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Global: A Different Lens
Stephen Roach
United States: Technology Redux?
Richard Berner
morganstanley.com
Global: A Different Lens
Stephen Roach (from Sydney)
Context is everything in the macro research business. As I travel the world, I still find that most view the US macro outlook through the lens of a traditional business cycle framework. That’s not unlike the approach that remains in favor back home. I guess I’m on a different planet. I continue to see the US macro through the lens of a popped asset bubble. As a result, the macro I practice these days couldn’t be more dissimilar from that embraced by the broad consensus of investors, businesspeople, and policy makers.
For me, the past several years have been like peeling away the layers of an onion. Once the equity bubble popped, the steady progression of subsequent events has fallen into place in a fairly logical and predictable fashion. Nasdaq, of course, was the first to go -- and, sadly, is still going. It’s currently off 73% from its March 2000 high. The information technology bubble was next to fall in line, with nominal IT hardware expenditures plunging 26% over the four quarters of 2001. The linkage between the Nasdaq and IT bubbles is crystal clear in my mind. As Nasdaq soared toward 5000, Corporate America -- especially the so-called Old Economy companies -- was keen to reinvent itself as a collection of e-based New Economy companies. It was a surefire recipe for stodgy US businesses to receive a zippy Nasdaq-like re-rating. The B2B and B2C frenzies provided the cover, and the IT-induced spending binge was on with a vengeance. The Y2K mania was the icing on this cake. The IT cycle went to excess and the rest is history.
Not much argument on this point. However, most of the financial market participants I meet with don’t want to take the post-bubble shakeout beyond the ensuing IT carnage. Implicit in this line of reasoning is the belief that any damage from the asset bubble was confined to that relatively narrow portion of the economy that got carried away with a legitimate technological revolution. After all, even at its peak in late 2000, nominal IT accounted for only about 5% of America’s GDP. Why indict the remaining 95% of the US economy?
Here’s where the rubber meets the road for my stylized depiction of macro. As I see it, the bubble went far enough -- for long enough -- to have permeated most other facets of economic activity in the United States. Not only did it entice Corporate America to go on to binge out on IT spending, but it also lulled consumers into the mistaken belief that a surging equity market had become a new and permanent source of saving. It’s hardly a coincidence, in my view, that a pre-bubble personal saving rate of 6.6% in late 1994 plunged to 0.5% in March 2000. Consumers were more than willing to extract new sources of purchasing power from what they perceived to be ever-appreciating equity assets. Unlike businesses, consumers have remained in denial -- keeping many of the dreams of the bubble still alive. That’s because asset-driven saving strategies have gotten a new lease on life in this post-Nasdaq-bubble climate. Property market appreciation has taken over where Nasdaq left off, and consumers have continued down the merry road of extracting incremental purchasing power from yet another bubble -- their homes.
Sadly, it doesn’t stop there. The US economy has taken on most of the other classic characteristics of a post-bubble era. The debt-deflation syndrome is especially worrisome in that regard. Private sector debt loads remain at record highs to this day -- for consumers and businesses alike. Even debt service burdens are at records for American households -- especially shocking in a climate when market interest rates are at 40-year lows. The excesses of the debt cycle are always the transmission mechanism for the extremes of wealth-related impacts on real economic activity -- they are the principal means by which new sources of purchasing power are extracted from frothy asset markets. Moreover, to the extent that asset bubbles promote an uneconomic expansion on the supply side of the real economy, the popping of that bubble unleashes a powerful deflationary impulse. The capital spending binge of the late 1990s is classic in that regard. So, too, is the message from the broadest measure of the US inflation rate -- an anemic 0.5% average increase in the GDP chain-weighted price index in the two quarters ending in 1Q02. America is now teetering closer to the brink of outright deflation that any point in the past 48 years.
All this sets the stage for what could be several more years of a post-bubble shakeout. The excesses of the debt cycle are a breeding ground for systemic risks in the financial system -- and for the financial accident that always seeks to arise out of this climate (see my 10 July dispatch "The Risk of Financial Accidents" and my 8 July dispatch, "The Drumbeat of Systemic Risk"). In addition, the debt cycle lies at the heart of America’s current-account financing conundrum. Lacking in domestic saving, the United States has had to tap foreign saving pools to finance excessive spending at home. The result has been a record-setting balance-of-payments deficit and the related overhang of a dollar bubble. As seen from that perspective, the recent popping of the dollar bubble makes perfect sense -- it’s just the latest layer of the onion to get peeled off.
This admittedly stylized depiction of America’s post-bubble macro climate provides some important hints as to what lies ahead. Two other bubbles still seem likely to be popped -- the property bubble and America’s consumption bubble. It’s only a matter of when -- not if -- in my view. As always, supply-demand imbalances hold the key to the property market. New homebuilding supply has been coming on stream with considerable vigor in the past couple of years. That’s the message from the surprising strength of housing starts. Unfortunately, it’s occurred at precisely the same time that demand underpinnings are being weakened by rising unemployment. As I see it, the housing cycle is much closer to the end than to the beginning.
