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The US market may have crossed into the zone where psychology - and the potential for investors to make decisions based less on fundamentals than on what they believe other investors will do - becomes more important than an assessment of the facts. To put it another way, a market that arguably paid little attention to fundamentals on the way up, as investors pushed many stocks to absurd levels versus underlying earnings in the euphoria of spring, probably isn't going to pay much attention to fundamentals on the way down, either. - Tom Petruno, LA Times 8-30-98 [Editor's Note: Just a reminder that we have been here before. We just can't find our sense of deja vous.]
One reason investors may have been taken aback by the news was that only two months earlier, Papa John's reported record Q3 revenue and earnings per share. For the nine months ended Sept. 24, per-share earnings rose 20% from the 1999 period. Unfortunately, the company's per-share earnings growth was not a result of higher net income; it stemmed from an aggressive share repurchase plan begun by Papa John's a year ago. Net income at Papa John's for the first nine months of 2000 was actually flat from a year earlier. But because the company had repurchased 6.3 million shares during the period, reducing the number used to calculate per-share earnings, investors focusing only on that figure saw a company on a roll. Stock buybacks have grown increasingly common recently at American corporations. Three years ago, according to Thomson Financial/Securities Data, 771 companies had buyback plans that were pending or completed. This year, the number is 24% higher. While buying in stock when it is cheap may be a sensible use of capital, repurchasing shares when they are trading at sky-high valuations, as many companies have done, seems downright dumb. Dru Milby, Papa John's chief financial officer, said the company began buying last year only after its stock had dropped by one-third. The trouble is that this year, the company has had to borrow mightily to pay for the buyback. As a result, Papa John's interest costs have swelled, cutting into profits. More distressing, its stock is 21% below the $25, on average, that the company has paid to buy it. So almost $32 million spent by the company has vaporized. Since the buyback began, the company has paid $187.2 million to repurchase stock. The company's debt has soared, to $139.5 million on Nov. 2, from $6.2 million a year earlier. Interest expense was $151,000 for the first three quarters of 1999; it rose to $4.9 million for the same period this year. Shawn Friedkin, a hedge fund manager at M. A. Berman has made a bet against the company by selling short a small number of its shares. 'You take on debt to expand your business,' he said. 'To take on debt to buy your stock is a recipe for disaster.' As stock prices continue to fall, more investors are relearning an old and valuable lesson. Assets can shrink in value, but debt never does. Related: WSJ, 12-18 Corporate America went on a record buyback binge, with companies repurchasing $123 billion of their own stock last year and another $91 billion in the first nine months of this year, compared with just $10 billion in 1991, according to data compiled by Rick Escherich, a managing director at J.P. Morgan. Buying back stock when it is cheap can boost shareholder value. But buying back stock when it is expensive is just plain dumb. Ccorporate America's attitudes continue to be the reverse of investment theory: Now that stocks are falling, companies are cutting back instead of revving up their repurchases to take advantage of the cheaper prices. A study by Bridgewater Associates finds that announced buybacks have plunged this year. "We've had an unusually large number of credit-rating reductions due to buybacks and their impact on the debt/equity ratio," says John Lonski, chief economist at Moody's Investors Service. and the net financial result
Sources: The companies, WSJ research
But a new study has found that this conventional wisdom, known as "defer bonds first," is rarely good advice. The research was conducted by three economics professors - James Poterba of MIT and John Shoven and Clemens Sialm of Stanford. A summary is available free at papers.nber.org/papers/w7991. The study says the conventional advice ignores the high taxes generated by the typical stock fund and the availability of tax-exempt municipal bonds for the fixed-income part of a portfolio. Most investors in tax-deferred accounts buy stocks through mutual funds, not individually. The typical stock fund pays enough in dividends and, more important, trades so often that the after-tax return of the average domestic stock fund is nearly 20% below its pretax return, according to Mr. Poterba. So favoring stock funds in a retirement account can pay off in tax savings. Moreover, municipal bonds allow investors to avoid taxes on the fixed-income portion of their portfolios, even in their taxable accounts. Most investors can earn just as much from municipal bonds as they do after paying taxes on their taxable bonds. The only exception occurred when their equity money was invested in stock index funds, which incur relatively few taxes because they seldom trade. But even then, the strategy of emphasizing stocks in retirement accounts fared about as well as the conventional, reverse approach. By deferring stocks first, you should be no worse off at retirement than if you defer bonds first, and you are likely to be much wealthier. Related: John Waggoner, USA Today 12-15 If you wake up screaming, "I'm ruined!" every night, you probably have too much money in stocks.
