Half Full or Half Empty?

“If you look at life one way, there is always cause for alarm.”  -Elizabeth Bowen, Irish novelist

That the economy is ailing is no surprise to anyone.  Unemployment statistics, additional corporate layoffs, and earnings disappointments are part of every news segment.  While there is plenty of support for the negative case, there is also cause for optimism.  Many strategists are now saying that the market is at or near the bottom.  They say that it is too late to be defensive in portfolio makeup, and that the risk/reward ratio now favors being more invested in equities than bonds.  Even the mostly pessimistic Morgan Stanley strategist, Barton Biggs came out last week in favor of buying stocks now.  The economists at Credit Suisse First Boston make the following points;

“Consumer sentiment has defined every major market bottom and recovery.  We are not far from historic lows.  One must realize that stocks are likely to rebound well before employment conditions.  From October 1990 to October 1991, the unemployment rate increased from 5.5% to 7.5%.  Despite that trend, the S&P 500 rebounded 33% with strong outperformance in cyclical stocks from consumer, industrial and tech land.  When we last experienced a synchronized global recession in 1974 and sentiment eroded below 70%, the S&P 500 rebounded a stunning 31% six months later.”

A better than expected NAPM survey says that manufacturing was clearly on the mend before the September 11th attacks, but it says little about the state of things after.  We must wait until the October report to get a clearer picture.  The good news for manufacturing is that the inventory adjustment was well advanced prior to September.  The bad news is that a large retrenchment in consumer spending could cause another wave of involuntary inventory building, so we would expect producers to be cautious over the near term.  Automakers are holding down Q4 production schedules, which as of now are on course to subtract roughly 0.5% from Q4 real GDP growth.  While most recessions have been flagged by the high-beta industrial sector (which is why the NAPM manufacturing survey has been such a reliable business cycle indicator through history), the worst of the fallout from 9/11 could affect manufacturing with a lag.

The most immediate impact from the crisis was in service producing industries such as transportation, tourism and financial services.  As a result, the NAPM non-manufacturing survey, rarely watched closely because it has such limited history (back to 1997), could receive more attention than usual over the next few months. The index provided a dramatic positive surprise for the market on Wednesday as it reported a 50.2 (a number greater than 50 indicates expansion).  The market expected a 45.6 number that followed last month’s 45.5.  The ‘half empty’ crowd immediately attributed the number to expectation, on the part of survey respondents, of a patriotic buying rally.  We will watch closely.

The market continued its Wednesday rally as Bush presented the details of his fiscal stimulus package aimed at reducing taxes for individuals and corporations and providing investment incentives for business.  Business investment creates jobs.  Job losses in September totaled 199,000 after declining 84,000 in August.  The largest previous drop, of 259,000, was in February 1991 when the US was in recession.  Economists expect the unemployment rate to get worse from here as a result of September 11th.  In light of these probabilities our President, Congress, and Federal Reserve have been rather aggressive in their policy moves to bolster the economy and maintain confidence.  Yesterday, Bush proposed $3 billion in aid to help workers who lost their jobs after the attacks by adding 13 weeks of unemployment benefits to the current 26-week limit in states hit hardest.

Lower market rates should ultimately go a long way in refortifying the household balance sheet by bringing down debt-servicing costs, as well as unlocking cash from mortgage refinancing for debt reduction. Tax cuts are also doing their part by boosting the personal savings rate sharply.  When confidence is restored, consumers should be well placed to take advantage.  But given the lack of confidence now, and general uncertainty in the business outlook over the near term, we are unlikely to see the full benefits from the policy stimulus until next year.

While our markets have been emotional and volatile of late, they are still capable of anticipating and discounting future possibilities.  Wednesday and Thursday’s rallies were predicated on the merits of the government’s stimulus package and some encouraging remarks from the CEOs of Cisco, Dell, and Microsoft.  While many companies continue to warn of earnings disappointments and layoffs, a few industry leaders are saying some positive things about their business prospects even in the midst of these challenging times.

Last night I spent some time working on the CDs I plan to give the committee members putting together our 30th high school reunion.  It’s been bittersweet traveling back those thirty years.  There was some really great music in 1971.  It was as diverse and chaotic as the times.  Karen Carpenter, Donny Osmond, Bobby Sherman, and Tony Orlando typified the innocence of youth in their carefree lighthearted songs.  The Rolling Stones, the independent Beetles, and Led Zeppelin were mostly interested in selling records, but occasionally managed to inject some relevance for the times.  Crosby Stills, Nash and Young reminded us of our government’s alienation from the people with their tribute to the four Kent State students shot by guardsmen putting down a riot following a demonstration against the Vietnam War.  Integration was in full swing during these difficult times.  My high school halls were manned with National Guard troops, put there to maintain an orderly integration process.  It was not.  Marvin Gaye and Elvis Presley sang of the troubles of black youths in our inner cities.  Stevie Wonder and Marvin reminded us of the pollution of our earth.  In Fire and Rain, James Taylor sang of our inner struggles and of the difficulties of growing up as teenagers.  By 1971 our generation and our nation had lost more of its innocence.  We were a country bitterly divided on many fronts.  It took years to recover.

Today, our country is as united as it has been since World War II.  I think it helps us heal faster than we did in the 70’s.  It makes us stronger, and I think, more tolerant.  It is my fervent hope that our leaders use this spirit of national and global unity to view life in more than one way as Elizabeth Bowen advises.  While maintaining the conviction that terrorism will not accomplish its objective of toppling capitalism is important, I trust our leaders will understand and diffuse the hate that fuels it.  Capitalism, while not perfect, has proven itself to be the best socio-economic structure so far to advance humankind’s standard of living.  But unless all nations participate, it fails.  Capitalism requires free, peaceful, and open markets to thrive.  I hope we have the resolve to make that happen.  The signs are encouraging.