Experts agree it’s not over, but when it will end is debatable
“Fasten your seatbelts, it’s going to be a bumpy night.” – Bette Davis, “All About Eve”
The shaky world that is the US economy has come to this: An advertisement on the New York Times daily e-mail asks readers to guess the Aug. 3 closing of the Dow in which the winner gets the point value in cash.
Gallows humor? Maybe.
Who’s to say if the same contest wouldn’t be held if the market were rocketing skyward as it did in the halcyon days of the late 1990s. But the market has been on shaky ground since last summer and continues to rise and fall with sobering earnings reports by companies listed in NASDAQ and the New York Stock Exchange.
One of the problems that contributed to the current downturn in the markets, according to Paul Muzzey, president of Milwaukee-based Capital Investment Services of America, is that people were too optimistic over the past decade, driving stock prices up even though sales and corporate earnings didn’t rise proportionately, too. Over the past 40 years, sales have driven earnings and stock prices reflected what happened to earnings over time.
In fact, Muzzey titled an economic forecast he presented to more than 100 people “The problem with capitalism is capitalists.” He explained that capitalism’s biggest flaw is that it relies on people — who tend to get carried away when things are going good or bad.
“Optimistic people tend to engage in optimistic behavior,” Muzzey said. That leads to risky behavior — especially in financial matters — including increasing debt, making optimistic financial projections and assuming the good times will continue. He calls the current economy “a capitalist hangover” where there is an over capacity of goods and services and stretched debt burdens.
And he warns that just like the last capitalist hangover — which coincidentally occurred when the current president’s father, George H. W. Bush, was elected and served — took several years to work through.
The similarities start with multiple rate cuts by the Federal Reserve, which local economists say will spur economic growth.
Bruce Bender, a professor in business administration at the University of Wisconsin-Milwaukee, says the double effect of lowering short-term interest rates and cutting taxes will help the economy.
“Lowering tax rates is a good thing,” Bender says. “When you lower rates you encourage more people to work more, invest more, perhaps take more risk.”
The tax rebate is misleading as an economic catalyst, to some extent, in that you have to ask what would the government be doing if it weren’t rebating the $300 to $600 checks to taxpayers, Bender says. The government would be paying down debt, which would in turn wind up in the hands of bond holders, or it would be spending the “rebate funds” on government programs so businesses of some sort would be getting the money.
“The money is being spent, it’s just being spent by different people,” Bender said of the soon-to-arrive rebate checks.
Besides, says Jim McGibany, an economics professor at Marquette University, consumer spending, which makes up about two-thirds of Gross Domestic Product (GDP), has remained relatively stable thus far. What needs to pick up is the more volatile business spending, which tends to surge while the economy is good and ebbs when the economy goes soft.
McGibany believes the rate cuts by the Fed will, indeed, spur the economy, but rate cuts have a lag effect.
“If past experience is any guide, it should happen sometime late this year or early next year — plus or minus 12 months of when they started cutting rates,” McGibany said.
One key indicator for McGibany is the growth in lending at commercial banks, indicating an increase in business investment.
“The other thing to look at — on a month-to-month basis — is what’s happening to personal income and spending,” McGibany says. “As long as that’s in the ballpark of where it’s been the last year — again, it hasn’t been great, but it hasn’t really dropped off either — remains relatively constant, or on a little bit of an uptick, the economy will continue at least as good as it’s been, if not a little bit better.”
Muzzey disagrees with the economists who think the Fed’s cuts are the key to recovery, saying that the Fed doesn’t have the ability to alter the economy as it once did because there are other monetary avenues available, such as Fannie Mae and Freddie Mac.
“In past periods, the Fed literally could squeeze the economy’s throat until it fainted,” Muzzey said. “Then it could release its grip, allowing the economy’s ‘blood’ to circulate, and activity would recover.”
That’s not to say the Fed doesn’t have influence. Most economists and Muzzey agree that the Fed is partially responsible for the slowdown when it continued to raise rates.
The recession of 1988-1992 had many rallies and it seemed the economy had turned corner after corner only to be set back again. Muzzey believes the same to be true for this recession. Aggravating the situation is the last decade’s pattern of pushing stock prices way above corporate earnings and sales.
“We expect once the economy gets out of this hangover that we’ll be going slow because the sales growth is going to be slow,” Muzzey said.
Muzzey’s recommendation? Buy stocks that have solid earnings based on growing sales.
And hang on. We’re in for a bumpy ride.
July 20, 2001 Small Business Times, Milwaukee
