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This recession was initially referred to as a capital spending recession. Capital spending in computer software and hardware and in telecommunications equipment has declined dramatically. Business has little reason to invest in computer upgrades, and the excess capacity in the telecommunications industry will take several quarters, if not years to require additional capacity. Major increases in capital spending are unlikely to occur this year.
Now the talk is of the reduction in inventories. As the inventory pipeline has been drawn down we are told we can expect manufacturing to increase. What happened to just-in-time inventory management, which was supposed to make inventory recessions a thing of the past? Could this also be a carryover of the Y2K fears where companies overstocked in fear there would be a disruption in supplies? This suggests that inventories are now at a sustainable level and are unlikely to increased significantly in the future.
While there are efforts to back off the negative news from Chairman Alan Greenspan’s testimony before Congress and comments from other Federal Reserve Bank officials have raised concern about the timing of a turnaround in the economy. If the Federal Reserve lowers interest rate at their next meeting, that would send a bad signal about the economy and would no doubt be reflected in stock prices.
From the data available, I expect the economy will slowly bottom over the next several months, with the recovery beginning late this year. The recovery will depend more on what happens to oil prices than any additional interest rate cuts or stimulus packages. If oil stays below $20 a barrel, the economy will slowly rebound. If the price of oil increases to above $25 as OPEC tries to control the price, the recovery would be delayed.
The World Economy
The recession has not been limited to the US, but so far troubles in other parts of the world have not spread to the US economy. At the same time the weak world economy offers little encouragement for a quick turnaround. The Argentina financial crisis, perhaps the greatest outside threat at the moment, so far has had little impact on the US economy. If the crisis should spread, then the US as well as other economies could be in trouble. Some US banks will report loan losses, and companies with operations in Argentina will report lower profits as a result of the exchange rate adjustment, but so far these do not appear to be a significant threat to either the US or the World economy.
The problem in Argentina began several years ago when the Argentina government fixed the peso/US dollar exchange rate (versus letting the exchange rate adjust to economic changes, particularly inflation) and accepted the US dollar as legal currency in Argentina to try to fight inflation. It was initially heralded as a wise economic move, and other developing countries were expected to soon follow. Unfortunately for Argentina, the dollar began to strengthen against other currencies around the world. This made Argentina’s exports more expensive than their competitors’. As a result, exports plummeted and unemployment rapidly increased. The government borrowed money on international markets and from international agencies to cover the deficit in hopes the exchange rate problems would improve. With the dollar’s continued strength, it was only a matter of time before the government defaulted on its loans and devalued the peso.
When a major developing country defaults on their international loans, as Argentina has, both foreign investment and foreign loans are likely to be curtailed for other developing countries. If this curtailment in investment becomes severe, other countries will find their economies in trouble. This would result in an international financial crisis and could result in a worldwide recession given the current weakness in the world economy. So far there is little evidence Argentina’s problems have spread, as international agencies appear to be working with Argentina to solve the problem.
Stocks in the News
The stock market will continue to struggle to advance during this year, as reported earnings for many companies will disappoint the investor. For those with a long-term approach to investing this should offer investment opportunities.
It was no surprise that the court failed to approve the Microsoft class action settlement. It appears as nothing more than a settlement that pays the lawyers and was a good long-term investment in marketing for Microsoft. The plaintiffs lawyers are no doubt anxious to settle, as there is a good chance that Microsoft would win if the case were to go to trial. The antitrust case is another story. I would expect that Microsoft will face additional penalties, but they should have little impact on their long-term prospects.
As new disclosures about Enron’s actions one can only wonder if the Enron-supported appointments to the Federal Energy Regulatory Agency influenced action of the agency in responding to the California energy crisis. The Enron story is not over.
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