Economic Strategist Foresees 2Q Recovery

May 17, 2002
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GRAND RAPIDS — The events of Sept. 11 further contributed to an already struggling economy, but one of the longest lasting economic consequences of those events will be their negative effect on productivity.

That was what Richard Nash, chief market strategist and managing director of Victory Capital Management, predicted in an address to a group of investors gathered at the Amway Grand Plaza recently.

Post Sept. 11, dollars now have to be spent on insurance, airport security, mail inspection, border patrol and international cargo inspection.

Companies that relied on just-in-time inventory practices may now have to adopt a just-in-case philosophy and keep more inventory on hand just in case the supply chain gets disrupted again.

“All this time and all these expenses add little to major output, so look for lower productivity numbers over the next couple of years,” Nash said.

Even before Sept 11, the economic outlook for 2002 wasn’t exactly robust because consumers spent money throughout the entire slowdown. Nash had forecast that the economy would “barely keep its head above water” in avoiding two consecutive negative quarters of Gross Domestic Product (GDP).

Usually during an economic slowdown consumers curtail expenditures and that creates some pent-up demand for goods and services that’s unleashed when the economy begins to recover.

But since consumers didn’t change their spending behavior in the months before Sept. 11, the forecast is for a brief, shallow recession.

GDP in the third quarter was down 1.1 percent, and Nash expects it will be down roughly 1.5 percent in the fourth quarter and will remain sluggish in the first quarter of 2002. His expectation for all of next year is GDP growth of roughly 1.75 percent.

“We think once we get to the fourth quarter of 2002 we’re going to have economic growth approximating 4 percent once again because there’s lots of stimulus in the system,” Nash said.

The Fed lowered the interest rate 10 times this year by a total 450 basis points. The hope is for at least one more 25-basis point cut either this month or in January, Nash said. In addition to the interest rate cuts, the Fed is supplying much needed liquidity for financial markets.

Though it might take some political arm-wrestling between now and Christmas, he thinks the roughly $90 billion stimulus package is likely to be enacted by the end of this year. Other means of stimulus include:

  • Declines in energy prices have served as de facto tax cuts for both consumers and corporations.

  • Oil prices have come down by almost $14 a barrel since Sept. 11, which, based on daily U.S. consumption, equates to roughly $100 billion annualized extra purchasing power.

  • Lower mortgage rates have resulted in record demand for refinancing, which should provide consumers with dollars to spend.

  • Inventories had already been slashed prior to Sept. 11. In previous economic slowdowns, about two-thirds of the decline in GDP has been due to inventory liquidations.

“This good inventory position, combined with the stimulus in the system, argues for a much briefer and shallower recession than we’ve seen in other economic slowdowns,” Nash said.

He anticipates recovery in 2002’s second quarter.

The inflation outlook is favorable and will remain positive in 2002 because, historically, inflation slows dramatically after a recession, he said.

One of the worries in 2002 will be unemployment, which Nash estimates will rise from 4.5 percent currently to 6.5 percent by mid 2002.

In the service sector of the economy, the health care and defense industries will show some pricing power. Insurance premiums, Nash predicted, are going to rise quite substantially, particularly for commercial properties.

Victory Capital Management expects the Fed to leave the interest rate unchanged for at least the first two quarters of next year and begin raising rates in the third quarter. Nash estimates about this time next year the federal funds rate will be about 3.25 percent.

The corporate earnings outlook is “tough” for 2002. Earnings have been dismal this year and are not going to get any better in the fourth quarter.

Historically, the fourth quarter of any year usually reflects the lowest quality earnings as companies take year-end write-offs, he said. That will be particularly true this year following the events of Sept. 11.    

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