The analogy today is the construction of the new technology. It seems that there's too much of it. That's not my analysis. Federal Reserve Chairman Alan Greenspan used it in his speech to bankers Tuesday. You can read his words for yourself, at www.federalreserve.gov. In their desire to be "first to market," the "gorilla" of their fields, many tech companies produced more than anyone could consume. Having overshot demand, they've got an old-fashioned problem - too much stuff. Investors were overly optimistic as well. Now they're coming up short. Their losses and their avoidance now of these stocks is depressing the market for new equity issues from the tech business. Cyclicality in semiconductors used to be standard. A shortage in one season sparked overproduction in the next, which resulted in oversupply later, followed by decreased production, and shortage once more. But some hoped this wouldn't happen in the new economy. The theory was that semiconductors had been cyclical in part because they had limited uses. With wireless phones, handheld devices, Internet appliances, broadband "buildout," we were entering an uncharted era of possibly limitless demand. Demand was hard enough to anticipate in the familiar old economy. In the new, unfamiliar one, it's harder still - especially when everyone's rushing at "Internet speed." That could make the new economy more vulnerable to cycles and downturns, not less, as many theorists theorized. Related: Hal Varian, UC Berkley, NY Times 12-18 Capitalist economies have a long history of overinvestment in hot new technologies. In the 1880's, more miles of railroad track were laid than in any other decade of American history. In the 1890's, the resulting excess capacity led to more miles of track in bankruptcy than in any other decade in American history. In the 1990's, we have seen huge investments in information technology, with much of the infrastructure investment being debt-financed. We are already seeing signs of excess capacity in long-haul fiber optics. Will telecommunications infrastructure suffer the same fate as the railroads? Related: Nancy Lazar, International Strategy & Investment Group, from a Sandra Ward interview in Barrons 11-20 Tech is cyclical. If anything, technology is more cyclical today than in the past [becuase ot has] a bigger share of capital spending. If companies have to cut back on capital expenditures, it is more difficult today not to cut back on tech. In the old days, when tech was 5%-10%-20% of your cap-ex budget and you had to cut back, you could leave tech alone. Today, tech is approaching 50% of cap-ex and that makes it more vulnerable to a cyclical slowdown, not less. Also, a lot of the boom in tech has been financed by debt. Nonfinancial corporate debt has been growing very rapidly for two years, 13% for two years. I can't prove this is all tech-related, but a good chunk of it is. If you look at the corporate financing gap, which is the difference between corporate cash flow and capital spending, you have had this huge deficit. The level of cap-ex has been rising faster than the level of cash flow. A lot of the junk-bond problems are tech-related. So, the fact that tech cap-ex is now such a big part of cap-ex and that a lot of it has been leveraged make tech a more, not less, cyclical industry. Related: Stephen Dunphy, Seattle Times 12-10 Greenspan's apparent satisfaction with the current-inflation outlook rests on his view that higher labor and raw materials costs are being absorbed through lower corporate profits, not higher prices, thereby eroding profit margins. In particular, Greenspan said, 'corporate businesses, constrained by competitive market forces, have not been able to raise prices to fully offset energy-cost increases.' Lower corporate profit margins likely will inspire less capital investment in technology by many companies in the months ahead. Much like consumers, there is a sort of corporate-wealth effect - companies are more willing to invest in new capital projects if their stock price is holding up. That may be the real signal here - the end to the capital-spending boom that has been one of the hallmarks of the 10-year expansion. Business-equipment purchases since 1991 have totaled nearly $9 trillion, sometimes growing 15 to 20% a year. In Q3 the pace of capital spending slowed nearly 50%. That's halfway to a slowdown. Related: Steven Pearlstein, Washington Post, 12-10 Stephen Roach, Morgan Stanley Dean Witter, cautions that the cutback in investments [or capital spending] could prove even steeper in the new economy than the old. In the old days, giant service industries would respond to a downturn by laying off people and cutting back on things like travel and advertising - what accountants call variable costs. But in the new economy, personnel and other variable costs have been driven down so low that there isn't much room to cut even when sales slow. That means the only other place to cut is capital expenditures. Related: Edward Yardeni, chief investment strategist at Deutsche Bank Securities, NY Times 12-10 There is a theory