"A Tough Environment for Investors"

Economist William Wolman favors cash and some unusual bond plays in a market he sees as being difficult, even after Iraq

Even if the Iraq crisis comes to a swift and successful conclusion, other problems in the global economy and in the U.S. mean continuing trouble for the stock market, believes William Wolman, a longtime BusinessWeek economist, author, and CNBC commentator. Among the problems he sees are an end to the housing and auto booms, pressure on wages from the shift of more jobs abroad, and declining competitiveness of old-line U.S. manufacturing.

Although he still sees the stock market as a place to be for the very long run, Wolman suggests that investors emphasize cash and bonds, especially TIPs (the Treasury's inflation-protected securities), as methods to preserve capital.

These were some of the points Wolman made in an investing chat presented Mar. 4 by BusinessWeek Online on America Online, in response to questions from the audience and from Karyn McCormack of BW Online. A complete transcript of this chat is available from BusinessWeek Online on AOL, keyword: BW Talk.

Q: What will a war mean for the markets?


Assuming an easy victory for the U.S., which I assume, there could be a short-term pop, but then the problems that I foresee in the global economy will begin to take their toll.

Q: Bill, are you still a U.S. bond bull?


It's hard to be a bond bull with interest rates so low and commodity prices rising so fast. So while I believe that the Federal Reserve can engineer something of a rise in long-term bond prices by simply buying those bonds directly in the open market, the gains would have to be extremely limited. This is a really tough environment for investors.

Q: Fed Chairman Alan Greenspan said today consumer spending could be hurt as home refinancings simmer down. The big auto makers also said demand is slowing. What do you think?


Indeed, these are two of the points that must be made about problems that go well beyond Iraq and terrorism. Although Greenspan has been slow to admit it, any sensible analyst would have to conclude that the mortgage market will no longer be able to function as what has in effect been a cash machine for American consumers, and that has very strong implications in limiting the rate of growth of consumer spending.

This week's auto numbers are a sobering reminder that like the housing boom, the auto boom has limits which are now making themselves felt. There is a sign that the demand for SUVs has peaked and is falling, partly because of gas prices, partly because of guilty consciences about gas-guzzling.

Q: Will inflation ignite because of an easy Fed monetary policy, huge federal deficits, and a weak dollar?


That's a good question. "Ignite" may be a strong word, but each of these factors does exert upward pressure on prices.... The saving grace so far has been rising productivity and a totally defanged labor movement, which is unable to exert upward pressure on wages. But even with that soft labor market, the ability of U.S. companies to ship work abroad, especially to China and India, will continue to hurt wages.

People should remember that the time during which it was only routine manufacturing jobs that were shipped abroad has long gone. Now there's major movement abroad of all kinds of Internet and other high-tech jobs (see BW Cover Story, 2/3/02, "The New Global Job Shift"). It's likely, in fact, that your bank account is being posted on the Net not in the U.S. but in India or China. So, yes, there will be a modest rise in inflation, as we have already seen in the first quarter, and it will continue even though economic growth will be painfully slow.

Q: Where should I stash cash?


The answer lies in the bond market. Although returns are very low, you will nevertheless preserve your capital. The book written by Anne Colamosca and myself, The Great 401(k) Hoax, is being issued in paperback edition, which will be in the stores and at Amazon toward the end of this month. It contains new rules for investing in this very difficult environment and suggests some bond plays that you may not have thought of before.

One place to invest, which everyone should use, are the government's TIPS -- the inflation-protected bonds issued by the U.S. Treasury. The return last year was, believe it or not, over 10%. These are round numbers and are unlikely to be repeated in U.S. markets this year or next, but if you take the trouble, you can find foreign-government bonds that have very good prospects over the next couple of years, particularly given the weakness of the dollar.

Q: How about emerging markets in Europe? Can you get an acceptable return vs. risk?


Eastern Europe really is a potentially dynamic sector of the world economy. I think, as a matter of fact, that the Romanian market, incredible as it may seem, was one of the leaders in growth last year.... I also notice that in his letter to his stockholders, Warren Buffett talked favorably about the bonds of some of these countries and other emerging countries in the world.

Q: Bill, do you support Bush's tax cuts?


The answer to that is a resounding no. I believe that we're now in the period in which the right approach to policy is not trickle-down economics, but rather trickle-up economics. And therefore, I would focus my tax relief on the genuine average American -- the person for whom half of the people are above and half the people are below in income level. It's not the phony average you get when you use the kind of average that includes the zillionaires. I also believe that state and local governments in this country are in a severe budget crunch for which federal help is required. And I would spend money that way.

Q: Do you see defense spending helping the economy?


As incredible as it may seem, news coverage of the revision in gross domestic product [which came out late last week] missed the major point -- that rising defense spending provided a lot of stimulus to the economy. As a matter of fact, one-third of the increase in real GDP was the result of higher defense spending. I find this somewhat disturbing, since ignoring the role of defense spending gives a false impression of the strength of the private economy.

Also, incredible as it may seem, there's a shortage of productive capacity in oil, even though the world economy is growing slowly. So I'm very worried that should the Iraqi oil fields be destroyed, we could have very severe oil shortages and a surge in energy prices of a size that no one is expecting. I have reported with oil executives over the years, and in recent years I had no sense that they anticipated this kind of shortage. So there's a danger here that's worth exploring

Edited by Jack Dierdorff

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