On the Money: US catches a serious cold and global markets sneeze in tune

By Michael Coote

Friday 28th June 2002

The US sharemarket has failed to fire despite some evidence that the economy is picking up speed.

Reluctance of its indices to lift in response to declaration that the recession is over has prompted concern.

It is not normal for the US sharemarket to refuse to respond to evidence that the underlying economy has turned the corner, particularly when interest rates have been cut so deeply by the Federal Reserve.

The Economist of June 22 noted the present malaise was the first of its type in the US since the 1920s.

The usual pattern is for the US sharemarket to jump within six months of the end of recession.

This time around the market does not want to know about the glad tidings of expected resumption of growth.

There are a number of reasons given for the failure to forge ahead. Some are economic.

US consumer demand has slumped with retail sales down by 0.9% in May. Unemployment numbers have not shown substantial reversal. Investment remains weak.

Household indebtedness is high. The current account deficit has blown out and threatens to exceed 4% of GDP as Americans continue to rely on the savings of foreigners to finance their living standards.

The fiscal situation has deteriorated with expectation that this year's government deficit may hit 1.5% of GDP and that a balanced budget will not be achieved by 2005.

The combination of tax cuts with commitments to higher federal spending has been mis-timed considering the slowdown in the economy and resulting lower tax take.

State government spending has collapsed due to legal limitations on running deficits.

Weakness in the greenback indicates foreign investors are getting squeamish about America Inc as a proposition.

On the corporate front, Enronitis continues to debilitate investor confidence.

A double whammy hit came this week with the revelation Worldcom had overstated cashflow by nearly $US4 billion.

Some 1000 US corporations have restated their earnings since 1997, which is a polite way of saying they were short on honest numbers.

Accountancy firms apart from Arthur Andersen, not to mention big-name securities houses, are running for cover while US regulators squabble about how to force improvements to once-vaunted American standards of business ethics and prosecutors with political aspirations come a-calling with writs and demands for damages.

The guts of share price increase lies in improved outlook for earnings and profits. If people refuse to believe in the numbers they are not going to bid up shares, especially when economic recovery is sputtering.

The credibility of the US sharemarket has crashed and it is not clear how long it will take for trust to be restored.

In an article entitled "Waiting for the band to strike up" the Economist argues that the old-fashioned risk premium on shares has returned with a vengeance after being largely discarded during the tech bubble.

The mood of investors has swung from optimistic greed for reward to pessimistic fear of risk.

More ominously, the article argues risk premiums are still not high enough to reflect the usual differential above bonds. The implication is that the sharemarket has further to fall.

A conservative estimate of the risk premium of US shares over government bonds is 4%.

If investors imposed that premium now, says the Economist, they would cut share prices by another quarter.

On the technical analysis front, the lows post-September 11 look increasingly fragile as a basis of support.

The American humiliation is not without its ironies. Scared money is running to Japan and other Asian economies, boosting sharemarkets in the very countries the US and its watchdog, the IMF, have been lecturing on improving their accounting, governance, regulation and business ethics.

American credit rating agencies, so tough on many of these countries, are now blushing at the ratings they gave US companies during the same period.

We in New Zealand have seen a strain of Enronitis, namely Equiticorposis, in the wake of our 1987 sharemarket crash.

Before we get too smug however, we should remember that Kiwi investors have been frightened off local shares for years in the wake of 1987.

Until the US gets its house in order it is not clear when international sharemarkets can be expected to stabilise.

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