Forum Archive Index - December 2001

["G Stolwyk" <stolwyk@wave.co.nz>]

Introduction: Date: 13 Dec. 2001. The three participants from the "Irreverent series" have decided to hold a brainstorming session on current prospects of the US sharemarket. Messrs. "H" and "G" are having drinks while waiting for Dr Crash (C) to arrive. 

 

H: You are late C, what happened?

C: My name created a stampede at the Ministry: the building was full of people when a colleague in a waiting room on the top floor could'nt reach me and shouted from a distance: " CRAAAASSSSHHHHHH".

 

Within seconds, the floors were vacated. Staff rushed into their offices to place sell orders with their brokers. People pushed each other down the stairs and they were joined by others who followed in lemming-like fashion. They were trying to get to the nearest phone. Others used their mobile.

 

I was held up in the melee and hence, I am late!

 

H: We are here to discuss the US equity market. I propose that you and I discuss the positives and negatives and let G to do the introduction and summing up.

 

G: Our thanks to Winner 69 who introduced the subject in:

http://www.sharechat.co.nz/archives/2001/12/msg00013.shtml

 

and that site includes:

http://www.fortune.com/indext.jhtml?channel=print_article.jhtml&doc_id=205324

 

It discusses predictions from Warren Buffett.

 

Peter Maiden also mentioned a site; it refers to a book by Michael Alexander:

http://www.sharechat.co.nz/archives/2001/12/msg00015.shtml

 

We are aware that the US is the world's economic engine and we want to know its current health and prospects:

 

1. The economic situation outside the US.

H: Previous forecasts were far too optimistic and the nations' prospective GDP data have been slashed. In Europe, the UK is now to have a GDP growth of 1.4% in 2002.

 

Germany, which is Europe's economic engine, has close to zero growth. The rest of Europe does not look good, apart from Russia which is showing growth from a low base.

 

There is contraction and deflation in Japan.The situation is rough in Asia except for China. This country relies on deficit financing and has a reasonable GDP, considering that US demand is down. 

 

C: Oil is at present about $US18/barrel and once the US economy recovers, one can expect higher pricing.

 

Commodities: Aluminium: US 60 cents; copper: US 66 cents and nickel $ US 2.22. Metals have declined overnight.

At the same time 10 year US bonds have seen their yields overnight lowered to 4.97%. 

 

That could be the first indication that the US stockmarket recovery of some 20% since the WTC attack, is stalling. 

 

G: Summing up, it is clear that the US cannot expect help from other countries. The problem in Argentina won't go away, either.

 

2. The economic situation in the US. 

G: I want to refer to a few constraints on the US economy: 

2.1 Corporate and Household debt.

H: As I see it, there are the continuing effects not only from the Dotcom collapse but also from lowered expectations since the Sept. 2001 attack on the WTC: the gestation period of these two events will be a long one. 

 

During the Dotcom boom there were enormous debts incurred in the above mentioned categories:

There was  heavy corporate over investment while investors mortgaged their homes and bought more shares. Others bought homes at inflated prices and mortgaged these, believing that the good times would last forever.

 

The spending on investment and consumption was much higher than was earned. After the Dotcom collapse, cashflow became a problem as the value of assets fell. Property was sold at a loss. Refinancing lower valued property caused problems.

 

Greenspan then lowered interest rates and after the Presidential election, efforts were made to stimulate the economy by tax cuts. It was hoped that the US consumer would keep on spending. ( It is about 2/3 of the GDP ).

 

C: The outcome of the attack on the WTC aggravated the situation. The flow-on effects were massive in the Airline, tourism and related industries and unemployment is rising.

 

To improve the cash flow, use was made of foreign money inflows. However, the Current Account Deficit was lowered from 4.5% of GDP to the present 3.7%. To restore households to normal debt levels, they still need to undertake another 67% of the adjustment process. ( One third completed so far- AMB-AMRO ). 

 

G: Summing up, Corporates and Households are keen to reduce debt levels. Businesses were sold to foreigners and inventories were slashed. There were heavy discounts including those in the pre-Christmas trade. And this brings us to:

 

2.2 Deficit Financing and the Money Supply.

H: To stimulate the markets and to promote consumption, Greenspan has again lowered interest rates ( to 1.75% ). Unfortunately, the consumer wants to pay off more debt and much of the tax cuts does not finish up in the shops. Banks also tend to be more selective with granting of loans.

 

Discounts granted to consumers result in lower margins and less tax take. It is my understanding that the tax cuts were based on a normal year of consumption and profits.

 

Clearly, that is not going to be the case and there are additional items : The cost of the war in Afghanistan, its aftermath and possibly, other adventures to come. There will be a deficit, but the extent thereof is not yet known. 

C: Reports say that there is a significant increase in the money supply.  We are waiting for more data.

 

G: Overall summary: the two negatives mentioned in (2.2) could normally produce some inflation. However, due to less demand, we expect deflation. Lower profits and lower shareprices are likely to prevail. There are different P/E's being quoted but many accept that they are still too high anyway! 

 

Greenspan supplied the fuel ( liquidity)  to initially fire up the market after the Sept. attack on the WTC. These stimulants ( tax cuts, cuts in interest rates)  will help but do not quickly remove the underlying explained problems of the US.  

 

Manufacturing continues to contract sharply and is now at least at a twenty year's low. We expect a strong increase in unemployment with a curb on the growth of wages. Data to come in the next two months will be crucial.

 

It will take time to correct long standing imbalances and to bring the economy back to some sort of equilibrium. We feel that economic forecasts continue to be too optimistic.

  

There are other issues, eg. treatment of US accounting rules ( including goodwill) and a - much later - possible reaction to the increased supply of money and deficit financing. We won't discuss these at this stage.

 

2.3 Predictions given in above mentioned web sites.

H: It was said that there may not be much change in the S&P 500 in the next 15 to 20 years! I feel that comparisons are difficult to make as the flow of information, the speed of transactions, the formation and expansion of the EEC, the globalisation as well as co-operation between the world's major financial institutions can be crucial and often, positive factors.

 

C: We have already mentioned that in our opinion, the US  P/E's could be lowered. Much can happen in such a long time. There will be corrections, sharp uptrends and down trends. At the end of trading on Dec.12, the S&P was 1137, the Dow on 9895 and the Nasdaq was on 2011. 

 

Those are our opinions,

 

Gerry