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Be Afraid, Be Very afraid ! By Sean Corrigan from Capital Insight Ltd. 08-31-2001 Click here to email this article to a friend
Just think how bad the reaction would have been if the first revision of US GDP had been negative? How far would the stock market have fallen and how gloomy would the headlines have been then?
In fact, GDP was negative on the quarter - or at least that was the outcome for the Private components of this suspect aggregate wherein wealth creation, as opposed to its redistribution, is most likely to lurk. This fell 0.9% annualized in real terms, the first such drop since 1991.
The bad news doesn't stop there either. Equipment and software spending (EQ&SW) fell in nominal terms by 16.5% annualized (nominal dollars are what sales and earnings are calculated in, remember) and is now off 9.5% annualized since the QIII-2000 peak - the fastest decline on both timescales in at least 30 years.
Notwithstanding this, EQ&SW as a proportion of all the consumptive elements in GDP (PCE, residential spending and government intrusions) even now remains a full standard deviation above its 30-year average and it still stands above all previous cycle peaks in this sample. Moreover, if the past is any guide to this episode, we should expect the rebalancing to continue to the point where this proportion falls at least another 20% as the economy contracts.
So much for the economy level, but also at the firm level there are warning signs. The pull back in spending has, unfortunately, only just drawn ahead of the marked deterioration in companies' net cash flow, which meant that, in Q1, EQ&SW represented fully 105.7% of aggregate free cash flow - its highest level in at least a generation.
Last quarter finally saw a diminution of this overspend, but only to 101.3% (the 8th highest in the 122 quarters we downloaded) and still 2.2 standard deviations over its 83% mean. For the pessimists, the ratio at its troughs seems to lie below 75%.
Now none of this is linear. If some businesses spend less on investment goods, others' free cash flow will decline. That of course will increase the pressure on them to cut costs - of which the biggest and next most easily reduced variable cost is labour. That, in turn, is likely to be an increasingly attractive option whether or not wages stagnate, if some of the horror stories in the press about health premiums and general employee liability insurance are to be taken seriously.
The Boom, remember, is all about financial markets and the Fed forcing interest rates too low, to the point where extra higher-order investment projects are undertaken, just as the same lower rates are prejudicing people against the increased savings needed to fund them.
The Bust, when it comes, is a process of the surrender of these superfluous higher-order layers of production to the more insistent and less time-consuming (and hence less capital intensive) segments, close to the now-victorious consumer.
Contrary to what we read in the media and hear repeated ad nauseam from the Street's talking heads (the guys who thought Amazon was worth a $1000 a share), if the consumer keeps spending heavily, the dislocation at the top end of the capital goods sector will actually be more severe and probably more prolonged as a result.
It is a shame that people have been so thoroughly steeped in Keynesian/Monetarist illogic that they will react in blind panic to signs of that very restoration of moderation on the part of consumers which would otherwise be the salvation of large parts of industry. Though, as we will contend below, there might be a silver lining in that particular cloud.
All of this is a clear argument for selling Nasdaq - at least against the broader market, if not outright - and it shows why the bond market is still right to bet on lower funding costs to carry its inventory of fixed-income paper in the coming months.
Not that this side of the phenomenon is restricted to the US, of course. Look at poor old Japan where Industrial Production fell sharply once more in July, to rack up a 19.2% YTD annualized decline - the steepest fall since the horror years in the wake of the first Oil Shock. The index has now has lapsed back to a mark last seen in the early Spring of 1994.
It is not only the Nikkei which has lost a decade.
As for the other side of the phenomenon - consumers spending madly - oblivious to the gathering tempest, what about the UK?
The latest data showed another sharp increase in lending to individuals such that, in the last 12 months, mortgage lending has risen by GBP45 billion and credit card borrowing has increased GBP15 billion or so. This equates, roughly to an extra GBP1,000 per head - almost 10% of disposable income and 2 ½ times the increase in that income in the period - so that debt/income is now pushing a cool 110%.
But not to worry, house price inflation will keep the wolf from the (heavily-geared) new door, just as it will in the US, Canada and Australia and among others.
So we can expect more money to be printed - money which will likely intensify demand in the sectors more happily placed to satisfy consumer tastes (so boosting revenues there), but which cannot immediately conjure up the resources to meet this extra call upon them.
