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March
11, 2003, 8:00 a.m.
March-ing
Forward
Iraq’s
disarmament will substantially boost the stock market.
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financial markets will re-price favorably upon Iraq’s disarmament, which
should happen within weeks. Yes, there was a February slump in the U.S.
economy, but expansion is set to resume in the near term.
The
U.S. lost 308,000 jobs in February. This lowers employment to 130.5 million,
down from a peak of 132.5 million in February and March of 2001, but still
up 20.7 million from ten years ago. Futures contracts on the federal funds
rate are predicting an 0.25% interest-rate cut to 1% by summer, implying
a continued slump. But there should not be any more rate cuts after that.
The current environment — 2.9% GDP growth in 2002, 2.6% inflation,
5.8% unemployment, low inventories, and a weaker dollar — would normally
invite much higher interest rates.
Meanwhile, S&P equity
futures are exhibiting “backwardation” — meaning lower prices in
the future than at present. This puts sentiment, as measured by backwardation,
at its most pessimistic since September 1982 (which was a major market
bottom).
But there is significant
good news out there today:
—
U.S. financial markets and the dollar rallied on March 7 in the
face of the disappointing jobs number.
— Despite
dollar weakness, bond yields have remained low, and show no sign
of inflation risk or aversion to U.S. assets.
— The
unemployment rate is still only 5.8%, well below previous business
cycles.
— Wages
are growing relatively fast, reflecting a productive, flexible labor
force. Over the last twelve months, nominal wages rose 3.2%, an indication
of labor-market tightness more consistent with the 5.8% unemployment
rate than with the recent weakness in job growth. Labor-market weakness
after the 1990-1991 recession was worse, causing wage growth to fall
to 2.2%, with 7.6% unemployment. In inflation-adjusted terms, the wage
gap in favor of the current cycle would be even wider since core inflation
is much lower.
— Corporate
earnings are growing again and have gained substantial ground relative
to market capitalization. On a year-over-year basis, after-tax corporate
profits grew 13% in the third quarter of 2002, 12% in the second quarter
of 2002, and 22% in the first quarter of 2002.
— Comparing
price-to-earnings ratios today, equity valuation (having bubbled
in the late 1990s) has fallen back toward bond valuation. The
equity P/E ratio is now similar to where it was in the mid-1990s and
well below the peak in the third quarter of 2000.
Here's the bottom
line: The economic and market pessimism of recent months is directly related
to Iraq uncertainty. There will be a substantial re-pricing of
financial markets upon Iraqi disarmament. Investors, be ready.
—
Mr. Malpass is the Chief Global Economist for Bear Stearns.
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