out there that we have overinvested [in capital spending]. But technology capital spending is quite different from more traditional capital spending. Whenever the economy fell into a recession in the past, capital spending stopped because there was no point in expanding capacity. But technology spending increases productivity and reduces costs. These are things you have to do to be competitive. For much of the last year I have been doing monthly surveys of about 100 chief information officers. They have been unflinching, saying that capital spending will increase 18% next year. Now, it is conceivable that these people haven't gotten the word from their chief investment officers that budgets have been cut. But so far it looks like information technology budgets are intact. Related: LA Times 12-21 A Morgan Stanley Dean Witter Discover & Co. survey indicated technology spending will rise 8% next year, a significantly slower pace than the 12% rise in 2000. Separately, a Merrill Lynch-commissioned survey of corporate technology buyers forecast a similar spending pullback. Related: John Lonski, Moodys 12-11 From the peak 40.2% year-to-year growth rate of the quarter-ended May 2000, the annual increase of new orders for electronics (namely semiconductors) has since sagged to the 9.5% of the quarter-ended October. After having advanced by 25.1% year-over-year through the first nine months of 2000, new bookings for communications equipment ebbed to an 8.8% increase for the quarter-ended October. However, computer equipment orders advanced by 30.4% annually for the quarter-ended October, bettering their 22.6% yearly surge of January-September 2000. Comparatively low rates of capacity utilization, costlier debt and equity capital, the likelihood of slower growth for aggregate demand, and the paring of earnings forecasts all favor a slowing of capital expenditures. Too much capital spending can be a bad thing. Business investment spending's rapid 10.3% average annual advance of the past five years has been funded, in part, by the rapid growth of business debt. Earnings worries and the latest surge in corporate credit rating downgrades are partly the offshoot of sometimes overly ambitious capital spending programs. Related: C/NET 12-15 Technology mutual funds saw more money flowing out than in for a fourth consecutive week, setting a record not seen during the past three years. Mutual funds that invest in technology stocks were hit with $510 million in net redemptions for the week ended Dec. 13, bringing the total outflow to $1.1 billion for the past four weeks, according to AMG Data Services. Related: Floyd Norris, NY Times 12-22 Microsoft has announced that it plans to cut costs and raise salaries. Raises are needed because real pay is down a lot at Microsoft and a host of other technology companies. The money used to be in stock options, but now more than half the outstanding options at Microsoft are underwater. Generally accepted accounting principles did not treat all those options as compensation. So investors will see Microsoft's labor costs going up while workers know their income has fallen sharply. Microsoft can afford to pay more cash. Many companies cannot, and the need to do so will squeeze already tight budgets. "Investment spending will shrink significantly next year," said Robert Barbera, the chief economist of Hoenig & Company. The productivity figures that seemed so impressive will decline along with that sector's fortunes. Related: Barrons 12-25 Fred Hickey, editor of the High-Tech Strategist, points out that the Nasdaq 100 still trades for over 100 times trailing earnings. "That's not a screaming buy. Everyone thinks that just because prices have been cut in half there must be good values. But they're not." One of his big concerns is the PC sector. "People have to come to grips with the understanding that the market is saturated," he says. For the first time in 20 years, PC sales are falling at a double-digit rate, reflecting weak corporate demand following Y2K-related buying in 1999 and a well-penetrated consumer sector. His view is that PC sales will become more cyclical. Motorola, Hickey argues, is one of the best values in technology. "Here's a company with a $40 billion market value that has $40 billion in sales," In contrast, Veritas Software has a $35 billion market value but only $1 billion in sales. Nokia sports a $200 billion market value on $30 billion in sales. "The areas where Motorola is strong (networking and wireless) are better places to be than PCs." Related: James Flanigan, LA Times 12-31 If such productivity gains were to diminish, as growth of business capital investment slows to a rate of 6.5% from more than 10% in 2000, the economy would have problems not easily fixed by lower interest rates or taxes. 'If information technology were to lose its luster, the engine responsible for the acceleration in productivity growth would be gone, and there would be no easy way to get it back,' says economist Joshua Feinman of Deutsche Asset Management, a New York investment division of Germany's largest bank.