Imagine if you prudently cut back on your spending on weekends in Vegas, or postponed the purchase of that new SUV, only to see the price of medical care, or utilities rise. How good would that make you feel?
As the Japanese press reported on the most recent jobless numbers:
- 'One of the largest challenges to the Koizumi administration is dealing with a mismatch between the skills that growth sector industries need and those of displaced workers. In Tokyo, 183,718 workers signed up at Hello Work centers for 115,735 job openings, an average of 0.63 positions per job hunter. Compare that to 3.17 information processing posts available per job hunter for those with required qualifications.'
The BOJ can print Yen, you see, but it cannot print IT skills. Money is easy to create - resources are, however, not so easily unearthed or reallocated.
Meanwhile, ask Scott McNealy, CEO of New Era giant Sun Microsystems - hinting at a Q1 loss and a 25%-plus fall in revenues - whether the problem is more money in the system. Ask the fibre optic makers, pondering a report which highlights the overbuild by suggesting demand will fall for the next three years. Ask broadband providers struggling to persuade householders that they really do need those enhanced download speeds. Ask the chip makers slashing prices by up to a half, ask the mobile handset makers facing saturation, whether another 5% or 10% on the money supply, or another 25bp cut in short rates, will rescue them?
Which is not to say we deny the Monetarist creed that more money can often create more economic activity - we just fret that it almost invariably causes more ills than it seems to be curing, by distorting relative prices and contracts.
More generally, consider the question whether, if your business is on the ropes because you've run out of the necessary timber to build a house, you can complete the edifice simply by ordering that all rulers and tape measures are recalibrated so that inches take up less space on them? That's all that printing money is trying to do.
Of course, as an aside, it also frustrates existing contracts by defrauding creditors ('Yup, here you go. Here's the two yards of timber you ordered - the NEW smaller yards, that is!') and it deludes savers who confuse money with wealth ('Look! Smaller dollars means your stock portfolio and home prices will seem much bigger when next we measure them!') so that they spend what they can ill-afford.
For now, that money in the US is going into two main outlets, housing and bonds. Ironically, what will no doubt turn out to be badly-distorted personal spending and income numbers just released are giving the impression that no-one spent their tax checks and that savings are back up at early 1999 levels and this supposed ill is intensifying the sell Tech, buy Treasury trade.
Good! The stock market got us into this mess, now let its demise boost consumer fears and thus induce a little therapeutic thrift, stymieing Greenspan and the Voodoo Economics crowd with their fetish of liquidity, and amid the rubble, we can rebuild a sounder base for genuine progress.
-- steven valdiserri (firstname.lastname@example.org), August 31, 2001
Wow! I'm impressed. I don't understand it, but in some strange, convoluted way it all seems to make sense.
-- RogerT (rogerT@c-zone.net), August 31, 2001.
You say that it is a shame that we have been steeped in Keynesian economics, however it is only through government interference in the markets that you have the hugely powerful corporations overflowing with cash. A recent study of the fortune 100 companies found that 20 of them had been saved from bankruptcy at some point by government bailing them out. The initail investment in what we now call the tech sector was made by the public sector, from the web to fibre optics. Outlays that the private sector would never have ventured into as it was to long term to wait for returns. The costs were socialised, the profits now privatised. Free Markets are good in theory, but ever since the great depression have never existed in reality. Why? because as everyones favourate profit, Adam Smith pointed out 'there is no future for joint stock companies.' i.e. loss of concentration of wealth and privilage. Totally unacceptable. We hear lots about scroungers of our tax dollars. They are usually held up to be poor individuals, rather than the Lockheed Martins of the world whom we pay billions to produce militaristic crap that threatens the world and makes them rich.
-- Phil Chapman (email@example.com), August 31, 2001.
I found the re-calibrations of the instruments to measure what money buys to be most intriguing, indeed.
-- Chance (firstname.lastname@example.org), August 31, 2001.
Why is it the British are so good at economic analysis?
This is a brilliant piece of interpretive writing.
-- Big Cheese (email@example.com), August 31, 2001.
If the writer is correct (and he talks with so much common sense it's scary), and we have another 20% drop to look forward to, it will be a devastating Fall season for the Stock Market.
-- JackW (firstname.lastname@example.org), August 31, 2001.