Bears Refuse to Go Into Hibernation
The Nasdaq composite index just posted its first quarterly gain after four straight losing quarters, yet Wall Street’s bears seem more confident than ever in their grim outlook.
Reality hasn’t finished biting the stock market, such professional pessimists say.
A U.S. economic recession probably is underway, the bears contend, and a global recession is a growing possibility. Investors soon will realize that corporate profits aren’t bouncing back until 2002, if then, they say. Once that news sinks in, stocks--still pricey by historical standards--will swoon again.
Although the Federal Reserve Board has been slashing interest rates with near abandon, and taxpayers within weeks will begin receiving checks under President Bush’s tax-rebate program, the bears believe both measures will prove to be too late to stave off deeper economic woes.
In many respects, the bearish case isn’t new--which is why the majority of Wall Street pros don’t buy it.
Some of the pessimists’ dire predictions about stock market valuations did come true when the Internet bubble burst. But the depressions, bank panics, real estate collapses and other catastrophes foretold by the most extreme prognosticators during the 1980s and 1990s seem as unlikely today as they did when the technology bull market was in full flower.
Still, the bearish case has some key fundamentals on its side for the first time since the early 1990s: overcapacity and strained credit afflicting many industries, a weakening economic picture overseas and--above all--a U.S. consumer chin-deep in debt and unable to maintain the spending that has been carrying the economy for the last year, the bears say.
“If the consumer can keep the faith and kind of not look at the facts, maybe we can work some magic here, but it’s tough with the job market going the way it has been,” said Lakshman Achuthan, managing director of the Economic Cycle Research Institute in New York.
Initial state unemployment claims, for example, increased at an annualized rate of 41% in the second quarter, compared with a year earlier. That is the steepest year-over-year rise in such claims since the 1980 recession.
On Friday, the government said the economy shed a net 114,000 jobs in June, capping the biggest three-month job loss since the 1990-1991 recession.
The National Bureau of Economic Research, official arbiter of U.S. business cycles, watches four key indicators: industrial production, manufacturing and trade sales, employment and personal income. Except for income, all the barometers are pointing down, some to an extent previously seen only in recessions, Achuthan said.
“If it’s not a recession, it’s the worst non-recession we’ve ever had,” he added.
More optimistic observers took heart last week from two indicators of unexpected vigor in the manufacturing sector. Monday, the National Assn. of Purchasing Management reported that its index of manufacturing activity showed the pace of decline in the sector was the slowest since November. Tuesday, the Commerce Department said factory orders jumped 2.3% in May.
Nonetheless, the Economic Cycle Research Institute’s proprietary indexes of leading and coincident employment indicators have been flashing recessionary signals since late last year, and they’re warning that employment isn’t likely to turn around before next year.
“There’s a lot more to come” of layoffs and cost cutting that companies have been undertaking in recent months, said Robert B. MacIntosh, chief economist at Eaton Vance Management in Boston. “I don’t think a lot of companies have come to grips with the problem yet.”
The problem for business, as MacIntosh and other economists see it, is excess capacity caused by years of overinvestment.
The phenomenon has been easy to spot in such industries as telecommunications because it has been marked by an implosion of stock market values. But the problem is broader than telecommunications or even technology, analysts say.
The remarkable improvement in information technology in recent years has enabled business managers to sense weakening demand earlier than ever and avoid the kind of inventory buildups that used to cause cyclical downturns all by themselves.
But slumps caused by inventory backlogs tend to be milder and briefer than what’s facing us now, Achuthan said.
Capacity utilization at U.S. factories is at the lowest level since 1983, he noted. Thus, even if business picks up, it will be some time before manufacturers feel the need to invest in new plants and equipment. That will make any recovery more sluggish and fragile, Achuthan said.
Normally, a Fed-easing campaign as aggressive as the current one--2.75 percentage points of rate cuts in six months--could be expected to spur business investment. But if companies already have more machines, more warehouse space, a bigger fleet and more computing capacity than they can use, the Fed may end up with the classic dilemma of “pushing on a string”--offering credit to borrowers who have no need for it.
The global picture also is increasingly gloomy, some economists say.
U.S. recoveries from the recessions of the early 1990s and early 1980s came about partly with the help of more vigorous economies overseas. Most of Europe was still growing during the U.S. recession of 1990, and Japan remained strong during the 1981-82 recession.