History says the stock market, or a good chunk of it, should rally if investors believe that interest rates are going down. Foreign stock markets likewise should view an easier Fed as a reason to rebound. But how much can markets rebound, and for how long? [Was the question answered Tuesday 12-5? The Nasdaq can rally 10% in one day, but fail to keep those gains.] If the economy is in fact slowing sharply, the issue of the Fed wanting to save us from recession will quickly morph into a debate over whether the Fed is too late. That is what has happened before at many of these economic inflection points, and it seems reasonable to believe it will happen again. And the end result may be more, rather than less, confusion and doubt in the stock market, at least in the near term. The point being, no one should assume that Wall Street's troubles are over for good just because the Fed turns friendly. It's a step in the right direction, but just a step. The Global Bear Market LA Times 12-3-2000
Riskier companies have suffered most of the pain so far. They have managed to issue only $41 billion in junk bonds so far this year, way below last year's $95 billion and 1998's $140 billion, according to Credit Suisse First Boston. Syndicated loans to firms with single-B, below-investment-grade credit ratings total a mere $225 million so far in the fourth quarter, vs. $5 billion in the like period last year, says S&P Portfolio Management Data. But a broad swath of stronger businesses is affected as well. A Federal Reserve survey shows that 44% of U.S.-based banks have tightened standards for commercial and industrial loans in the past three months, in part because regulators are pushing them to curtail risky lending. Many of the largest and most profitable U.S. corporations have seen their borrowing costs go up. So far in the fourth quarter, Moody's has been lowering the credit ratings of 3.9 corporate borrowers for every one it raises, the worst ratio since Q4-90. Why the squeeze? Simply put, many see the US as headed into the downward phase of the economic cycle. The U.S. economy grew at just a 2.4% annual rate in Q3 - less than half Q2's pace - and capital spending, PC sales and auto sales all are coming under pressure. Any sign of slowing makes lenders less confident of borrowers' future earnings, and therefore ability to repay. Moreover, lenders are discovering that they gave money to lots of companies that shouldn't have been funded nearly so richly. In June, total borrowing by nonfinancial U.S. companies stood at $4.6 trillion, up 61% from five years before, Moody's says. Now, more debt is going bad. The junk-bond default rate is above 5%, the highest in nearly a decade. And 3.3% of syndicated loans were considered troubled as of the end of March this year, up from 1.3% two years earlier, according to bank regulators' latest Shared National Credit survey. The number of banks involved in 10 or more syndicated loans to riskier companies has plunged to 42 so far this year from 110 last year, according to S&P Portfolio Management Data. Even the "risk premium" that investors demand for holding even blue-chip corporate bonds has risen sharply. The 5,000 corporate bonds in Salomon Smith Barney's Broad Investment Grade Index are trading at 1.9 percentage points over Treasurys, compared with 1.2 percentage points in January. Some contend that a shift of lending from the banks to debt-securities markets magnifies the danger. Banks have relationships with the borrowers, but bondholders don't, and they tend to act quickly and all on the same information. Related: Barrons 12-11 One indication that lenders are becoming more cautious [due to the deteriorating credit quality of U.S. corporations] came in the Senior Loan Officer Survey on Bank Lending Practices. The November reading showed that lenders were tightening their standards "somewhat" in the previous three months. Still, the survey, which has proven a statistically significant leading indicator of lending trends and economic growth, is not sounding truly recessionary alarms, observed Maury Harris, US chief economist at UBS Warburg. Although the rise in credit problems is accelerating, it is not brand new. For existing bank loans to US corporations, the number of credit-ratings downgrades has far exceeded upgrades for the last 14 consecutive quarters, dating back to 