OK...this has GOT to be the bottom...right?
March 14, 2001
As I look into the eyes of random strangers I see an eerie calm. A serene, blissful blind spot to the economic turmoil spreading around the globe? Or a strained attempt to hide the fear that may be creeping amongst us...?
Well, there must be chaos going down, because I am writing yet another missive on the economy to anyone who will listen. I have widened the audience for this one even further because of the deterioration in economic fundamentals has gotten more and more profound...and global. Most importantly, the Federal Reserve's (aka Greenspan's court) meeting next week now sits on the most important cusp of economic activity since the financial crisis of the summer of 1998. (Unfortunately, the most important transitions are yet to come this year!)
Since not everyone reading this is an active investor, I will divide this into sections. The first will give my newest observations. The second will include some stuff I have already said (I apologize for some of the repetition, but it is to tell a complete story to the newbies reading this!). The last section is devoted to investing opinions.
**** DOMINOES ****
First, let me say that I continue to see things get worse and NOT better. While these conditions validate most of my previous missives during which I retained shreds of optimism, I am also becoming more and more alarmed. I continue to urge everyone to have back-up plans and to be prepared. Our path out of this will not be quick as many hope. We need some luck in that inflation stays tame as the Fed tries to stimulate the economy by lowering interest rates. We need some fortune with consumers managing to spend in healthy amounts without going further into debt. We also need corporate America to bleed off their excessive inventories as best as they can. Eventually, we may need global governments to step in and become the spenders of last resort...
I will also say that Greenspan's words are beginning to worry me. The market's plunges reflect decreasing confidence in the Fed's, and the government's, ability to steer the economy. Greenspan cannot admit that earlier interest rate hikes were partially meant to prevent just the type of stock market meltdown that we have seen. But it is alarming that he does not forthrightly admit that this severe decline in stock wealth will drag on the economy in the same way he feared that a rise in stock wealth would fuel over-spending. Most troubling is that he verbally relies on the forecasts of stock analysts to point to the continued growth prospects of the economy. These are the same people he once accused of irrational exuberance. These are the same people who keep reducing these growth predictions by the week! These are the same people who I have little confidence in ---- they tell us to buy from the peak all the way to the bottom, and only say sell once all hope is finally lost (a contrarian signal to begin buying of course). I will be reading Greenspan's words next Tuesday very carefully.
When I first read "The Internet Depression" I was struck by how wild and radical its words seemed to be. I am now struck by how accurate these words were.... I continue to harp on its principles and will do so again. The economic forecasters continue to be wrong, the Fed continues to be stuck in a quandary between inflation and recession, and the economy has taken its most rapid downturn, perhaps ever. All of these were accurately predicted in this book. All the reasons for it were accurately described as well. And the dominoes continue to fall. The energy crisis has presented the Fed with its first serious challenge to economy steering, but the near-collapse of the Japanese economy presents an even bigger challenge as its roots are not here. In case you have not heard, Japan's stock market has reached a SIXTEEN YEAR low. It marks a low-point in post-war Japanese economic development and presents a dire lesson to those who do not take the pops of bubbles seriously. (Japan's real estate and stock market bubble ended in the late 80s/early 90s, and they have not stopped suffering from this demise. Of course, "suffering" is relative. Japanese still enjoy low unemployment rates).
The world loves America. When it is buying the product of their excess capacity that is. Our continued economic troubles are dampening demand worldwide. As I mentioned before, there is no safety anymore in counting on economic growth elsewhere in the world because of the amount of dependence so many countries have on their exports to the U.S., especially in the Asian-Pacific Rim. Japan's troubles are now getting serious enough to threaten a global banking crisis. I won't go into the gory details here but as their economy continues to collapse, Japanese investors will surely be forced to sell off global assets to preserve wealth. If it has not happened already, imagine what a massive Japanese sell-off of stocks and US Treasuries could do to our economy. I tremble to even consider it. The Yen will depreciate against the dollar, and the once powerful Japanese will be even less able to buy world goods or invest in world markets or assets. The currency crisis in Turkey had a small effect (will this continue?). A Japanese collapse will rip around the world. They are the second largest economy in the world...'nuff said.