Yet the American consumer remains steeped in denial. Before this post-bubble shakeout is over, I believe that denial will crack. Saving-short and overly indebted, consumers have thus far ignored the perils of rising unemployment and the related downward pressures on wage income generation. That, in my view, will change if the jobless rate continues to rise, as I suspect it will in a climate of ongoing corporate cost cutting. Lacking in asset-based incremental purchasing power, consumers will have no choice other than to relearn the art of saving from their paychecks. The ticking of the demographic clock can only put greater pressure on the coming shift in the preference for saving. The aging generation of baby-boomers adds a new urgency to retirement planning. The secular shift from defined-benefit to defined-contribution pension regimes only heightens that urgency. The consumer bubble will probably be the last bubble to pop. But I remain convinced that any post-bubble adjustment in the US economy will remain incomplete until this layer of the onion is peeled as well.
Finally, there are critical cultural, social, and political implications of any post-bubble shakeout. America’s corporate governance shock -- and the regulatory backlash it is triggering -- are at the top of my list in that regard. The greed and hubris of the late 1990s was classic in distorting the values of the American system. Again, that should not be so surprising. Bubbles do that -- in fact, every one I’ve ever studied leads to precisely this same point of warped values and socio-cultural excesses. The good news is that our system is coping with these very excesses today. The bad news is that my macro lens tells me there are still several more layers to this onion to be peeled. As I said, it all depends on context.
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United States: Technology Redux?
Richard Berner with Shital Patel (New York)
Three months ago I thought information technology demand -- with the notable exception of telecommunications equipment -- was beginning to turn up. Although capital spending still faced post-bubble headwinds, we'd just been through the biggest tech-spending bust in history, and the fundamentals were turning favorable. Of course, I looked at tech demand through an economist's lens: sequentially, seasonally adjusted, and perhaps most important of all, adjusted for the significant price declines that have been and always will be technology's hallmark. Thus, I knew it would be difficult to persuade investors and analysts who look at year-over-year nominal results that an upturn was brewing.
Difficult? The call was a complete disaster. I was right in a narrow sense -- real IT spending rose at an 8.6% annual rate in the first quarter of 2002. But foreign producers satisfied much of the domestic demand, and a vicious pricing downdraft killed nominal revenues for local companies. As a result, they saw no sign of a pickup in demand, and their share prices were hammered even before the latest downturn began.
Now I believe the call should work. The five factors that I thought would help revive capital spending are still in play. The overhang of high-tech capital -- except in telecom equipment -- is largely gone. The economy has accelerated, and profits are improving. The pretax cost of capital for investment-grade and most middle-market companies has come down, and the accelerated depreciation enacted in March will reduce it slightly further on an after-tax basis.
Moreover, tech demand continues to improve, and local companies should see some of the benefits. The pricing environment is still cutthroat, but the declines are less intense. And now that investors are forsaking equities indiscriminately, maybe -- just maybe -- there's more bad news in the price than either cyclical or secular fundamentals would suggest.
The improvement in tech demand is still not immediately obvious. It's not a boom; foreign producers are satisfying a significant part of the upswing, and price declines obscure the pickup in volumes. Except for telecom equipment, however, corporate demand for information technology has turned up. Four metrics validate that call. Orders, shipments, and production are all rising again. And price declines are back in line with historical norms; for example, 15-20% for computers and peripherals. Even before inflation adjustment, nominal orders for a broad range of IT equipment jumped at a 13.7% annual rate in the six months ending in May, and real orders for the narrower subgroup of computers and peripherals rose at a 3.8% rate in the same period (these data exclude semiconductors). Both are still below year-ago levels, but the inflection point is clear in recent data.
More detailed data are available for shipments. Real shipments for computers, storage devices, and other peripherals were up 2.5%, 30.2% and 6.7% respectively, in the year ended in May. Real domestic demand (shipments less net exports) is much stronger: For example, real computer demand is up 17% from a year ago. Inventories are now getting back in line with sales, so production is improving -- for computers, communications equipment and semiconductors, at a 21.4% annual rate in the six months ended in May. Computer prices (adjusted for quality changes) are off 26% from a year ago, but six months ago, the decline was 30%.
Nowhere is there a bigger capacity glut than in telecommunications services and in much of tech itself. The former implies that telecom equipment demand won't pick up until 2004. At 64.2%, the capacity utilization rate for the aggregate of computers, communication equipment, and peripherals has bounced off the recent bottom, but it still stands at record lows. Small wonder that IT companies have so little pricing power and that consumers are feasting on bargains. Until tech companies rationalize the capacity glut, I believe pricing traction will remain tenuous at best. Those price declines will significantly offset volume gains. Consequently, even in recovery, investors should expect tech revenues to grow by only 5-10% annually
The winners so far in the US IT growth derby are not computer makers, but those who make peripherals: Real storage and networking demand is booming again, and even nominal shipments are rising. Real shipments for storage devices surged at a 64.8% clip the past six months, while bookings for other peripherals accelerated to a 20.4% clip in that timeframe. In contrast, domestic computer shipments are still lackluster, as noted above, but real domestic demand growth is very strong and downward pricing pressures are ebbing.
Will all this good news cheer investors? Just as irrational exuberance created the bubble, irrational pessimism may be deflating it. Or is it rational? Either way, the news will have to scare the sellers to turn the stock market around. |
