Over the past few months, general sentiment has shifted from recognition that the economy is finally...
Over the past few months, general sentiment has shifted from recognition that the economy is finally experiencing some welcomed slowing, to more serious worries that we may be in for a greater deceleration than the Federal Reserve has accounted for.
Talk of recession has surfaced with increasing frequency in discussions about the economic outlook. We view such levels of pessimism as an overreaction to the softening data.
GDP growth has slowed from 8.3% in the fourth quarter 1999 to just 1.1% in the fourth quarter 2000. Consensus GDP growth for 2001 is 2.1%, with a period of near-zero growth in the first half to be followed by accelerating growth in the second. The economy's slowdown has followed the plans of the Federal Reserve, although anxieties about overshooting into recession have recently been considerable.
It has been noted, however, that there is a tight correlation between movements in the Nasdaq and consumer confidence measures two months later. The continued recent fall in the Nasdaq may therefore lead to further declines in consumer confidence measures and spending could drop off dramatically in the near future.
On the other hand, mortgage applications for refinancing have recently spiked upwards. This is one positive economic development, insofar as families tend to spend savings gained from their monthly mortgage payments.
Inflation is no longer public enemy number one. The employment cost index, a Greenspan favourite, was up 0.8% in fourth quarter 2000, down from 0.9% in the third quarter of 2000. Leading indicators for inflation are pointing downward. Commodity prices have softened across the board, timber prices have fallen, and gold has been stagnant. Productivity growth, the crucial driver behind strong, non-inflationary economic growth, grew at 2.4% annualised in fourth quarter, down from the gains of the two previous quarters but still high by historic comparison.
Recent indications of actual and planned technology spending lead us to think productivity gains will remain robust. One risk is the possibility that the widely reported inventory overhang may take longer to work through than originally expected, so manufacturers may be forced to continue to cut back on output.
The two valuation props for stocks (earnings growth expectations and P/E ratios) continue to provide support.
Worries about the economy have had a catastrophic effect on equity markets, and growth stocks have understandably suffered most. On the anniversary of the Nasdaq's all time high, the world's leading technology index had lost 62% of its value.
Even if investor confidence improves in the coming months, spurred by looser monetary policy, it is unlikely that equity markets will rescale previous heights for some time.
Trent May is a fund manager at Invesco Funds Group
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