Repeat After Me: It's Really Not So Bad
By Christopher Farrell
Despite the latest easing by the Federal Reserve Board, the bad economic news keeps piling up. Indeed, it seemed that few paid attention to the expansion's 10th anniversary recently. Why should they, with the economy so close to the breaking point?
No question, the ugliness is mounting in many ways. High-tech behemoth 3M will hand out pink slips to some 5,000 workers. JDS Uniphase, the once high-flying fiber-optic component supplier, will slash its workforce by 20%. Brand-name computermaker Compaq Corp. recently declared that it will cut 10% of its workforce. United Parcel Service, the mammoth delivery company for the New Economy, plans on slashing its capital spending budget by some $300 million, to $2.5 billion.
So far, the economy's troubles are largely concentrated in manufacturing and the information and communications technology industries. But now it seems that everyone, from Federal Reserve Chairman Alan Greenspan to the store manager at the local Home Depot, is convinced that the turmoil in these critical sectors threatens to take down the entire economy, as business investment contracts and job losses mount.
I'm no Pollyanna. But let's get a grip. The Fed is now moving aggressively to shore up the economy, and more rate cuts are likely in the weeks ahead. Bond investors, too, also expect that the Fed's easing will work. With long-term interest rates at 5.21% -- nearly one-and-a-half percentage points above short-term rates at 3.78% -- the "positive" slope of the yield curve suggests investors are anticipating increased credit demand and the kind of inflationary pressure that would come from an expanding economy.
Several other factors are working in the economy's favor. Thanks to the lower interest rates, the residential housing market remains strong. For instance, sales of existing homes soared in March to the second highest level on record, while the median price of a home rose to a new high of $143,500. That's not typical when the economy is failing.
Mortgage refinancings have soared, with 30-year fixed mortgage rates around 7%. Economy.com estimates that $1 trillion in outstanding mortgage debt could be profitably refinanced at current rates, and the Mortgage Banker Association's index of applications for mortgage refinancing loans is consistent with this forecast. Orders for big-ticket durable goods rose 3% in March vs. a consensus estimate of a 0.5% gain.
WAVES OF DESPAIR.
Stock market valuations are more reasonable, too, with faint signs that the battered high-tech sector may be close to a bottom. For instance, the secular earnings growth for the information and communications tech sector is about 16%, calculate Neil Williams and Alain Kerneis of Goldman, Sachs & Co.'s global portfolio strategy group. The 15% to 20% decline in earnings per share currently built into Wall Street analysts' expectations would push actual earnings about 10% below trend.
Now that doesn't mean they only thing we have to fear is fear itself -- especially considering the stock market's volatility of late. Wall Street veterans warn that bear markets are defined less by the traditional metric of a 20% decline in the market averages and more by waves of investor despair and disillusionment. If you want to see the latter, just spend some time watching CNBC and the Bloomberg Channel.
I've also been reading and hearing a rising tide of market commentary drawing ominous parallels to the U.S. market in the depressing 1930s and 1970s, along with predictions that we're doomed to replicate Japan's dismal performance since 1989. Even the recent rebound in the market isn't generating much enthusiasm. Perhaps we're too inundated with cautions that bear markets are typically punctuated by a 40% spike up -- the legendary dead-cat bounce or "suckers" rally.
Jim Griffin, chief investment strategist at Aeltus Investment Management, who pens a wry weekly look at the market, recently confessed that he put too much of his personal capital to work early in 2001. He thought the combination of stock market carnage, excessive investor pessimism, and Fed interest rate cuts meant a market bottom was just around the corner. "Early is another five-letter word for wrong," he notes.
Still, an Old Economy industry recently struck me as a somewhat contrarian indicator to the general gloom in the markets: Airports are jammed, planes are uncomfortably full, and the overall flying experience is just as miserable as it was during the late 1990s, when the economy roared. Considering the double-digit pay hikes the mechanics at Northwest Airlines and the pilots at Delta Air Lines are set to get, managements are clearly betting that the economic downturn will be short.
It's a reasonable gamble. The Fed mistakenly clamped down far too hard on the economy when it started hiking rates in 1999, and the central bank was far too slow in reversing its policy stance. But there's no longer any doubt that the Fed knows it made a mistake.
The central bank has clearly signaled that it will continue to ease as much and for as long as it takes to get the economy back on track. How long will the downturn last? With a bit of luck and the Fed on the right path, it could be a lot shorter than the current gloom suggests.
Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online
Edited by Beth Belton
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