1997. Lenders are demanding a larger level of cash flow relative to the loans. On average, leveraged borrowers' debt came to 5.8 times that of their cash flow in 1996, according to Babak Varzandeh, a director at S&P/Portfolio Management Data. The average this year is dramatically different, with leveraged borrowers' debt amounting to four times their cash flow. As a result of all of this, S&P's Varzandeh said, credit ratings on new syndicated loans in 2000 are much better than the historical average, suggesting better credit quality for loans made this year. Related: Barrons 12-4 By 2001, Moody's predicts, 8.4% of the junk debt now outstanding will default. Standard & Poor's has also issued a report forecasting record corporate defaults this year. So far, $37.7 billion of debt is affected, and S&P expects the toll to grow. Related: Phyllis Berman, Forbes 12-25 Bank of America's bad-loan load grew 44% in the third quarter over the same period last year; FleetBoston's 30%; and Bank One's 29%. A big regional, Wachovia, saw its nonperforming loans almost double to $460 million. All four have conceded that the fourth quarter could bring still more troubled debt. The federal regulator's annual report on the banking industry released in October estimated that $56 billion in commercial banks loans classified adversely. That is 8% of the total $701 billion of outstanding commercial loans, up from 5.3% just last year. Within weeks regulators were again pressing the banks to go even further and reclassify still more loans as riskyÙand that could force banks to increase their reserves. Federal bank examiners have been swarming over syndicated-loan portfolios at several leading banks and forcing downgrades. The examiners rate loans on a scale of shakiness that ranges from 1 (gilt-edged) to 10. They are pushing banks to reclassify some 3- and 4-rated loans, which compel up to 1.3% in reserves against the loan, to 7 (5% reserve), 8 (15%) or 9 (50%). Once a loan is reclassified, all institutions holding a piece of the loan are bound by the new rating.
The consensus is that the economy is making a soft landing that will leave the annual growth rate around 2.5% for a while. The Nasdaq decline is viewed as a correction of overinflated valuations, plus perhaps a little overreaction that has created bargains among the ruins. At the heart of the optimism is the view that the so- called new economy is alive and well. Those gains in productivity are slashing costs enough to assure that inflation will not be a threat, whatever happens to such old-economy indicators as oil prices. That means the Federal Reserve will be able and willing to bail out the economy by cutting interest rates next year. The weakest part of that argument is the assumption that business spending on technology will continue at the explosive rate of recent years. Robert Barbera, the chief economist of Hoenig & Company, notes that the durable goods report issued this week shows that orders for electronic and other electrical equipment from July through October were running 6% ahead of the 1999 pace. In the first half of the year they were up 24%. A rise of 6% is far from horrible, but it is hard to believe that the drop stops here. Most of those computer and telecommunications companies on Nasdaq were buyers of hot new hardware and software. Now many are scrambling to pay their bills, and new orders are out of the question. "This is not a valuation adjustment with no economic repercussions," Mr. Barbera said. The huge surge in capital spending, which is now coming to an end, may turn out to be the signal economic event of the last five years. It raised overall corporate profits because the profits made by the sellers were not offset by expenses of the buyers, who treated the spending as investments. That encouraged investors, and the availability of cheap capital encouraged more capital spending, which pushed up profits further and sparked talk of a new era. Now that virtuous circle is ending. Profits will suffer as depreciation expenses rise. Consumers will cut back as their investments suffer. Tax receipts will be surprisingly low as capital gains payments fall. The Fed will try to help by cutting interest rates next year, but the surprise may be how little help that provides. Related: Steven Milunovich, technology strategist at Merrill Lynch (quoted in