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Following the turbulence of 2000 in financial markets – with the euro in free fall, volatility in tech stocks, a climbing oil price and continuing problems in Japan – economists are divided into two camps over the outlook for 2001: the cautious and the downright worried.
Merrill Lynch’s army of analysts take the cautious – even a cautiously optimistic – line, arguing that though global growth will continue to slow, conditions are in place that will result in positive returns in equity markets and a soft landing in the global economy.
Michael Hartnett, senior international economist at Merrill Lynch, says that there are three questions facing the global economy in the coming year: will there be a soft landing, will the US Federal Reserve and the European Central Bank (ECB) ease monetary conditions, and will the euro bottom out and find itself a range? “The answers to these questions are yes, yes and yes,” he says.
Merrill Lynch expects global growth to slow from 4.2% in 2000 to 3.2% in 2001, with US growth falling to 3.3% from the 5.1% of 2000, but suggests that capital investment in equipment and software in the US should remain high enough to maintain the improving trend of US productivity and support growth. “The risk of recession is low,” says Bruce Steinberg, chief economist at Merrill Lynch.
Merrill Lynch also feels that inflationary pressures will ease because the high oil price should fall after the northern hemisphere winter. It predicts that this will enable the Fed to reduce interest rates. It expects the Fed to ease monetary conditions twice in the first half of 2001. Steinberg says: “We expect the Fed to ease US monetary policy, dropping the Fed Funds rate to 6%.” This should enable the ECB to follow.
Lehman Brothers also expects US GDP growth to slow in 2001 to an average of 3.4%, as opposed to 5.1% in 2000. Lehman Brothers predicts a soft landing for the US economy and also forecasts that the Fed will keep rates at 6.5%, while acknowledging that there is some chance of a cut of 25 basis points in 2001 Q1.
The spectacularly bad performance of the euro was, says Merrill’s Hartnett, “one of the surprises of 2000”. But he feels the worst is now over for the beleaguered currency and the outlook for 2001 is promising. “We are optimistic that the euro has troughed,” he says. Merrill Lynch is expecting the euro to rally somewhat against the US dollar and achieve stability in the $0.86 to $0.96 range and it is looks as if the currency is finding its feet against the dollar.
With this in mind, Merrill is recommending a conservative investment strategy for the coming year until “central banks have eased sufficiently to turn economies around”. Richard Bernstein, chief quantitative strategist, says: “The investment theme for 2001 is ‘B2B’, but this time it stands for ‘back to basics.’ Instead of the fastest earnings growth, we suggest investors look for good, old-fashioned basics like stability of earnings growth.”
This entails a look towards more traditional industry sectors and remaining wary of technology, media and telecoms stocks. Last December’s profit warning by the industry’s biggest player, Microsoft, and falling prices for the likes of Siemens and Infineon may not yet have driven the sector to the point of offering value. Merrill Lynch prefers financials, oils, IT hardware and other selected defensives such as tobacco.
Goldman Sachs analysts agree with this defensive strategy. The firm’s report headlined European equities are not discounting a global recession, argues: “Slower than expected growth points to defensives: We expect beverages, food retailers, food producers and utilities to outperform if the major economic shock in 2001 is slower than expected growth.” Goldman says investors should seek security in these areas while avoiding the “highly exposed” sectors such as automotives, chemicals and luxury goods.
Goldman sounds a more pessimistic note than Merrill with real concern over the sharp fall in technology stocks. “The combination of a collapse in share prices in the technology sector,” says the report, “along with sharp declines in new orders for technology products, raises the possibility that the bursting of the US technology bubble could lead to a more generalized recession.”
It continues: “We do not forecast a recession but the risks are rising. If it occurs, profit forecasts for 2002 in Europe could be 40% too high.”
The firm recommends action be taken to stimulate the global economy, claiming that it is “not too late to avert a recession by lowering interest rates: in the view of the GS economics team, there is still time and scope for policymakers to head off a hard landing in 2001.”