The energy crisis continues to be a wildcard. Washington State has now raised a red flag warning us that the state will teeter on recession if the energy crisis facing the entire Western US is not resolved soon. Western governors, Republicans and Democrats, are crying out louder for energy price caps. California seems to have averted disaster, but is still struggling mightily. The raising clamor about changing the rules of the game, that is, challenging deregulation, shows that we are in for a transformative economic event. "The Internet Depression" predicted that when people begin demanding changes in economic rules and challenge the good of free, capitalistic, unfettered markets, trouble must be serious.
Finally, I am getting more and more anecdotal evidence that the job market is quite weak right now. Every single one of my friends looking for work is struggling to land something desirable. As a consultant I get to peer inside companies and swap stories with other people who see inside other companies. There is a unanimous opinion the current slowdown is the swiftest and most severe ever seen in memory. No one was prepared for this swift decline, and companies are reeling trying to cope. Yet, "The Internet Depression" predicted just this type of decline very accurately! The resulting chaos and de-stabilization promises to last at least for the rest of this year. Their is simply no near-term catalyst to kick-start things.
The domino effect has become quite clear. Pundits ignored the signs. They laughed at failing dot-coms. They said don't rush to prospect gold, sell the equipment to the miners. In this case, there was even a gold rush for equipment makers. There was a gold rush for almost EVERYTHING tech-related. All rushes end, and usually quite spectacularly. Then the pundits laughed at the tech bubble. However, we are more dependent on the tech economy than ever. We never believed technology was cyclic, but it is..and even more so than the general economy (again, predicted by "The Internet Depression" --- I have described why in previous mails). The swoons of tech are sending the last dominoes of the economy down now...the collapse of the Dow and the S&P 500 serve as proxies of the final dominoes.
Again, I am looking for an early 2002 recovery...and I consider this a HOPE. The Fed will be surprised to find just how ineffective their tools will seem in the near-term. However dire this sounds, current conditions don't seem to reflect the seriousness of our situation (outside the stock market of course). I hope to clarify that below.
**** THE ECONOMY ****
So what is going on? The Fed keeps telling us we are not in recession and will narrowly avoid one. In fact, they have orchestrated quite a vigorous campaign to do so. They even have guaranteed us they will take vigorous action at the first sign of economic weakness. Consumers are still spending in good amounts. While housing starts are finally dropping, most retail sales are robust. Sure 1000s of new layoffs are announced every week, but the economy in total continues to add MORE jobs, not take more away. Consumer confidence continues to erode, but it was so high before the bubble pop that it is still not in recession territory. Although household net worth last year decline for the first time in *55* YEARS, our incomes are holding firm, in fact, many continue to see wage INCREASES....even with worker productivity declining slightly in the last quarter. Even better, Bush is promising to lower our taxes so that we can spend even MORE money (our negative savings rate indicates that we will actually spend $1.50 or so for every $1 we get back from Uncle Sammy)! While energy prices continue to rise, overall inflation seems tame so we need not fear being forced to buy less with the same dollar.
And yet, the American stock markets have all collapsed in the past year with no bottom yet in sight. Why, oh, why, oh?!?
One simple word: uncertainty. The stock market needs a certain amount of certainty to maintain prices. Yet, the only certainty in the past year has been that corporate profits have been in steady decline and have dropped off a cliff in the past 3-4 months. As you can see above every good piece of economic news is wiped out by some equivalent bad news. Even worse, in economic hard times, the stock market needs a certain amount of BAD news to keep up hope for further interest rate cuts from Greenspan. Much to the market's dismay, there remains enough strength in our economy to make the Fed cautious of aggressively slashing rates. And why do the stock market's woes matter? Well, American households have more of their assets tied into the markets than ever before (30% or so!). Corporations depend on the equity markets more than ever to finance business expansion and employee salaries.