the NY Times 12-3) Momentum in semiconductor shipments is slowing from 60% growth to 40% growth. Growth in pc unit sales is slowing from about 18% to the low teens. Expectations of mobile telephone handset sales have come down from midyear. And capital spending budgets for telecommunications companies are expected to be flat-ish for 2001. With the demand slowdown, it looks like we could have a two-quarter inventory correction. I wouldn't have money invested in technology I couldn't afford to lose. Things will probably get worse before they get better, because the fundamentals are worsening. We are in a "know economy," not the "new economy." It is an economy that is increasingly dependent on knowledge and intangible assets, and technology plays a critical role in that. A technology downturn may be more than the nine months we have had. But it is probably not going to last for five years. Related:Fred Barbash,Washington Post 12-3 Some respected statistical analysts think the Dow could fall an additional 40-50%. That would put the Dow at about 5000, where it was in 1996. The Nasdaq would revert to about 1300 to 1600, its range in 1997. Others predict the markets might go into an extended hover around today's levels, with equity prices staying flat for eight or 10 or even 15 years. These predictions are based on academic assumptions that markets revert to historical means. The worst-case scenarios of the number crunchers at Salomon Smith Barney Research suggest that if the Nasdaq reverted to its 28-year mean--a 13.61% annualized gain--it would hit about 1600 by the end of this year, according to that firm's calculations. That's down about 40 percent from Friday's close and about 68 percent below the Nasdaq's high in March. Similarly, the Dow would be cut almost in half, too, if it reverted to its 103-year mean, say the Salomon Smith Barney analysts. Rather than plummeting by half, the Nasdaq composite could revert simply by gaining nothing until March 2008. And if the Dow reverted to a 20-year norm instead of a 103-year norm, it would bottom out at about 8400, rather than 5300--or, in the alternative, go nowhere until May 2003. Writes Salomon's Jonathan Lin: "... There is the possibility that the Dow might not only revert to the mean, but overshoot it by some margin in the process. This is the reality of the conclusion that one would draw by studying the very long-term progression of the market. Related:Caroline Baum, Bloomberg 11-29 Perhaps as a result of slowing profits or falling stock prices, business fixed investment in equipment and software slumped. This has implications for economic growth, not to mention productivity. The 5.8% Q3 increase in this measure of technology spending was the smallest since the fourth quarter of 1997. Capital spending contributed a scant 0.59 percentage points to real GDP growth last quarter compared with an average 1.5 percentage-point contribution in the previous seven quarters. The tech boom fostered by the tech-stock boom is in jeopardy, according to Bob Barbera, chief economist at Hoenig & Co. Barbera envisions three possible scenarios unfolding next year, with the probability of the first one waning with each passing day. `The first scenario is that this is all about a valuation adjustment, and that once it's done, the tech wonderment continues,' Barbera says. `The decline in tech stocks says nothing about the underlying dynamic of the tech sector.' That's the good news. The second and third scenarios differ only in the way they play themselves out. `The second scenario is the tech wreck presages a wreck for tech activity,' Barbera says. `It leads to a sharp slowing in economy activity.' Scenario three starts with a tech wreck and ends with a Fed rescue. The rescue is justified on the economic grounds, not as a life preserver for stock investors. There is nothing about recession in the Fed's mandate. Barbera senses his clients shifting away from scenario one into two and three. If that's the case, then the only question is how much medicine the Fed administers and when. In the same way the technology sector ignored the first 100 basis points of Fed tightening, the behavior may be symmetrical on the way down, Barbera surmises. If that's the case, `then there's substantially more ease (in the pipeline) than that reflected in the fed funds futures contract,' he says.
