Will 2001 Be Haunted by the Specter of the Four E's?

If you want to know exactly what's been bedeviling the U.S. economy of late and what might rankle it further next year, just think of the letter E.

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That's because the so-called "Four E's" -- a group of financial furies made up of energy, the euro, earnings and, of course, the presidential election -- have now been identified as the main spoilers rocking the economic boat in recent months. They have already wrought much mischief, but a few E's might have more wickedness in store for investors in the coming year.

Looking back, these four goblins have been busy brewing up trouble. The apparently never-ending election kept things stormy on Wall Street for weeks, and companies reporting poor third-quarter earnings and issuing fourth-quarter earnings warnings have deflated stock prices and reduced investor optimism. Turmoil in the Middle East and rising oil costs have pushed up the cost of energy for consumers and businesses, and the euro has fallen sharply, making U.S. exports more expensive and contributing to the growing trade deficit.

Looking forward to next year, investors may see a more settled state of affairs, says Robert Klemkosky, a professor of finance at Indiana University's Kelley School of Business. Oil prices will likely stabilize after the winter as the demand for energy abates, taking pressure off businesses and consumers. There will be a slower rate of earnings growth, but it will be trending up nonetheless. The dollar is likely to depreciate against the euro and there will be slower U.S. growth, and that's news for the U.S. trade deficit, says Maury Harris, U.S. chief economist at UBS Warburg. And just in case you're not already sick of hearing about it, there might even be some residue from the U.S. presidential election, he adds.

Here's an overview of how the "Four E's" might mess with your investments next year:

Energy

In September, turmoil in the Middle East and rising oil prices were giving U.S. consumers, U.S. businesses and the U.S. markets the collective willies. As rising regional violence jeopardized the region's oil production, and companies and consumers worried about heating their homes and running their businesses, crude oil hit a 10-year high of $38 a barrel, prompting the Clinton administration to tap the nation's emergency oil reserve.

Today, the energy situation looks no better. At its most recent meeting, the Federal Reserve, while refraining from changing interest rates, flagged the potential inflationary effects of higher oil prices. And in a recent meeting of the U.S. Senate Committee on Energy and Natural Resources energy experts acknowledged that the country is in an energy crisis. They said that consumers and businesses shouldn't expect any relief on energy bills this winter, due to short supplies of natural gas, cold winter weather and increased energy demands from a soaring economy. What's more, amid a bungled effort to deregulate the state's power market, California is struggling to power homes in a winter power shortage.

A cold winter will have an adverse effect on energy costs says James L. Williams, an economist at WTRG Economics, an oil and gas forecasting company in London, Ark. "I expect a lot of volatility in the cost of heating oil and natural gas, and that is all weather-related," he says, adding that heating oil prices could skyrocket with the next cold snap. This will dig into consumers' disposable income, and businesses will be affected by the higher cost of manufacturing.

But the misery should break by next spring. High oil prices in September sparked increased production outside OPEC, including nations such as the U.S. and Russia, and this coupled with two OPEC production hikes has rebuilt stocks a little he says. Thorsten Fischer, an economist at West Chester, Pa.-based Economy.com thinks crude oil prices will ease to around $22 or $25 a barrel after the winter heating season, which usually ends after February, and so will the cost of products like motor gas and jet fuel. Also helping the situation: a worldwide economic slowdown decreasing the demand for oil and its byproducts.

Earnings

It was an unrelenting problem in the third quarter. PC makers like Apple(AAPL Quote), chipmaker Intel(INTC Quote) and others announced disappointing earnings results.

Will that bloodletting continue in 2001? Already, a handful of fourth-quarter earnings warnings have come from Compaq(CPQ Quote), Microsoft(MSFT Quote) and Advanced Micro Devices(AMD Quote). Other tech companies might follow suit and preannounce poor results for the fourth quarter, says Joe Beaulieu, a technology analyst Morningstar. These companies include IBM(IBM Quote), he says.

Still, so far poor earnings news hasn't beaten down these companies' already damaged stock prices, and this could signify investors' belief that the technology sector carnage has bottomed out, says Beaulieu.

Diminished spending on IT could also be a factor, Beaulieu adds. "The latest tech boom been fueled by companies building out their IT infrastructure to take advantage of e-commerce, and that might slow down now," he says. "The big issue for the tech sector is if we don't get the soft landing we are all hoping for we could see a decline in corporate IT spending, which would result in another round of earnings disappointments and lowered expectations for 2001."

Diminished expectations for tech companies might make it easier for them to make their numbers says Philip C. Johnson, a financial planner in Clifton Park, N.Y. "I expect that, given that earnings expectations will be tempered after the warnings we have seen, there will be a lower bar for companies next year," he says. "The hope is that all the bad news has already hit the markets and good earnings will be easier to attain."

The Election

Uncertainty about the outcome of the presidential election made for a tumultuous time on Wall Street this year. But following the U.S. Supreme Court decision and Vice President Al Gore's concession, George W. Bush is set to become the 43rd U.S. president. Will that help end all those financial woes?

Even though the uncertainty is over, we may not be out of the woods. Bush will preside over an almost evenly split Congress, and it will be hard to push through economic changes he announced during the presidential campaign, such as his proposed $1.3 trillion tax cut. However, the market typically likes a gridlocked Washington, so it doesn't get in the way of making money on Wall Street.

"The Republicans will need Democratic votes to push through a major tax cut," says Dennis J. Goldford, chair of the politics department at Drake University in Des Moines, Iowa. The Democrats will likely block any legislation that does not benefit them, he says, adding that the inability of the president to control the new Congress will also hinder him from producing major policy changes that will quickly erode the budget surplus. Further, the fact that Dennis Hastert, the GOP speaker of the House, has said he disagrees with Bush's big tax plan will make it very tough for Dubya to make headway on the Hill.

If Bush does manage to push through a tax cut and the economy is running at full steam, the extra cash in the system could cause more inflationary pressure, Goldford reasons. "If the economy is cooling, do you want to heat it up again?" he asks "And would the Fed then tighten interest rates to avoid inflation pressures?"

The Euro

The euro has found its feet against the dollar, reaching its highest level of 4 cents above its all-time low of 82.3 cents, but a strong euro might not necessarily be good news all around.

"The euro should rally in 2001," says Robert Klemkosky. "The dollar will depreciate against the euro, and there will be slower U.S. growth." That's good news for the U.S. trade deficit because it will dampen U.S. imports, he says, adding that without the trade deficit as a burden the U.S. economy might have grown 1% or 1.5% more in 2000.

However, while a euro recovery might be good news in some ways for the U.S. economy and help U.S. multinationals with a strong presence in Europe like McDonald's(MCD Quote), the already slowing U.S. economy might be hurt further as overseas investors might see Europe as a more attractive place to invest and pull back their U.S. investments.

"My guess is Europe is going to be looked at closely for its investment potential," says Philip C. Johnson. "I think that will make Europe a good place to invest, and if the euro increases and energy costs come down then that could be a double positive for Europe because high energy costs and a weak euro was a double negative for the region in 2000."