Now, “We’re set for the first synchronous global recession since 1974-75,” argued Austin, Texas-based economist and money manager Van R. Hoisington. “This is not a forecast--it’s happening.”
Economic growth rates in Japan, Taiwan and Mexico are close to zero if not actually negative, and Europe’s two biggest economies, Germany and France, have been weakening steadily in recent months.
“Having the three big engines [the United States, Japan and Europe] all standing idle at the same time is highly detrimental to global activity,” Hoisington said.
The continued strength of the dollar against foreign currencies has badly hurt the U.S. manufacturing sector. The positive flip side is supposed to be that foreign factories and economies keep humming as they ship their cheaper goods our way. At present, though, the American consumer’s appetite for imports isn’t strong enough to balance the weakness in other markets, analysts say.
“World trade is shrinking,” Hoisington said, and the process could get worse if the erosion of U.S. manufacturing jobs sparks greater protectionist sentiment.
Since April 1998, 1.4 million manufacturing jobs have been lost. Because they are relatively high-paying jobs that tend to create supporting service-sector jobs, such losses make a big splash in the affected congressional districts, making protectionism a politically enticing option.
If foreign trade isn’t about to restart the economy, what about the consumer sector? Consumer spending accounts for two-thirds of gross domestic product, and it has been the most reliable part of the growth equation for years.
Monday, the Commerce Department reported that consumer spending rose an unexpectedly strong 0.5% in May. But Thursday the department said it had erred, and revised the figure down to 0.3%. And increasingly in recent weeks, major retailers have warned that sales growth dimmed substantially as the second quarter progressed. Federated Department Stores and Longs Drug Stores were among the retailers issuing downbeat sales forecasts last week.
If consumers haven’t exhausted their spending capacity, it’s likely to happen soon, said David A. Levy, vice chairman of the Jerome Levy Economics Institute in Mount Kisco, N.Y.
The debt-service burden on consumers--mortgage and consumerdebt payments as a percentage of household disposable income--is approaching the all-time highs of the mid-1980s, Levy said last week.
The debt-service burden peaked at 14.38% of income in the fourth quarter of 1986. After easing back under 12% in the early to mid-1990s, the level rose more or less steadily until it hit 14.28% in the fourth quarter of last year, the most recent number available.
That average figure may seem low to many consumers with fat mortgages, but that’s because it is measured economywide--including millions of Americans, especially retirees, with low or no debt.
The statistic is worse than it appears, Levy said, because auto leases--an increasingly popular way to finance cars--don’t show up in the numbers, whereas conventional auto loans do.
Measured another way, in terms of total household debt outstanding as a percentage of disposable income, the stress is at an all-time high. Households now maintain a record average of $1.05 in total debt for every $1 of income.
Theoretically there is a limit to how much debt consumers are willing to take on to maintain their spending, and Levy believes the limit is close at hand.
He predicted that, faced with increasing layoffs and other kinds of cutbacks on the job, consumers are in the process of reining in their spending and devoting more attention to repairing their personal finances.
If consumers decide to use most of their tax refunds to pay down debt rather than buy more goods, as Levy thinks is likely, the economic stimulus of the tax cut will be muted. And without robust consumer spending, the bears contend, it is hard to make a case for a rebound in corporate profits until 2002 at best.
Therefore, it is only a matter of time before investors face the facts and again begin marking down stock valuations from their historically high levels, the bears insist. The spring market rebound, they say, was based on a profit recovery that now appears illusory.
Stock market naysayers such as Dallas-based David Tice of the Prudent Bear Fund say another setback for the market will dispel the belief that every drop is a buying opportunity.
The next down leg, he predicts, will be a long one.
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Grim Outlook for Jobs
A key measure of the U.S. employment picture, the Coincident Employment Index tracked by the Economic Cycle Research Institute, has fallen into territory previously seen only during full-fledged recessions. The index tracks job growth, layoffs, the size of the labor force and other employment trends.
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CEI growth rate (monthly percent change, annualized)
May 2001: -0.6%
Source: Economic Cycle Research Institute
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Calm Before a New Storm?
The Nasdaq composite stock index resurged in the spring from the two-year lows reached April 4. But Wall Street’s bears argue that the technology-dominated index is poised to fall again as investors give up hope for a near-term recovery in corporate profits.
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Nasdaq composite index, weekly closes
Friday: 2,004.16
Source: Bloomberg News
