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FINANCIAL TIMES
June 5, 2001
GS Global Economics Paper No. 62
Contact Barry
Riley
Swings and Roundabouts
The global stock market has progressed in strong waves recently, with
the FTSE World Index in dollars falling 27 per cent between August and
March, then rebounding 15 per cent. In the extreme case of the US Nasdaq
Index the movements have been much greater - a decline of 61 per cent and
a recovery of 41 per cent over the same periods. But
during the past couple of weeks the markets have started to retreat again
slightly. The next stage will be critical.
A modest recovery in commodity prices has faltered too (though oil
still threatens the $30 a barrel level). Base metals, in particular, have
weakened. The common factor influencing equities and industrial
commodities is that hopes of a quick global recovery have faded, and the
markets have had to adjust to disappointing output statistics and further
corporate earnings downgrades.
Financial historians like Bob
Hoye, of the
Vancouver-based newsletter and website Institutional Advisors, point to
similarities with the closing stages of past great bubbles.
After a strong rally such markets have entered a second major decline -
as Wall Street did in the latter part of 1930.
The first wave of selling can be described as technical, being related
to the unwinding of speculation. This time the decline culminated in a
phase of extreme weakness in March. Waiting on the sidelines, however, has
been a massive volume of liquidity to fuel the rally, encouraged by rapid
interest rate cuts.
A second wave of selling, however, is based on fundamentals, as
investors struggle to adjust to weak earnings trends (aggravated by the
dilution of existing capital as balance sheets receive emergency repairs).
Alan Greenspan, curiously, is not helping much. Speaking in Singapore
on Monday he boasted that there was little danger of inflation in the US
economy. But that was due to "a very extraordinary lack of pricing
power" and pressure on profit margins: that does not sound very
encouraging for equities.
A debate is visible at Goldman Sachs, where two of the firm's top US
economists have just published a research paper* on the collapse of the
great capital investment boom. William Dudley and Jan Hatzius say there
has been too much optimism in the US corporate sector about the future
rate of return on capital, which in fact stagnated in the late 1990s and
is now declining significantly.
Valiantly, nonetheless, the
firm's global strategist Neil Williams is trying to defend the 14 per
cent consensus earnings growth rate for global equities pencilled in by
analysts for 2002, although he admits that there is a normal upwards bias:
the year-ahead forecasts during the 1990s were, on average, overestimates
by a margin of 8 percentage points. Goldman's own top down forecast for
earnings growth in 2002 is 10 per cent, starting from a weak base level:
the consensus expectation for 2001 is minus 1 per cent, although the
outturn could easily be worse because a terrible earnings reporting season
is in the offing.
Given very unfamiliar conditions the key question is whether we should
seek guidance from the last 25 years or the last century. Recoveries have
been reliable after the relatively mild recessions experienced during the
past few decades: Wall Street has always rallied strongly if interest
rates have been cut, as this year, as much as five times. But then, the US
bubble of the late 1990s may turn out to have been more akin to the 1980s
Japanese bubble than to the various smaller market cycles on Wall Street
during the past half-century.
Immense volumes of potential savings are driving the markets. Indeed,
governments are seeking to solve their long-term pensions problems by
encouraging investment in bonds and equities. But there could be a
shortage of profitable investment opportunities. It is quite possible that
21st century telecoms will turn out in the long run to be rather like 19th
century railroads, being extremely valuable for the economy but deeply
disappointing for investors.
History offers a sketchy guide rather than a precise blueprint. The
global equity market does not have to follow the pattern of the early
1930s on Wall Street, or even the 1990s in Tokyo. But it seems prudent
to expect that the turnaround will take a long time.
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