for much of the firm's success. "We look at a lot of data. We have a great research staff. We talk to our clients a lot and see what they're looking at. We spend a lot of time looking at charts. We try to have some ideas of what will help create big swings in the economy. Those things can change. We try not to be married to an idea."
Lazar notes that the firm's weekly surveys are particularly useful when it comes to identifying a turning point. "Our surveys tell us where we are," she says. "They don't tell us where we are going. Someone once told me, if you can figure out where you are, that's more than half the battle."
Now, nearly six months after ISI made its bold call for a perfect recovery, it's forecasting an even more perfect recovery. A stronger, longer recovery. The aggressive easing of interest rates by the Federal Reserve, especially following the events of September 11, a big drop in energy prices in the last year and massive inventory reductions are leading indicators that point to GDP growth of 6% in 2002.
The recovery will be stronger than that of 1991, according to ISI, because historically the pace of the recovery is proportional to decline in G7 rates. G7 rates declined 11% prior to 1991's rebound; they fell 48% prior to the current snapback in the economy. Importantly, the recovery is happening around the globe, lifting Europe, Brazil, and even Japan.
Concerned, however, that any number of risk factors -- from trade wars to consumer debt to a shortfall in corporate profits -- could undermine such heady growth, ISI is conservatively forecasting real GDP growth of 4%. But the bias in the forecast is a positive one.
"What seems to be happening is that the recovery is sprouting more legs," Lazar says as she leans across a conference table in the firm's midtown Manhattan office to riffle through a fat handout filled with ISI's signature charts and models and scrawlings. "For the first quarter, the demand side is turning out to be more stable and stronger than we expected. Consumer spending looked like it was going to be about 2%, but at least in the first quarter is going to be closer to 3%. Capital spending looked like it was going to decline about 2%, and now it looks like it will probably be up 2%, maybe even 5%."
There is also early evidence the credit crunch may be easing. In the first week of March, issuance of commercial paper rose by $10 billion; ISI's bank business loan-demand survey showed increases for the second week in a row, and corporate bond yields declined. Promising signs, but still too soon to declare a trend.
Lazar blithely dismisses fears of a "double-dip" recession occurring in the second half, relying on history as a guide: There's never been a double-dip in the first year of a recovery. There's never been a down quarter in the first year of a recovery based on 1954, 1958, 1961, 1971, 1975, 1983 and 1991.
On the inflation front, the firm's outlook couldn't be more sanguine. ISI is forecasting zero inflation for the year. Not only will growth be stronger than expected, inflation will be lower than expected. Excess capacity and a boost in productivity will keep inflation low, though ISI is predicting the Federal Reserve will raise interest rates by 50 basis points in the fourth quarter. The better inflation news should take the pressure off the bond market.
"We think this is a temporary selloff in bonds, and bond yields are likely to be lower as we go into the second and third quarter," says Lazar.
This should also be a good environment for stocks. ISI forecasts a 30% rise in S&P 500 operating earnings this year, to $50. Admittedly, P/Es are high, but lower inflation will support higher multiples. ISI expects the market to trade in a 10% range this year.
One unknown: the performance of the dollar. ISI's optimistic outlook on inflation is based on the dollar's strength now. And if foreign markets were to outperform the U.S. in this synchronized global recovery, it could lead to weakness in the dollar.
ISI, of course, has its radar out for any such signals. Indeed, Lazar notes that the S&P 500 will likely indicate any coming plunge in the dollar if its performance begins to trail that of foreign markets. And if that happens all bets for a Perfect Recovery could be off.
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