Related:Pundit Roundup, SmartMoney 12-1 Lehman Brothers chief investment strategist Jeffrey Applegate is anticipating a Christmas rally. While he isn't promising the volatility is over, he says this is the best buying opportunity since the Asian crisis. Not only is technology here to stay; it's also cheap, he figures. As of Thursday, the tech portion of the S&P 500 was trading at a price-to-earnings-growth, or PEG, ratio of 1.2, while the rest of the stocks that make up the index trade at a PEG of 1.3. At these prices, he says, these companies aren't getting the respect they deserve. Morgan Stanley Dean Witter's Barton Biggs passionately believes the technology slowdown is just beginning and the correction hasn't gone far enough. 'How much are you willing to pay for big potential but extreme risk and high analytical complexity and uncertainty?' he asks. Biggs thinks earnings expectations for 2001 are still too high, and he anticipates some sort of credit crunch. 'I suspect a great deal of debt is linked one way or another to the Nasdaq, and we won't know the identities until the belly-ups surface,' he says. Goldman Sachs's Abby Joseph Cohen continues to encourage her clients to buy on the current weakness. Morgan Stanley Dean Witter's Byron Wien says 'the market is struggling toward some fair-value level.' A year ago, Wien's models said the market was 50% overvalued. Today, it rests comfortably at less than 10% overvalued. 'The market is becoming more rational, but it hasn't totally shaken off the party atmosphere of earlier this year,' Wien says. Market-Capitalization-weighted P/E Multiples for sectors of the S&P 500; (based on earnings for the trailing 12 months) WSJ 11-27-00
Just the Facts Fiscal policy is stingy, resulting in a federal budget surplus at a robust 2.4% share of GDP. 'A tight fiscal policy perhaps deserves some of the blame for the current slew of downwardly revised projections of corporate earnings,' says Kamalesh Rao, economist at Moody's. 'For the first time in 30 years, we're in a position where both fiscal and monetary policy could be used to stimulate an economy that is sputtering or heading for a recession,' says Mark Zandi, chief economist at Economy.com. Adds James Paulson, chief investment officer at Wells Capital Management: "The very tightness of both means we have a ton of ammo to use." (Business Wk 12-15) Amid the beaten-down sectors of the corporate-bond market, companies are beginning to buy back their own debt at discount prices. The reduction of debt not only improves a company's balance sheet, but the savings realized by buying debt at a discount can be reported as an extraordinary gain, improving earnings. One Catch-22 is that when debt trades at a steep discount, it's often because the company has liquidity problems and thus doesn't have the cash to buy back its debt. (WSJ 12-15) With 6,000 Internet job sites in operation, the BLS says more than twice as many people now look for work online than use private employment agencies. (WSJ 12-12) All economic slowdowns are not created equal, and some economists believe that the characteristics of the current one are more worrisome than equity investors seem to think. If the economic slowdown comes from more modest job creation than the nation has seen recently, the Fed will be pleased because it means that inflation stays in check. If, however, growth stalls because productivity falls, it will keep the Fed policy makers on inflation alert and thus less likely to cut rates aggressively. (Gretchen Morgenson, NY Times 12-10) I must admit I was fooled by the branding of Web sites. I thought that customers would be reluctant to learn new Web addresses because of information overload. Therefore, a site establishing a presence, such as Amazon, would have economic benefits because of the knowledge of its name. What I failed to realize is the speed by which users dumped sites that did not perform and sought out new sites that might do better. As a result, the value of branding was only temporary in most cases -and much less than the advertising costs needed to establish those brands. (Donald Ratajczak, AJC 12-10) Not since King George III of England ruled over the American colonies have foreigners had a greater claim on the US than they do today. From a paltry $900 million in 1994, net foreign purchases of US equities rose sharply to $94.3 billion in 1999 and to a record $173.0 billion over the 12 months through September. For perspective, note that equities saw mutual-fund inflows of $187 billion in 1999 and $157 billion in 1998. Of the $4.5 trillion of corporate bonds outstanding, foreign holdings, $908 billion, now exceed that of US households' $765 billion. Foreign investors now hold a record 41% of publicly held Treasuries. Foreign investors have also been big players in the market for securities issued by U.S. government agencies, having bought roughly half of their total issuance in 1999. Between 1997 and 1999, foreign direct investments - in factories, real estate and the like - quadrupled, to $282.9 billion. (Barrons 12-11) A Gallup poll of Americans last weekend found a new pessimism