At this time last year, markets around the globe were focused on growth investments, growth fueled by feverish increases in the price of technology stocks and expectations of sustained economic expansion.
Now, enthusiasm for growth investing has been replaced by fears about fizzling technology stocks, declining consumer confidence and a hard economic landing.
The concern is whether the economic slowdown foreseen for the United States could lead to a global recession.
Canada, which is dependant on exports to the U.S. for its economic performance, will inevitably be affected by an American slowdown, albeit in the form of a delayed reaction.
Read Also
Agriculture needs to prepare for government spending cuts
As government makes necessary cuts to spending, what can be reduced or restructured in the budgets for agriculture?
But rather than a global recession,
I think we are looking at a slowdown in earnings growth. The severity of this slowdown isn’t as bad as the
pessimists think, for the following reasons.
First, aggressive interest rate cuts in January and March by the Bank of Canada and the U.S. Federal Reserve should stimulate economic growth. History has proven that markets do respond to rate cuts.
For example, in the last 80 years, the Federal Reserve initiated an interest rate easing strategy 22 times.
Between the first and second rate cuts, the Dow Jones Industrial Average had an average rise of just 1.5 percent. However, after the second cut, the Dow Jones averaged 13.6 percent for the next six months and 26.3 percent one year later.
The only periods of decline for the Dow Jones following rate cuts occurred in 1929 and 1981. In both cases the economy was in severe decline with no indication of short-term recovery.
More rate cuts are likely this year if inflation proves tame.
Second, inflation is largely a non-issue since energy prices have begun to drop.
The Federal Reserve and economists expect the U.S. will have less than one percent gross domestic growth for the first three months of this year, the slowest in 51/2 years, but they indicate that the second half of the year should see a strong recovery.
In Canada, Statistics Canada reported GDP growth of 0.3 percent in January, contributing to first-quarter forecasts of one percent growth, much better than previous forecasts.
Third, economic indicators reveal that despite sinking corporate profits, demand and production are sound and employment numbers have remained surprisingly strong.
The latest consumer confidence poll in the U.S. by the Conference Board, a non-profit research organization for senior executives, surprised economists. It gave some support to the equity markets, raising hopes that the American economy will not enter into a recession after all.
The Conference Board said its index jumped to 117 in March from 109.2 in February, the first gain since September. Expectations over the next six months rose to 83.6 from what economists considered a bearish 70.7 in February.
Alan Greenspan, Federal Reserve chair, has said that consumer spending in the U.S. is vital to ward off recession. February data indicated consumer spending grew a healthy 0.4 percent, in line with previous months. Consumer spending represents about two-thirds of the overall U.S. economy.
Is this a bottoming out of consumer confidence? To date, the biggest drag on the economy has been the stock market.
Fourth, the direction and steepness of the yield curve, which relates yields of bonds of the same quality but different maturities in a graphic form, is considered to be a reliable indicator of economic recovery.
Recently, the bond market sold off aggressively, creating a steep upward yield curve. That tells us
investors are beginning to price in some sort of
element of economic recovery.
Finally, the weak earnings growth is forecast into mid-2001 and has already been reflected in stock prices. Further earnings releases shouldn’t surprise investors.
Historically, better stock returns have been achieved when expectations for the future became the most pessimistic.
That pessimism is reflected in today’s declining valuations.
So far in 2001 we have seen strong recovery in earnings in sectors such as energy, pipelines and financials.
A transition in equity performance in the first half of 2001 should take place from defensive areas toward expansion as we enter a new earnings growth cycle in late 2001-2002.
Interest should shift to consumer cyclicals and capital goods before moving into growth sectors such as technology, specifically software, semiconductors and communications and media.
Given the state of the market and uncertain times ahead, my suggestion is to keep your head down and take a longer term view.
If you have money to invest, this may be an opportunity to buy stocks at a cheap price.
If you give in to the panic and fear, when you look back at this short-term market downdraft you’ll see that you hurt yourself.
No one really knows when the bottom has been reached, but we’ll be sure to read all about it six months after it happens.
Ian Morrison is a financial consultant with Wood Gundy Private Client Investments in Calgary and is licensed to sell insurance products. His views do not necessarily reflect those of CIBC World Markets Inc. This article is for information only. Morrison can be reached at 800-332-1407 or by e-mail at morrisoi@cibc.ca.