-- JOBS --
Let's go straight for what matters to most of us: employment. Besides inflation, nothing means more than unemployment numbers. As long as unemployment stays low (and wages robust), the Fed risks inflation if it over-stimulates the economy. The Feds reluctance to move faster since January's interest rate cuts is killing the markets right now. However, these numbers look backwards. Looking forward, we note that the layoff announcements from companies do not take immediate effect. Instead, they seek to reduce workforces through natural attrition and gradual firings, sometimes spread over a year or more! They are hoping that by the time comes to actually cut people, the economy will improve enough to eliminate the need for these cuts. Since these same companies will not hire new workers in the near-term, the unemployment rate can only rise with time. I have increasing anecdotal evidence that the job market is quite weak right now. Every single one of my friends looking for work is still looking and struggling. I keep reading about the popularity of "out-of-work" parties for unemployed tech workers...a friend of mine just came back from one of these tonight...the party was filled past capacity. We have to wonder how much the Fed will believe what is right in front of its eyes.
-- TAXES --
Maybe you are looking for tax relief? Well, I actually support a massive, across-the-board tax cut. The government is flush with money and doesn't most of it. In fact, it will only go to waste in pork barrel projects if it sits there too long. However, the fiscal stimulus of these cuts promises to be minimal. First, the average refund per tax-payer will be small compared to income. Worse still, the congress will not be able to pass these cuts in time to save us money in April. Apparently, the phased structure of the cut gives us more money in future years and not NOW. You can almost kiss this money goodbye as future legislative sessions are almost guaranteed to revoke these deferred monies. Thus, whatever gets past (and whenever) will not be enough to kick consumers into spending our way out of recession.
-- CONSUMER CONFIDENCE & CONSUMPTION --
So, how do you feel? Well, it is often said that recessions are psychological: if everyone remains optimistic and cheery and keeps spending like nothing is wrong, we can all be collectively happier. Well, maybe this works in communist countries, but economic hardship has a very real component. The people who run businesses are not perfect. Collectively, companies in entire industries rush to opportunity and retrench from troubles like herds. Economic cycles are well-understood and well-studied. When an economy over-extends, a very real contraction occurs to bring supply and demand back in line. Excess inventories must be sold off, often at discount. Today's inventory corrections will be even more vicious because products become obsolete more quickly than ever: a lot o this stuff will become simple junk!
Where too many jobs were created to make and provide products and services no longer needed, these jobs must go. As these jobs go, so goes the spending from those wages and the corporate spending on supplies and other assets. The greater the over-extension, the more likely we hit recession on the way back to balance. Psychology can make things worse as people begin to fear their own economic futures enough to start saving for that possible rainy day. That money sits in a bank or a mattress, and while it may be available for companies to invest in economic activity, it is also not available to purchase the output of that activity. The spiral continues downward until some event gives people hope again (like a new technology that opens new markets and new jobs, etc..)
Nothing else defines the American economy more than its consumerism. We have all been raised to believe spending and spending and spending and consuming ever more things is good. We commercialize everything. This is how we get economic growth that is faster than population growth. Our economic strength and growth are the envy of the world. The drawback is that we also become addicts of growth and anything that disturbs this constant need to consume, sends the economy for a loop. In fact, this buying behavior fuels a large part of GLOBAL economic activity. I have previously spoken at length about how this time around, our slowdown will likely drag the world down into recession. The more global the malaise the harder and longer it will take for us to recover. Already, companies are admitting that global markets are looking weaker and weaker for their products. I will reiterate that Japan's coming collapse is a sobering act to keep a watch on.
-- INFLATION?!?! --
It cannot be! Inflation?!? Lagging indicators of inflation all increased last quarter. Companies will feel ever more pressure to raise prices as we clamor for more pay to compensate for worthless stock options and CEOs face shrinking markets (and thus revenues). Greenspan claims not to be worried. But apparently, a more technical, forward-looking indicator is showing that inflation pressures are REAL. Greenspan actually keeps an eye on THIS number. The fact he has chosen not to mention this red flag worries me a lot. It indicates how much of monetary policy may be riding hope more than precise planning.
Whew! Enough of this economy stuff. How about some investing ideas in these crazy times!?
