Markets See the Doughnut, Not the Hole

The stock market persists in seeing a bright outlook for the economy despite worrisome signs and forecasts.

Unemployment figures for February, announced Friday, are pretty bad. Nationwide the jobless rate is up sharply to 6.5% and California, at 7.4%, has one of the highest jobless rates in the nation.

And the outlook is not encouraging. "Layoffs at defense firms are continuing," says David Hensley of the UCLA Business Forecasting Project. Nationally, hiring prospects are the worst they've been since the 1982 recession, according to a survey by Manpower Inc. of 15,000 employers in 469 cities.

In the background, moreover, many economists fear a worldwide shortage of capital because of the vast amounts of money needed to rebuild the war-torn Middle East, coming on top of the needs of Eastern Europe and the hundreds of billions tied up in bad real estate loans in U.S. banks. The fear is that interest rates will rise again and abort any chance that the economy will come out of recession. A capital shortage would be a direct threat to all aspects of your finances, from your mortgage to your paycheck and investments.

So why are the stock markets so strong? In addition to the New York Stock Exchange, energy issues on the American Stock Exchange and stocks of small companies traded on the NASDAQ market system are doing very well. Stocks are soaring in other countries also, making a global bull market unanimous. What's going on?

Simply this: The fears of many economists are overblown. Much more likely is the forecast delivered in testimony to Congress last week by Robert Reischauer, head of the Congressional Budget Office, that the short war, relatively low oil prices and Federal Reserve easing on interest rates would produce a U.S. recovery by midyear. And the economy, said Reischauer, would be marked by lower inflation--3% to 4% annually, as opposed to 5%-plus--and lower interest rates.

If you look around, you can figure out for yourself why hope makes more sense than fear. Low inflation is a safe bet because there's almost no inflationary pressure in the economy now. It's a good news-bad news situation. Rising jobless levels don't go together with wage and salary inflation. Houses sitting on the market and cars sitting unsold in showrooms don't lead to price hikes.

As for higher interest rates and capital shortages, where's the evidence? If capital were in short supply, interest rates would be rising now. Instead they're coming down.

Truth is, there's less global demand for loans and investment at the moment than economists imagine. Rebuilding the Middle East may be great business in the next few years, but very little is being done at present as tensions and outright civil wars in Kuwait and Iraq delay decision making.

When it gets going, Middle East business will develop gradually, as has Eastern Europe. Major U.S. companies, such as General Electric, General Motors, Coca-Cola and Digital Equipment, have made investments in East European countries but that hasn't strained their ability to make other investments at home or abroad.

When you hear fears about interest rates, remember there are always offsetting factors. In the United States, interest rates are coming down because loan demand is down. Economist Edward Hyman, of the C. J. Lawrence brokerage firm, says U.S. credit demands have declined $200 billion in the past couple of years. In Japan, there was a rush of borrowing to buy real estate. Now there is a lot of overpriced real estate and no rush of buyers. That doesn't mean Japanese markets will collapse--just that real estate prices will come down to attract buyers.

The same is true of the real estate holdings of U.S. banks and savings and loans, which are now being bundled up for sale at lower prices to institutional investors. Pension funds, which have less than 4% of their trillions of dollars in assets invested in real estate, are ready to pick up long-term bargains.

U.S. banks won't collapse from writing down real estate loans. That's why banks have reserves against losses, explains the head of a major U.S. banking company. "Banks in general have satisfactory reserves against a 30% decline in real estate values," says this executive. "And in the unlikely event that declines are greater than 30%, most banks could handle that also."

Pension funds picking up real estate at low prices today will see values rise over the years as the economy grows again.

Great, you say, but when will it grow again and where will the jobs come from? From a recovery in construction and housing that will start this spring. Low interest rates and low inflation will accentuate a healthy trend in housing affordability--more young people can afford houses now than at any time since 1977.

Recessions end, old patterns change, new growth commences. Longer term, there will be new business in the Middle East, and many other places at home and abroad. That's why stock markets everywhere see a bright outlook through the present gloom.

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