The second phase of the slowdown has begun
May 5, 2001
With the economic and market news churning daily, you just knew I couldn't keep quiet much longer!
Well, last week's numbers showing dramatic increases in joblessness indicate the second phase of this slowdown has finally begun. The first phase consisted of companies cutting purchasing from other companies in order to rebalance inventories and to cut expenses in the face of their own slowed down demand. As CEOs and CFOs have finally faced reality that the slowdown is real, they are getting costs under control. However, this is bad news for US because joblessness will continue to rise until demand strongly picks up. There is even anecdotal evidence that companies have rescinded a large number of offers to this year's college grads.
Ironically, this may not matter to the stock market since unemployment is a LAGGING indicator of economic malaise. Companies have already announced their layoffs. In fact, unemployment continued to rise for 15 months AFTER 1991's recession was already over. Layoffs will now only matter if consumers fear joblessness enough to rein in spending. The continued relative strength in consumer spending indicates the average American is not paying much attention to what is going on in the economy (or not caring), but the fear of joblessness will get everyone's attention.
In the blind optimism that the worst is in fact behind us, the market launched on a mini-mania in April. This latest buying binge has been predicated on the expectation that not only will the economy begin recovering in the 4th quarter of this year (or earlier!), but that the ensuing growth will be ROBUST into 2002, almost picking up where we left off. This couldn't be more wrong, and all the evidence and facts given to us by corporate CEOs and economists suggest that we should be very modest in our expectations: the economy will begin recovering SLOWLY in 2002. Even the Fed continues to ratchet down its own expectations of growth. Let us not forget all the risks remaining in the economy moving forward (I have discussed all of these before: high debt, high energy costs, poor energy infrastructure, slowing growth in the global economy, and now a looming breach in consumer confidence).
The restored rich valuations in most stocks, especially technology stocks, indicates that greed is still rampant in the markets and fear from the last bubble pop has not run its course yet. In fact, this current mania has a self-reinforcing mechanism in that the higher stocks go the more desperate the later participants become in an effort not miss out on all the profits. Everyone now understands, and believes, you have to buy when things look darkest, that you must buy well ahead of the actual recovery. The rub is timing just when the recovery will actually happen!!!
Given that the markets STILL have not broken the overall downward trend, we should see the next wave of selling descending upon us as soon as next week, but definitely when companies begin to bombard us with a fresh round of poor earnings and earnings warnings. We will hear more stories and admissions that things still don't look good and that their is no visibility going forward. Another potential sell-off point is the Fed's May 15th meeting, if the Fed does not oblige the whining markets with aonther big cut (shockingly, the some members of the Fed have finally publicly admitted being worried about high levels of consumer debt and high energy costs...not exactly fodder for big interest rate cuts). Anyone buying equities after a long, strong run is sure to regret it (well until sometime in 2002 anyway) and should at least prepare to take profits wherever you're lucky enough to get them. However, I do think the lows we hit on April 4th should hold going forward given the Fed's constant rate cutting and the fact some form of recovery is imminent.
My best guess is that you continue to avoid chasing the market, but do not fight it. Do not buy after long run-ups, but buying after sharp dips should now be OK, especially for the long-term investor. Adding to mutual funds or indexed equities under this scenario is even safer. When the market signifcantly breaks its current downward trend (for example, the DOW launches above 11,000 or the NASDAQ streaks toward 2300), you will know the next bull market is truly upon us. Above all, do not expect the kind of returns we saw in the 90s. Many people are beginning to realize that not only are returns likely to drop back to historical norms of 6-10%, but that stocks may go nowhere for several years.
Finally, we should take note of what the bond market is telling us. The yield curve is steepening very quickly indicating that not only is an economic recovery imminent, but that bond traders now fear INFLATION more than recession. On the other hand, mortgage rates appear to be bottoming as future Fed cuts have come close to ending (or being priced in). This should slow down the current mania we have in home buying. If consumers finally show a reluctance to continue piling on the debt to buy other stuff, we will see the current slowdown extend itself longer than anyone is predicting. These two trends are well worth watching, so stay tuned!
I now leave you with some quotes from the presses that I feel should ring home loud and clear:
"Consumer debt as a share of the gross domestic product now stands at close to 71 percent, a new high, and up almost half from the early 1980's. As a share of personal income, household debt has risen to 85 percent, also a record. And personal savings as a percentage of disposable income went into negative territory last July, meaning that for the first time, consumers as a whole were spending more than they had in disposable income. In January, the figure fell to a negative 0.98 percent, the lowest ever. In February it rose a bit, but it remains at a negative 0.91 percent."
"The good folks at the ISI Group sent me this factoid today -- U.S. nonfinancial corporate debt equaled 46.9% of GDP as of the fourth quarter of 2000, a post-1960 all-time high. That's not quite the best position to be in heading into a recession."
"... less than 30 minutes later [after predicting a recession], Steinberg issued a follow-up report, declaring: 'After further consideration, we are not, at this point, moving to a recession forecast.' Steinberg added that he maintains an outlook that growth will pick up in the fourth quarter. There's nothing wrong, per se, with Steinberg airing his thought process. In fact, some would say it's preferable. But the back-and-forth does suggest how unsettled many market players are because of the powerful, yet conflicting, forces at work."
"We're not going overboard -- not jumping into second-tier tech and not loading up on equities," said Brett Gallagher, head of U.S equities and deputy chief investment officer at Julius Baer Investment Management, which manages about $5 billion. "But you don't want to fight with this market [because] the worst thing is if you get so far behind the [benchmark] index and get handcuffed because if you're wrong, you're going to lose your job."
Be careful out there!