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Whither the U.S. Economy?
by Ali Salim
November ended with a bang. The Dow Jones industrial index average, not only cleared the massive fall in August/September, but went past the July 17 high to record territory. Looks like stock investors have brushed aside economists' predictions of slower growth in their buying spree, bouyed by a number of high-profile mergers and Fed's interest rate cuts. Morgan Stanley Dean Witter's investment strategist, Peter Canelo, put it succintly, "In truth, what we had before was a panic. The market over-reacted to problems in the international areana, over-reacted to a possibility of a credit crunch, over-reacted to the Long-Term Capital (Management) hedge fund situation." On economists' prediction, he added, "I never pay attention to them. It can be dangerous."
The merger market saw 10 mergers in the US$1 billion plus range, including Tyco International Ltd's agreement to buy AMP Inc. for US$11.3 billion, Deutsche Bank AG's acquisition of Bankers Trust Corp for US$9 billion and American Online Inc. proposed take-over of Netscape at US$4 billion.
More good news. Unemployment remains low, as does inflation. Consumer spending is not abating, and stands at a whopping two-thirds of gross national product. Housing starts are near an 11-year high (despite the worst decline in Western states). Car and truck sales is likely to finish 1998 at 15 million, making for an unprecendented fifth straight year of robust activity.
So how are the pessimists reacting to all the good news? Suprisingly, not badly. The good news they say is exactly the problem. The earnings performance of Corporate America has been dreadful since late 1997, and owe it as much to local conditions as to poor foreign climate. Here is their defense:
Any rebuttals? Poor corporate earnings can rattle the stock markets again but efficient market hypothesis postulates that current prices already reflect expectations of weaker profits (with possible rebound in 1999). Labor payroll gains have actually slowed. Since July payroll gains averaged 178,000 per month, down from 244,000 in the first half.
- Job growth is slowing, a key sign that overall economic growth is shifting to lower gear.
- Corporate margins are declining, despite gains in productivity, implying labor cost increases are higher than productivity gains.
- The Leveraged buy-out equity funds are at a low US$50 billion, while the merger market is running at its current US$2 trillion rate, making cash deals unlikely. Financial buyers in the merger business plan to use bank debt (low interest rates) which will accentuate a credit crunch when it happens.
Labor Department reported productivity at a health 2.3% annualised rate in the third quarter, while labor costs growth was only marginally higher at 2.6%. And a slow-down in service sector (which engages 80% of all workers) is quite likely, thereby balancing the pressures.
LBO funds may leverage, but are unlikely to get away with the 20% equity deals they did in the 80's since lenders are now too nervous to allow it. Thus, the merger activity will slow down to affordable levels, and managers will begin to harvest cash and staying close to businesses they know best.
What are we going to see in the next couple of months?> The see-saw action of the Dow is due to the problem of confidence. The Dow fall is good medicine for those who take it. Market bottoms can only be identified in retrospect. If the medicine does not work, fear will overwhealm greed. Just see what happened in Asia, Russia and South America. But we will not know for sure. As Credit Suisse First Boston's top investment banker, Ken Miller, put it: "Of course, it's still possible that the Treasury's and central bankers' prescriptions may work, and the patient will be cured."
Alan Greenspan has a lot of work to do. President Clinton is quite busy with the impeachment issues. Veep Al Gore is not out of the woods yet on the soft election funds. So, Mr Asian flu and Mr Russian migraine, please find something else to do.