Here are three years of recent market history condensed into one sentence: The premillennium excess of 1999 begat a massive tech bubble that popped in 2000, which produced a slowdown of corporate profits in 2001 as the economy contracted and officially entered a recession. Got all that?
Now that we're all caught up, what will happen in 2002?
To answer that question,
talked with Christoph Bianchet, an economist with Credit Suisse Asset Management. A recent ¿migr¿ to New York from Zurich, where he was a portfolio manager, Bianchet brings a global perspective to the table, and he is fluent in German, English, French and Spanish (Today also happens to be his birthday.)
According to Bianchet, 2002 will be a decent year, one with growth due to the shrinking of inventories rather than an increase in demand. In other words, don't get too excited; the recovery will be slow and not entirely pain-free.
TSC: Let's start with a basic figure. How much do you think gross domestic product will grow in 2002?
I have currently penciled in 1.9% growth, which is somewhere in the middle of the pack. It's tough to keep track of consensus right now. I would think it's rather on the optimistic side.
TSC: What's your case for such optimism?
Bianchet: Let me first say one thing. In comparison to what we had been experiencing over the past five years until the end of 2000, 1.9% growth is very disappointing and well below the potential growth rate the Fed and most of the economists have in mind. We're talking about something that is not really exciting.
What brings me to this relatively bullish opinion -- at least in comparison to other economists' forecast -- is I think the biggest contribution will come from a simple inventory adjustment. It's a very cyclical thing that has to happen, because we were running down inventories to such an extent this year that a rebound just has to happen.
TSC: But if you look at telecommunications equipment, last year we were in a similar situation. People were talking about how their inventories would go down and how we'd have a second-half recovery this year. And yet that inventory problem didn't sort itself out.
Correct. In some areas, especially in some technology areas, there is still an excess in inventories. We are still talking about running down inventories further, I'd think, in the first quarter and maybe even in the second. But just from GDP accounting, you get a positive contribution.
I don't know how familiar you are with that calculation. When we're running down inventory this quarter at an annual rate which will probably exceed $100 billion, and in the subsequent quarter we get inventories being run down by, let's say, $50 billion. ... Even if inventories are continuing to run down, if it's at a slower pace than the current quarter, you're still going to see a positive contribution to GDP. It's the change of the change that goes into the calculation.
TSC: So that's supply. Do you see demand for a lot of things picking up in 2002?
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That is exactly where I'm very cautious. When you're talking about a growth in final domestic demand, which is consumer spending and investment, there I'm very conservative. I have figures penciled in between 0.5% and 1% growth in demand, which is not very exciting compared to the past, where we had consumers spending up to 3% more and even higher, with investment going up like a rocket.
I think that's exactly what's going to limit the whole growth story. Since we won't get final domestic demand really picking up, the rebound in inventories is going to be limited. We're talking about a situation where final domestic demand currently is still way above the current production. So once we have the level adjustment of current production to current demand, once this is over, there's not much follow-through. This is a very unpleasant situation, in general, for the economy.
I don't think the consumer is going to be driving the whole story, and I don't think investment spending is going to come back any time before the third or fourth quarter of next year.
TSC: Some say this recovery is going to be a lot like the one from the Gulf War, which was almost so slow that people thought we could still be in a recession. Will this recovery be like that, or is it fundamentally different because, unlike that time, we're entering a war, not coming out of one?
I would think in a way it's going to be comparable, because it will be very slow and very drawn out. But I don't think it has so much to do with the war, but rather with the unusual circumstances that this business cycle was created in.
To me it's a very unusual business cycle when you compare it to the previous cycles we've had since World War II
because it's been a real investment spending boom. It was a consumption boom, driven by expectations about future returns which were exaggerated, and now expectations have come down. The expected return on capital has come down, and so investment is going to suffer a lot.
It's a very unusual business cycle and it needs time to work off the excesses that accumulated over 1996 to 2000. In a way it's comparable to the recovery from the Gulf War, because it will be slow and drawn out. But it isn't really comparable in any other way. This is a very different situation.
TSC: Does the war factor in much to your predictions for 2002?
I think it's absolutely impossible to incorporate it. You don't know how you would quantify the one-in-a-thousand chance that something would go wrong. In a way, it's almost inevitable that something goes wrong in a campaign like this, but you can't predict what it will be, or when it will occur.
It's the most sensible thing to just assume that there's a certain level of uncertainty there which affects people's behavior. But the longer nothing happens, the more this level of uncertainty is going to fall. We're not actually factoring that into our forecasts. Most likely, we'll continue like we have since November. That's our basic assumption.
TSC: Right now, consumers haven't really been too affected by the rise in unemployment. Will higher unemployment affect the consumer's ability to spend?
: It has not yet had an effect because one thing has not happened yet. You haven't seen a substantial deceleration in wage- and salary-income growth. But this is going to happen. The longer we stay at this level of unemployment, or even if we go higher, employee-compensation growth is going to fall substantially. It's going to fall towards zero. Real disposable income for consumers is going to increase at a very anemic rate.
The problem is the U.S. economy's corporate profitability. Since 1997, corporate profits had been actually falling. When you look at profit share of GDP, that means margins have been falling. We need to see turnaround there. And the way to get a turnaround in profit share of GDP, is you need to cut employee compensation and employee-compensation growth. This is going to happen and it's going to affect the real disposable income growth of the consumer. This tells me you will see, maybe not an outright contraction in consumer spending, but certainly very slow growth.
TSC: And yet, you've got sort of a bullish outlook on things?
The whole scenario here is something I call a "muddling through" scenario. You can certainly paint much bleaker scenarios than I just did. You can say we're going into an outright deflationary environment where people hold back investment even further, where consumer spending falls off a cliff and that Fed policy is going to be ineffective.
I don't think we're going down that route. So the scenario I have is a muddling through scenario. The positive scenario would be that you say OK, the message we're currently getting from the labor market is that unemployment claims have come down since the peak. This information is real, and the labor markets are actually bottoming out. Next thing we'll see is an increase in jobs. That would be the positive case for the consumer. However, that would be the negative case for corporate earnings.
So what you could get in a positive sense, you'd see for a year or so that employment starts to increase again, that disposable income continues to rise at a substantial pace, and consumer spending keeps up, but at the same time, the underlying profitability of the company continues to deteriorate. And this is something that could go on for a year or so, with relatively healthy GDP growth, but then, ultimately, the clean-out process could be even harder than we expect.
But that would be something of a more positive spin for the short term.
TSC: Are we not out of the woods yet? Recessions are only supposed to last 11 months.
It's possible. If you look at the last 50 recessions in history only, which I don't think is the adequate thing to do here, the average recession has only lasted 11 months. If you go back into the previous century, in the 19th century, you find out that recessions lasted 21 months.
With this business cycle, as I described before, it's not out of the question that this could be more like the 19th century, which is much more drawn out than the postwar recessions we're used to. I think it's one thing to look at a very short history of 50 years and say it's going to be over. I'd say to look back a little longer and say there could be a risk that we're going through something very different than an ordinary postwar recession. Maybe it's a 19th-century recession.
TSC: Is history not a good barometer for this recession?
I'm of the camp that you need to look at the particular circumstances of any point in time. I don't think you should ignore history completely. You can always find similarities, and you always find analogies where you can say it looks a little like that or it looks a little like this. You shouldn't really draw hard conclusions from that.
But as I said earlier, you should go back in time and realize that there are recessions that lasted 21 months. That should make you a little more cautious in calling the end to the recession in two months, because there were times it was completely different. This is something you should take with you.