20 Jul 2001 Out of the Stormy Night and into the Fog
Increasingly, economists are saying the worst may be behind us, but recovery is not clearly in sight. Mr. Greenspan’s comments to Congress yesterday pointed to the possibility of a turn in the economy in the second half of this year, but he warned that the current malaise could likely continue for some time to come. Recent company earnings reports have not been as bad as feared while revenues did disappoint more often. Managers in general have done an excellent job cutting expenses in the face of this dramatic slowdown, but their reluctance or inability to provide any meaningful guidance about the near-term future weighed on stock prices.
This economy slowed so incredibly fast, most were taken by complete surprise. The confluence of Y2K, the ‘Internet Bubble’, telecommunications over-build, the SEC’s Full Disclosure Rule, excessively high interest rates during the second half of 2000, and regulatory and political party swings, have together served to slow to a crawl, if not end, the longest period of economic expansion our nation has ever enjoyed. If bull markets loathe uncertainty, bear markets devour it. Quarterly earnings reports broadcast to all investors at the same time (courtesy of Fair Disclosure) have increased volatility in stock prices compared to pre-F.D. times when information was disseminated more slowly. Given the decidedly negative tone in markets today, companies reporting disappointing results or guiding future expectations lower see their share prices punished as well as those of others in their industry. Harvey Pitt, the nominee for Securities and Exchange Commission chairman, recently indicated that he may consider changing the rule. In a recent confirmation hearing he said “I am concerned when a broad array of groups – the Securities Industry Association, the National Investor Relations Institute and others — have raised in some cases very serious concerns.” He went on the say “The SEC has an obligation to listen, to have a dialogue, to understand the criticism and to do a review.”
Why are so many good companies’ managers expressing so much uncertainty? A big part of the answer is the lack of orders. Just 12 months ago companies had more orders than they could fill. Orders literally dried up in a matter of months and in some cases, weeks. Capacity utilization (the rate factories are used) have fallen from its highest levels a year ago to its lowest levels in 18 years. Jack Welch of GE said the manufacturing economy is as bad as he as seen during his career.
On a positive note, the three best indicators of the future health of the economy indicate improvement. The National Association of Purchasing Management expectations index has moved up for the past five months. Consumer sentiment has improved over the past several months. Finally, interest rate spreads (the difference between risk-free bonds like treasuries and higher risk debt, such as telephone bonds) have narrowed. As these three measures improve, the likelihood of economic recovery increases.
Economic Statistics Released This Week:
Industrial production fell 0.7% in June, extending its slump to nine months as manufacturing showed its biggest drop since the year began. The string of negative readings is the longest since a 10-month stretch in 1982, a recession year. Manufacturers of everything from metals and machinery to consumer goods such as appliances and furniture led the decline, but information and telecommunications companies have been the hardest hit.
U.S. business inventories were unchanged in May as sales rose more than in any month since March of last year – a sign a pickup in the economy may boost production months from now.
The economy grew at a 1.2% annual rate in the first quarter, compared with the fourth quarter’s 1% growth rate, which was the slowest in 5 ½ years, according to government figures. Economists expect the economy grew no more than .5% in the second quarter ended in June.
Stockpiles fell by $19.2 billion at an annual pace in the first quarter, the first decline since the third quarter of 1991, and the largest since a $42 billion decrease in the first three months of 1983.
Industry operated at 77% of capacity in June, the lowest reading since August 1983, down from 77.6% in May.
Production of information processing equipment, a gauge of capital spending, fell 1.2% last month after falling 0.8% in May.
Few signs that consumers are helping – production of consumer durable goods, which includes automobiles, home electronics, appliances and furniture, fell 1.2% after rising 1.1% in May. Production of non-durable consumer goods, which include food, clothing and beverages, was unchanged after falling 0.3% in May.
Manufacturers shed 389,000 workers in the second quarter, the largest quarterly decrease since the first quarter of 1991 when 449,000 factory workers lost their jobs in the midst of the last recession.
The Fed expects the nation’s jobless rate to rise through the end of this year to about 4.75% to 5%.
The declines in production and profitability are some of the reasons Fed policy makers lowered their target for the overnight interest rate between banks six times since the start of the year. The rate, now at 3.75%, is the lowest in seven years.
U.S. consumer prices rose more than expected in June as higher costs for services such as medical care and air travel outweighed declines in energy and clothing, government figures showed.
Other statistics show inflation is tame. Last week, the Labor Department reported that prices paid to factories, farms and other producers declined 0.4% in June, the largest drop since February 1999. The government also reported that prices paid for imported goods dropped in June for the fourth month out of five.
The Labor Department said average weekly earnings adjusted for inflation rose 0.1% in June after rising 0.2% in May.
The price of gasoline declined 2.6% after rising 6% in May. The June decline was the largest since March. Average U.S. pump prices for gasoline are down 15.6 cents from a year ago, according to the Department of Energy’s weekly survey of about 800 filling stations. The average price of all grades of gasoline reached a record $1.748 a gallon during the week ended May 14.
Greenspan’s Testimony to Congress:
“We aren’t free of the risk that economic weakness will be greater than currently anticipated, and require further policy response,” but additional rate reductions would probably be limited because the central bank has already cut the benchmark overnight lending rate to its lowest in seven years.”
“The rate of deterioration is clearly slowing and indeed there is considerable evidence to suggest we are approaching stability at a lower level,” Greenspan said. And he said he is more optimistic than earlier this year about the prospects of recovery.”
“Despite all the shocks that are involved in both the domestic an international economy, our economy is still doing, not well, but clearly far better given what has happened, than I would have forecast six, eight, nine months ago.”
“As for the years beyond this horizon, there is still, in my judgment, ample evidence that we are experiencing only a pause in the investment in a broad set of innovations that has elevated the underlying growth in productivity to a rate significantly above that of the two decades preceding 1995.”
Notice that the Chairman is using less ‘Fedspeak’ than usual? In clear terms he said:
The door is wide open for further rate cuts if required.
Inflation is of little concern.
He would like to see long-term interest rates go down, keeping mortgage rates low and the housing market humming.
He forecasts a modest improvement in second half GDP growth, followed by a more vigorous recovery in 2002. The period of most intense weakness is probably behind us (though a sub-par performance was still likely over the near term)
He remains a productivity bull meaning he will likely raise the funds rate slower than many would think once the economy returns to growth.