Economy Says Buy Stocks in Bernanke Research on Uncertainty From Stanford
Stanford University economics associate professor Nicholas Bloom knows just what to do when executives and investors don’t: Buy shares.
“All my money is in the stock market,” said the former adviser to the U.K. Treasury Department, who has published three papers studying the impact of uncertainty on the economy.
While heightened insecurity can depress growth by prompting companies to put off investment and hiring, the effect is temporary, according to Bloom’s studies of periods such as the aftermath of the Sept. 11 terror attacks. Within six months, output and employment bounce back as anxiety wanes, he said.
That result echoes research published in 1980 by Federal Reserve Chairman Ben S. Bernanke when he was teaching at Stanford in California. The “resolution of uncertainty,” he wrote, can lead to “an investment boom” by businesses.
James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, and Joseph Quinlan, chief market strategist at U.S. Trust, Bank of America Private Wealth Management in New York, are betting Bloom is right. Paulsen, whose firm manages about $375 billion, sees the Standard & Poor’s 500 Index ending the year at 1,300 to 1,350, while Quinlan, who helps oversee around $308 billion, forecasts a rise to 1,250.
The index was down 10 percent yesterday from its 2010 high in April, closing at 1,095.34, even after rising 7.1 percent in the last six trading days. The MSCI World Index of 24 developed nations is also 10.7 percent below its April high, as investors have moved money from shares into bonds. Behind the declines: Europe’s sovereign-debt crisis and doubts about the ability of global policy makers to reorient and revive their economies in the wake of the 2008-2009 worldwide recession.
‘Enemy of Growth’
“Uncertainty is the enemy of growth,” said Richard Berner, co-head of global economics for Morgan Stanley in New York. He trimmed his forecast for U.S. gross domestic product in the second half of 2010 to an annualized rise of 3.25 percent from 3.5 percent.
Companies are hedging their bets. U.S. corporations had $1.84 trillion in cash and other so-called liquid assets at the end of the first quarter, up 26 percent from a year earlier, according to the Fed.
Japanese businesses held 202.7 trillion yen ($2.3 trillion) in currency and deposits on their balance sheets as of March 31, the most since the Bank of Japan began compiling quarterly data in 1997. Nonfinancial companies in the euro area had a nonseasonally adjusted surplus of 46 billion euros ($58.5 billion) between gross disposable income and spending on real assets in the fourth quarter, compared with a deficit of 152 billion euros in the second quarter of 2007, according to European Central Bank data.
While businesses and investors always have questions about policy makers’ intentions, Larry Kantor, head of research at Barclays Capital in New York, compares the current environment to the 1970s, when investors doubted officials could whip inflation. Then-Fed Chairman Paul Volcker drove the benchmark interest rate to 20 percent and succeeded in reining-in price pressures. Now the skepticism centers on whether authorities can deliver smooth and sustained growth, Kantor said.
“We are, I think, sliding into a situation where we’re likely to see several bad years ahead,” Nobel Prize-winning economist Paul Krugman said in a July 6 interview with Carol Massar on Bloomberg Television’s “Street Smart.”
“Given what I see in the political process, the odds are against us avoiding a really prolonged bad period,” he said.
Such pessimism is overdone, said Paulsen, arguing that the corporate sector “has plenty of capability” to invest and hire after a surge in earnings. U.S. profits increased by a third in the first quarter from a year earlier, according to the Commerce Department.
There are already signs that companies are starting to put some of that money to work after postponing purchases while the economy was contracting. Orders for nondefense capital goods excluding aircraft, a proxy for future business investment, climbed at a 29 percent annual pace during the three months ending in May, the latest Commerce data available.
“Many companies delayed their procurement of IT-related capital expenditures throughout the recession,” Timothy Main, chief executive officer of Jabil Circuit Inc., said on a June 22 conference call with analysts. “There’s certainly a significant catch-up” in spending taking place.
Shares in the St. Petersburg, Florida-based electronics manufacturer jumped 10.6 percent to $15.03 the following day, after Jabil reported third-quarter profit excluding some items of 40 cents a share, beating the average analyst estimate of 34 cents in a Bloomberg survey.
While companies are stepping up investment, they have been holding back on hiring because they don’t know how mooted policy changes will affect their bottom line, said Mark Zandi, chief economist at New York-based Moody’s Analytics. Private-sector payrolls rose 83,000 in June, less than the 110,000 gain economists polled by Bloomberg News predicted.
The uncertainty among business executives “runs the gamut,” Zandi said. Banks are unsure how much extra capital regulators will require them to set aside, power companies are waiting to see if the government caps carbon emissions and human-resource departments are still parsing the impact of the 10-year health-care overhaul Congress passed in March, he said.
Another unknown is the fate of former President George W. Bush’s tax cuts on personal income, capital gains and dividends, which expire at the end of 2010 unless Congress extends them.
Business people “are nervous about all of the policy debates and policy decisions being made,” Zandi said. “They’re important and we need to engage in these discussions, but I do think it’s now time for policy makers to put some of these things to rest and give some certainty to business people so they will go out and hire.”
Some of the ambiguity could lift after Congressional elections in November. With unemployment at 9.5 percent in June -- the 14th consecutive month the rate has topped 9 percent, American confidence in President Barack Obama sank to a new low in a Washington Post-ABC News poll published yesterday, raising doubts about his Democratic Party’s chances of retaining control of both the House and Senate.
“None of us knows whether Republicans are going to have moderate success, significant success or historic success,” said William Lane, Washington director for Peoria, Illinois- based Caterpillar Inc., the world’s largest maker of construction equipment. Still, it’s clear that Congress will be “re-centered after November,” he said.
Uncertainty is reverberating elsewhere in the global economy. Britain’s first coalition government since World War II has said it will cut its budget deficit to 1.2 percent of GDP by 2015-16 from 11.3 percent. Chancellor of the Exchequer George Osborne defended the fiscal stringency, arguing that it will lift a “black cloud” hanging over consumer and business sentiment.
“Having the confidence that there is a government with a plan dealing with the country’s biggest problem is, I think, absolutely paramount,” Osborne said on CNN’s “Fareed Zakaria GPS” on July 11.
“The fundamentals in the housing market are OK, it’s the macro issues where the uncertainties lie,” he said in a July 6 interview.
More Stress Tests
European leaders are seeking to bring clarity to their financial systems by stress-testing 91 of their banks; the results are due July 23. The Bloomberg Europe Banks and Financial Services Index rose 9.4 percent last week, its biggest weekly gain in a year, as authorities seek to reassure investors about the health of financial institutions and spur lending. The risk is they won’t see the tests as tough enough, leaving questions about how banks could withstand losses if the region’s debt crisis worsens.
“If confidence can be restored through these stress tests, then that would be good news in eliminating an enormous overhang over growth,” said Raghuram Rajan, a former International Monetary Fund chief economist who now teaches at the University of Chicago in Illinois.
In Japan, political uncertainty was heightened after Prime Minister Naoto Kan lost control of parliament’s upper house on July 12, undermining legislative efforts to cut the world’s largest public debt and creating the possibility of a third leadership change in a year.
“Political gridlock will make it difficult for Kan to take any drastic actions,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo.
Officials may be better off resolutely tackling problems in the economy instead of taking their time searching for the optimal solution, Bloom, 37, said his work shows.
“There is a dividend for policy makers to be decisive, as once their policies become clear, pent-up demand flows through,” he said.
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