Economic Fundamentals Are Not That Bad
- 2000 5 Oct
by: Dr. Walter Miller
Like the euro and the new economy, the year 2000 has not lived up to its advance billing, at least not in stock market terms. That said, the economic and investment fundamentals facing stocks today are not all bad.
Nine months into 2000, the stock markets of the world dont have much to show for their efforts. The major U.S. market averages are down from 2% to 10% so far this year, a far cry from the 20%-plus returns seen over the prior five years. While there are a few exceptions (notably Canada and Denmark), the markets of Europe, Japan and non-Japan Asia are mostly all down and behind the U.S. market to date in 2000. Granted, mid- and small-cap stocks in the U.S. are strongly in the black this year, but recently every attempt at a rally in the Dow, S&P 500 or Nasdaq has ended with a sell-off inspired by some big-name stock warning of disappointing results ahead (Intel, Kodak, Apple, Xerox). Consensus earnings estimates for the market have held up fairly well, but this may only be because perceptions have yet to catch up with reality. Is this edgy market for big-cap stocks signaling economic problems ahead or were stocks simply priced for perfection earlier this year? After all, Nasdaq was up 85% during 1999.
There is no doubt that the U.S. economy has slowed. Mondays report from the National Association of Purchasing Managers showed manufacturing growth in a downturn since February and at close to stall speed in August and September. The Conference Boards index of leading economic indicators has declined for three of the past four months. High oil and gasoline bills are crimping consumer spending, even at Wal-Mart. Industry wide, same-store sales are estimated to have risen about 3% in September from a year earlier, well below the robust growth rates of this past spring.
Still, consumers have hardly thrown in the towel on the 10-year expansion. Last Fridays report on personal income and spending showed a 0.4% rise in income and a 0.6% advance in spending during August, both before and after inflation (i.e., zero inflation for the month). Even if spending is flat for the month of September, the consumer sector will still register a 4% rate of growth in the third quarter, an improvement on the second quarters 3% rate, which happened to be the slowest growth rate since 1997. Personal income growth (2.8% in the latest three months and over the past year) has already experienced the soft landing that the Fed has been aiming for. Now the trick is for consumer spending to demonstrate the same sort of consistent slowdown without falling off into a hard landing or recession.
Will it matter to investors who wins next months presidential election? On the eve of the first debate between Al Gore and George W. Bush, the polls indicate that the 2000 election could be the tightest race in at least 24 years. At the risk of oversimplifying, when it comes to economic policy, Gore and Bush both appear to be fairly centrist candidates. On the signal economic issue of the campaign what to do with projected budget surpluses as far as the eye can see Gores approach boils down to a mix of domestic spending programs, tax cuts and debt paydown. Bush would return a greater portion of the surplus to taxpayers in the form of tax cuts. With federal tax receipts at record levels relative to the size of the U.S. economy, there would appear to be plenty of room for tax cuts. On the other hand, one cant argue with the results of the Clinton/Rubin formula of debt reduction and low interest rates the most enduring economic expansion and most vigorous stock market in U.S. history. Of course, whoever is elected, the looming surpluses are a nice problem to have. In any event, as far as the markets are concerned, the really important election of 2000 occurred in January, when President Clinton appointed Alan Greenspan to another four-year term as Federal Reserve Chairman.
The Fed left interest rates unchanged at its October 3 FOMC meeting. The last FOMC meeting before the November elections produced no surprises: the Fed kept the fed funds rate at 6.5% but suggested in its post-meeting statement that the risks continue to be weighted mainly toward conditions that may generate heightened inflation pressures in the future. In particular, the FOMC statement mentioned the possibility that higher energy prices pose a risk of raising inflation expectations. Barring a further slowing in business activity, talk of a cut in interest rates by the Fed would appear to be premature. Still, the odds appear to be solidly against higher rates for the foreseeable future.
INVESTMENT OUTLOOK . . . The consistent failure of the 2000 stock market to support any big cap stocks outside of the defensive sectors is something to be concerned about. To look on the bright side, the markets ability to cope with the severe corrections in the dot.coms and the biotechs without serious deterioration elsewhere is encouraging testimony to the powerful long-term fundamentals of equities. Of course, investors should always take care not to become overly reliant on the conventional wisdom whether it be the buy on the dips strategy that worked so well in 1998-99 or the Treasury bonds uber alles theme of 2000s first nine months. While we remain fans of the Fed and think the soft landing is still the most likely scenario for 2001, there is some danger of becoming too comfortable with the assumption that the Fed will stay in complete control of the business cycle.