National State Economic Outlooks OK

May 17, 2002
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GRAND RAPIDS — The U.S. economy is actually doing well, according to two analysts affiliated with Bank One. There’s no recession in sight. Really.

Anthony Chan, chief economist of Banc One Investment Advisors Corporation, and Peter Atwater, Banc One Investment Management Group’s CEO of Private Client Services, offered their views on emerging economic trends at a luncheon at the Amway Plaza Hotel recently.

Chan predicted economic growth, which was about 5 percent last year, will slow to about 2.5 percent this year because the equity market had a bad year in 2000 and consumers became more cautious.

“But keep in mind that slow economic growth is not negative economic growth,” Chan said. “You need two negative consecutive quarters of growth to get a recession.”

People will have to adjust to the slowdown but maybe not for long, Chan added, because the Fed has been aggressive in lowering interest rates. Slower economic growth will be reflected in lower demand for a lot of products in the local market.

In the office furniture industry, for example, a strong year is often followed by two slower years. The demand for office equipment was strong in 2000 so Chan anticipates demand in 2001 and 2002 will “show some pause.” His suspicion is that with lower interest rates, corporate profits will likely be healthier as the country approaches 2002, at which time demand will start to pick up.

Some 23.8 million jobs were created during the expansion of 1991 to 2000, more than were created during any other expansion in U.S. history, Chan said. In the last 10 years, Michigan created 700,000 jobs, of which 50,000 where in manufacturing. But the state can expect a slowdown in employment growth. Michigan’s unemployment rate is at 2.7 percent this month, the lowest it has been in a couple of decades. By the end of the year it could move closer to 3.8, but that’s still close to the national level.

The good news is Michigan is a lot more diversified than it was 10 years ago, so economic cycles ahead likely won’t have a severe impact, Chan said, adding that Michigan is now 95 percent diversified in comparison to other states in the nation.

The situation isn’t as bad as people think, he observed. Productivity — the most important indicator — is still very strong here. Consumer confidence continues to show weakness, but with lower interest rates it’s starting to turn a corner. Consumers “still have some more juice to go,” as Chan put it. One of the things encouraging them to spend money is real wages.

“My research shows that one of the first indicators that a recession is coming is when real average hourly earnings actually contract. Is that happening? No,” Chan emphasized. “The last third of the expansion is showing positive growth in earnings after adjustment for inflation. The bottom line is it’s still a positive third, suggesting no recession.”

From an investor’s perspective, 2000 was a terrible year across the board, with the Dow Jones Industrial Average dropping 6.2 percent, the first year in nine it has seen a decline and the worst year since 1981. The S&P 500 was down 10 percent, its worst year since 1977. The worst market of all was the Nasdaq, down almost 40 percent year-on-year.

The key question in 2001 is what’s going to happen to market price-earnings ratios. The S&P 500 price earnings ratio for the overall market exceeded 32. It’s down to 25, and the historical average is 18.

Last year was the first in 10 years that the bond market outperformed the stock market, with double digit returns in what is classically a 6 percent to 7 percent return sector of the market.

The year 2000 saw the beginning of improvement as the market moved out of large growth companies into smaller, mid-cap value companies. As Atwater explained, it was a classic rotation in market terms: When something gets too expensive, the market moves someplace else.

It was an orderly movement away from stocks that had reached absurd valuations in some cases into stocks that represented bargain basement prices, he said. The trend of small outperforming large, and value outperforming growth, is expected to continue in 2001.

Of the 17 market sectors Banc One Investment Management Group follows regularly, eight of them had positive returns last year. More impressive, Atwater said, were the returns on “some pretty dull parts of the market” — utilities, financial services, insurance and health care. Those sectors, ignored for nearly four years, came alive.

Last March, during the peak of the Internet boom, returns on Internet stocks were down 90 percent while utilities were up 63 percent — another example of the classic rotation to value, Atwater noted.

Normally, when the Fed lowers interest rates, utilities, health care and financial stocks continue to perform well. Yet when the Fed cut interest rates recently, those stocks began to fall. To Atwater that indicates investors expect that the economy is going to come back because the Fed cut rates, so they think it’s safe to get back into the technology market and the 200 percent returns enjoyed in past years. It’s a “technology addiction” thing.

Currently, there’s a pronounced tug of war going on between people who think the worst is past and it’s time to get back to the technology market, and people who believe there is further deterioration ahead, Atwater said.

“We expect this will be a pattern that plays out in significant volatility for some period of time this year until there is a clear signal of the direction of the U.S. economy,” Atwater noted. That volatility suggests the strategy of when to get in and when to get out of the market will be difficult to execute in 2001.

Interestingly, of the 317 IPOs (initial public offerings) that went on the market in 1999, only 33 are now trading above their IPO price. The best performing IPO for 2000, in fact, was Krispy Kreme Doughnut Corporation — up 295 percent — and about as far away from high tech as it gets.

The technology meltdown last year was “ugly, ugly and uglier,” Atwater said, using Net J as an example of the dot-com woes begun last year. Net J went public in December 1999, had a January 2000 return of 300 percent and was trading at 28 cents one year later.

Like 117 other dot-coms that failed last year, Net J simply didn’t have a viable business model going forward; its basic business proposition was flawed, he said. It was the epitome of people chasing potential returns in the Internet sector, and the epitome of a “concept stock” that attracted a lot of investment capital last year.

“Now we’re into carnage dot-com,” Atwater remarked, “and we expect we’ll continue to see one after another dot-com close their doors this year.”

Technology remains a key holding, but Atwater suggested this may be a good time to get back to some of the “old fashioned” technology companies, like IBM and Compaq Computer, that were never involved in excessive price earnings valuation and still represent a good value today.

If the economy worsens, the Bush administration could apply some of the $200 billion budget surplus it inherited toward fiscal stimulation to boost consumer confidence and spending, Atwater noted.

From an economic perspective, a wild card is the California energy crisis, which is probably not limited to California. Utah and Oregon also are experiencing shortages, which are spreading to other states. Energy shortages and escalating energy prices could become a significant drag on the economy.

Another potential problem is the level of debt in telecommunications companies. The telecoms are operating in deregulated environments now and have to make significant capital expenditures to compete. But in order to meet its debt service, this sector of the economy will not be able to make the capital investments it needs. Further impact is expected this year on companies like Cisco Systems, Nortel Networks and Lucent Technologies, Atwater said.

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