**** INVESTING IN THE MIDST OF FEAR ****
Investors face the worst of all possible worlds in trying to invest right now. On one hand you have tech stock prices falling like rocks but not as fast as earnings are falling...so prices are low, but still far from low enough. On the other hand, you had, until very recently, a bull run in stocks expected to recover first or stocks providing reliable earnings, leaving these stocks highly priced compared to their growth prospects. Thus, most stocks are pretty expensive and until earnings show real improvement, you face the prospect of buying almost any stock with severe downward risk.
At some point, we will hit a bottom and those lucky enough to invest at the time will clean up. Unfortunately, the hazard of picking that point is HUGE. Pundits have been calling bottoms to this market for almost a year now! Most of us will just have to wait until we are both confident in our ability to invest and a clear rally in the market that accompanies improving economic conditions. While we will miss a lot of the gains, we will miss a lot of potential losses. So, just get used to the idea you will MISS the bottom, and just be ready with cash to take as much as you can.
While macro-economic weakness is real, don't be fooled by companies hiding their internal weaknesses this way. Since the summer we have heard crying about energy prices, then the Euro, now slowed capital spending....when the market finally picks up, do not buy indiscriminately...! Stick with stuff you know. Stick with companies with proven track records.
Some companies are finally calling the economy for what is really going on: Intel warned about pending financial ruin in the telecommunications industry, Nortel says it cannot see an upturn until sometime in the fourth quarter of this year, and Sun gave the following:
"Ed Zander, Sun's chief operating officer, blamed the slowdown in information-technology spending for the company's woes. "Believe me," he said, "it's the U.S. economy." Mike Lehman, Sun's chief financial officer, was even more frank in his assessment of the industry's plight, calling upon the dreaded "R" word to add import to his comments. "This U.S. recession is what we and others in our industry are coping with," Lehman said. "In our collective experience at Sun, we have not seen such a widespread and sudden change in the overall demand picture in the U.S. as we are witnessing today.""
The most troubling aspect of the market decline now is the destruction of prices in financial stocks. These stocks were supposed to fare well as interest rates lower. Their prices have been weakening for a month, but the past week has been particularly brutal. This is an ominous signal of some type of financial catastrophe (Japan is a HUGE worry right now). It could also mean that people are beginning to worry about inflation. Regardless, the news is NOT good.
Do not use Fed meetings as buying points unless you are looking to play for short-term profits. Most of the moves in these meetings are already priced into stocks. While the economy remains weak any surprise moves will only produce temporary bear market rallies. Finally, if the Fed only gives the market 25 basis points, the market will drop even harder. There is a good chance for this scenario because Greenspan sees promising strength in the economy, and if he truly believes this, his training tells him that cutting rates too much will create dangerous conditions for renewed inflation fears. The last thing he wants to do is slash rates only to have to raise them soon again in the face of inflation.
The good news is that with the Dow finally buckling, a lot of good deals similar to the Dow's collapse last year will open up. As opposed to the tech collapse, you will soon be able to buy companies that have been through tough times before for decent prices. These will be companies you can easily understand with revenue streams you can rely on coming back. If you are a bit more conservative, look to snatch these companies first. Also making the selling worse in good companies will be the mutual funds that are forced to sell their good stocks to pay for the redemptions of people bailing.
In the tech sector, semiconductor stocks are most likely to lead the charge. They follow well-recognizable cycles. These companies are more likely than other companies to continue investing through rough times. And many are already priced for sale! The recent quick rise of semiconductors shows that people are dying to buy these stocks at the smallest sign of market recovery. Keep an eye on these for clues on overall tech market recovery.
Capitulation? What capitulation? Everyone keeps looking for that magic moment when everyone gives up and sells at any cost. Instead, we have gotten slow bleeding and a steady dose of pounding. Until despair and fear reign the land, we have not reached bottom!!!
Overall, extreme caution is warranted. With it taking at least 6-9 months for Fed easing to show effects, and with the economy moving more slowly than anyone could predict, you are safe taking things slowly. Avoid the days before taxes are paid as people will sell stocks to pay unexpected dues. Watch earnings seasons carefully. I am guessing that late summer and early Fall will be excellent times to snatch up bargains. If the market continues weakness through these prime periods, look for further economic weakness well into 2002.
Whew! Enough! I hope this has been a help. I will be taking a break as things unfold, but if something serious drops, expect me to comment!!!!