I am convinced that the outcome of the human tragedy of September 11 will be a gutsy renewal of solidarity and confidence, recently lacking in the US, on the part of Americans and foreigners.
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A return to normal is part of defying this evil. On September 17 the US Federal Reserve responded by cutting interest rates by 50 basis points, to make 350bp of cuts so far this year. The same day the New York Stock Exchange reopened after an unprecedented post-war four-day closure. The European Central Bank and other central banks followed the Fed’s rate-cutting lead.
On a broader front, US defence policy will be redefined to address the changed nature of war, and public spending will increase. This will have a beneficial fiscal impact on the US economy.
So I’m sticking my neck out and forecasting that global equity markets will move sharply up between now and the end of the year. The broader US indices could go up 15% to 20% and the technology-heavy Nasdaq Composite could rise by as much as 30%. In other words, tech stocks will lead the market on the way up as they did on the way down. European markets will take their lead from the US.
Oil prices will stabilize and return to normal levels as Arab Opec members move to support US efforts to obliterate terrorists
who represent a greater risk to their regimes than to America. And any rise in the gold price will prove temporary as the dollar bounces back.
There are also important economic fundamentals that encourage me. First, the US consumer remains rich in net wealth. That wealth was not consumed on the upside of the economic and market cycle and now constitutes a reserve that will continue to boost consumption.
The US consumer is 69% of the economy and private investment is only 18%. So an awful lot will have to go wrong with investment to wreck the economy as long as the US consumer continues chugging along. And with real disposable income – boosted by falling oil prices and tax cuts – still rising at 4.5% year on year and unemployment likely to peak at 5% to 5.5%, I reckon the US consumer will keep the economy’s head above water.
Second, new-economy productivity in the US means that there will be a rapid adjustment by companies to lower growth. A glance at the massive lay-offs and inventory liquidation by US companies charts the course. This maintains productivity and coils the spring of future profitability for a massive bounce-back when the cycle turns up. Productivity will drive the economic cycle upwards, once corporations have finished the job of wiping out excess capital and misallocated resources.
Third, the only area of overinvestment is in hi-tech industries and telecoms (especially European ones). The pace of change in hi-tech innovation for the corporate sector has increased, but the ability to pay for it has contracted. So now corporations are learning to manage their knowledge assets by shifting away from the desktop to networking based on dedicated servers. B2B commerce is being extended to control of e-procurement and production. And higher government spending in the aftermath of the terrorist attack will also contribute to increased demand.
And most of the excess hi-tech hardware inventories are outdated. They are being written off and will be thrown away fast. As soon as profits recover, the pace of corporate investment will jump. Corporations have no choice if they want to compete in the globalizing marketplace.
Finally, the world is becoming flush with liquidity again. Central banks around the world have pumped in as much cash as they did before Y2K. If the European Central Bank takes a leaf out of the Fed’s book and now begins a vigorous rate-cutting cycle, a rise in financial asset prices could follow.
So I reckon markets are set for a surprise. The third quarter of this year was set to be the bottom of the US economic cycle. The terrible events of 11 September and their consequences may mean that economic activity in the fourth quarter will also be weak. But I expect a recovery early in 2002. And once economic recovery starts, the financial markets will act like booster rockets, creating wealth to fuel demand – animal spirits will see to that.
There are obvious risks. The first is that rising unemployment in the US will cause consumer expenditure to tank. The second risk is that it is the US service sector that will start to shed jobs. The third is that widespread overcapacity throughout the economy will lead to a structural fall in investment that swamps a more or less stable consumer. But I’m convinced that these risks will not materialize, making US equities the best investment bet over the next 12 months.
US stocks certainly look more attractive than Japanese or European ones. The crew of the good ship Japan is gathered on the foredeck awaiting a signal from the bridge on whether prime minister Junichiro Koizumi will get serious about reform. But I’d give that only about 30% probability. If Koizumi reforms, he will have to expose the full horror story of Japan’s public finances. And if reform falters, fiscal stimuli will follow stimuli with the monotony of grey waves on a lifeless sea. Government bond issuance will rise even more.
There does appear to be enough bottom-up reform coming from the boardrooms of Japan’s big blues. And the equity market is historically cheap. But reform from above is needed to kickstart the Japanese stock market.
Sure, the cyclical headwinds in Europe will abate. Erosion of consumer purchasing power by imported inflation, excess telecoms investment, falling manufacturing exports and inventory liquidation will all matter less in 2002 than they have this year.
But European corporations have done much less than their US peers to get their costs sorted out. And Europe’s under-educated political class continues to make the case for investors taking all their money out of Europe and for foreigners to keep their money elsewhere – the latest idea being French prime minister Lionel Jospin’s proposal for the taxing of cross-border capital flows.
The result of this will be that eurozone GDP growth will be 1.5% to 2% next year and European equities will underperform those in the US. During this terrible crisis for America, the dollar has weakened, but not by much. The euro has appreciated to no higher than 93 cents. I am expecting the dollar to bounce back along with the US stock market.
