The severe correction in growth stocks that began in March of last year gathered pace as the year ...
The severe correction in growth stocks that began in March of last year gathered pace as the year progressed and has continued into 2001. Throughout this period, strategists have pointed to a variety of causes of this bear market, including the threat of inflation, the risk of rising interest rates, and the political farce that emerged following the Presidential elections. However, as last year drew to a close, the underlying reason for the slump emerged Ã the rate of economic growth has slowed dramatically.
Having struggled to slow the economy through a prolonged series of interest rate hikes throughout the first half of last year, the Federal Reserve's medicine finally impacted economic growth in the US. As the final quarter of 2000 unfolded, the pace of economic expansion slowed severely and suddenly.
The nature of this downturn has been unusual. It has largely been confined to just a few areas, most obviously autos, semiconductors and telecom equipment. What has taken everyone by surprise has been the speed of the deceleration. This is possibly the result of improved information levels among companies on issues such as demand and inventory levels as a result of technology spending in recent years.
Companies have reacted to excess inventory more rapidly and more aggressively than ever before. Job cut announcements have already become a feature of news headlines while many corporations have put in place capital spending lockdowns.
The question now facing investors in the equity market is whether the US can avoid a full-blown recession. With consumer spending accounting for approximately two-thirds of GDP, the key determinant of this will be how the consumer fares in the coming months. The risk is that the increasing frequency of redundancy announcements, combined with turmoil in the equity markets, will impact on confidence, causing an abrupt halt in consumer spending.
The key strategy of the Federal Reserve has been to cut interest rates. January witnessed a 100 basis point reduction in the key Federal Reserve Funds rate Ã the sharpest one-month reduction since the depths of the 1982 recession.
Although we are not out of the woods yet, the early indications seem to be that the Federal Reserve's medicine is working. Sales of important, large ticket, interest rate sensitive products, such as housing and autos, have held up remarkably well. The reality for the consumer is that few of them are actually losing their jobs and those that do are having little difficulty in finding new ones. The unemployment rate in February remained at a historically low level of 4.2% while average hourly earnings continue to increase at a healthy rate.
Looking forward, the consumer is also likely to benefit from still lower mortgage rates and there is the strong prospect of some fairly substantial tax cuts later in the year.
Stephen Kelly is manager of the Framlington American Growth Fund
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