about the economy, with 48% saying it's getting worse and 39% saying it's getting better. It was the first time in four years that a plurality held a negative view of the economy. (LA Times 12-8) .... Still, the economy grew at a 2.4% annual rate in Q3, down from 5.7% in Q2. It was the slowest pace since Q3-96, but still growth. The problem, Treasury Secretary Lawrence Summers pointed out, is that this is a second-derivative world; economists and investors judge economic health by the rate of change and less by the absolute level. But it's useful - and more cheerful - to ponder the first derivative. Since it's only a reduction in growth, that means the country will only become less rich than it otherwise would have, not poorer. (Steve Liesman, WSJ 12-11) The virtual absence of inflation is a big plus for the future economy. Recessions are almost always preceded by large inflation spikes. Big inflation increases create an economy-wide tax-hike effect, reducing the usefulness and buying power of money. It's a tax hike on money. Big interest-rate increases resulting from inflation turn off the credit spigots, raise financing costs, reduce investment demands, and compress stock market multiples. Inflation also penalizes investment risk and wealth creation by raising the effective tax rate on unindexed capital gains derived from the sale of stocks and other assets. Inflation is the most powerful recession inducer. (Lawrence Kudlow, CNBC 12-7)
The US trade deficit is set to surpass $450 billion. But while the gap in merchandise trade keeps growing, some economists see indications that the trend won't last the decade. The reason: the growing U.S. trade in services, which now tops $250 billion annually and runs a surplus of $80 billion. And both numbers, say economists, are poised to explode over the next 10 years. According to a University of Michigan forecast, US service exports will hit $650 billion by 2010 - about the same volume of current US exports of farm and factory goods. World-wide, cross-border sales of services are around $1.3 trillion, most booked by U.S. providers. Services sold by the No. 2 exporter, Britain, total just $100 billion. (WSJ 12-4) To put Nasdaq's ongoing collapse in perspective, major U.S. stock market indexes don't suffer meltdowns on this kind of scale but once in a generation (if we're lucky). The last time was 1973-74; the time before that was the 1930s. (Tom Petruno, LA Times 12-3) If you use history as a guide... we've already gone farther than the average pullback," notes Sam Stovall, senior investment strategist for Standard & Poor's. In a typical bear market, the Nasdaq gives back about 61% of its bull-market gains. It's already given back about 65% of the gains from the bull market that stretched from October 1998 to March of this year. In fact, tech has gotten so cheap that it is no longer the most highly valued sector in the S&P 500-stock index, Mr. Stovall says. Instead, health care is more expensive when you compare stock prices with expected earnings, and consumer staples are catching up. (WSJ 12-3) Since 1994, the number of self-employed Americans outside agriculture has fallen by 146,000, to 12.9 million, according to the Bureau of Labor Statistics. The period between 1994 and 1999, hailed as a golden age for entrepreneurs, is the first five-year span since the 1960's in which the number of self-employed fell. By contrast, for most of the last three decades, self-employment grew slightly faster than the overall labor force. As the economy has added millions of jobs, the portion of Americans who say that they work for themselves has dropped by almost one-tenth, according to the bureau's survey of 50,000 households. (NY times 12-1) Buying on dips has proved disastrous this year. Since the Nasdaq began falling in March, the index has put in 10 of the 12 biggest one-day percentage gains in its history - only to resume its decline as each gain evaporated in the days that followed. Analysts call them "bear-market rallies." (WSJ 11-27) It's not just the Fed that has been tightening. It is global central bankers that have been tightening. Even though the Fed stopped tightening in May, these other guys have continued to tighten. The European Central Bank just tightened in October. Over the past 17 months, we've counted 150 central-bank tightenings and the US Fed accounts for six of those. On a GDP-weighted basis, we are one of the bigger influences, but our Fed has had lots of company during this tightening cycle. That increases the odds of a more prolonged slowdown here and ups the odds of a global slowdown. We are likely to see the effects of these tightenings well into 2001, through the third and fourth quarter. (Nancy Lazar, International Strategy & Investment Group, Barrons 11-20) "The stock market does not go up and down," says Alan Skrainka, chief market strategist at Edward Jones. "It goes up, down, and up again." (WSJ 11-19) H.L. Mencken, patron saint of cynical journalists, once defined a wealthy man as one who earns $100 a year more than his wife's sister's husband. (Barrons 12-18) Home Page Previous Factoid Top Sites |