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Economics: A rising tide?
New York: October 14, 2003
By John R. Stephenson
Over the last year, the stock market has continued its steady
march upward. Last week the market surged on news that the
jobless claims in the U.S. had dropped to 382,000 from 405,000
(see figure 1) and that the economy had generated 57,000 jobs
in the month of September. This news took equity markets up
and gold down. So is the economic recovery here to stay and
can investors start celebrating again?
A careful review of the numbers leads to the conclusion that
it might be a little early to break out the champagne or to
take a luxury cruise. During an economic recovery, the economy
expands and generates at least some price pressure. But last
week’s U.S. producer price report showed only a .3%
rise in prices (a 0.0% rise when energy and food were factored
out). This lack of pricing pressure is particularly surprising
when you consider that the Federal Reserve has adopted a policy
of monetary stimulus, congress is turning more protectionist,
the dollar is weak and there are negative real interest rates.
Figure 1: U.S. Unemployment Claims
It is difficult to believe that the world’s major economies
are indeed improving and hence that equity valuations can
be justified. Technology companies, for example, have had
an incredible run-up over the last six months, but can you
really justify buying Yahoo (YHOO) at eighty-eight times forward
earnings? There are many skeptics out there including Merrill
Lynch’s chief economist who, in response to the recent
economic data, noted that “he’d never seen such
a massive market reaction to…an employment number that
was not statistically (different) from zero”.
The rest of the world (export markets for U.S. manufacturers)
looks a little shaky as well. Japan, the second largest economy
in the world, continues to prop up near comatose companies
with loan guarantees and has been delaying the start of serious
structural reforms. If the structural reforms (most notably
of the banking sector) were to occur, then Japan could most
likely return to a path of reasonable economic growth, say
on the order of 3% per year, but that would likely take a
decade or more to occur.
The principal reason why equity markets appear to be soaring
is not the improving fundamentals but rather the lack of alternative
investments that have the short-term potential to generate
yield. The story in tech land seems to be one of survivorship
bias, with the few decent remaining technology companies being
the beneficiary of the available investment dollars.
If you remain skeptical on the “recovery” story,
the prudent thing to do is to consider cashing in some of
your chips if you’ve been at the table this year (particularly
if you are a tech enthusiast) or to put down only a small
portion of your savings if you are hankering to get in. With
the dollar’s slide nowhere nearly finished, monetary
tightening not yet on the horizon, and protectionist forces
rallying around the flag in Washington it might get worse
before it gets better.
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