 oesn’t
it seem like only yesterday that the New Economy was in full bloom,
that real growth in the U.S. could be sustained at a 4-5% level, and
that the notion of a business cycle was essentially dead? After five
years of an incredible bull market, the professionals were forecasting
that the Dow Jones Industrial Average would broach 36,000 with more
than one forecast saying that, in twenty-five years, the Dow could
eclipse 100,000. That investor psychology drove the Dow well above
11,700 and the NASDAQ above 5,000 in early 2000.
So, what went
wrong since then? The abrupt decline in the stock market that precipitated
the current economic weakness was inevitable, and there have been
several factors that surprised a lot of Wall Street bulls since
January 2000.
The fears
of Y2K vaporized by January 2, 2000, but few analysts made note
of the fact that there had been an excess accumulation of computer
hardware and software to insure that Y2K would not cause a meltdown
of the financial system. Was it any wonder then that the up-trend
in spending on computers and related equipment could not be sustained?
No. The phenomenal rise in office and computer spending that buoyed
the economy from 1994 through early 2000 had to come to an
end.
A related
factor was the dot-com “bubble,” which could be equated to a gold
rush — too many speculators and not enough gold. Industry planners
included the dot-com industry in their glowing long-term forecasts
for sales and profits. When it became evident that the market for
dot-com services couldn’t produce sustainable profits, the collapse
affected a broad spectrum of technology-related companies. Also,
the continued fall in semiconductor and computer prices in an extremely
competitive environment and the oversupply of telecommunications
equipment aggravated a downturn in this sector.
Other factors
that set the stage for economic decline were government policy related.
The first was the volatile changes in monetary policy prior to and
after Y2K. Tricked by the final blow-off in the tech sector, the
Fed continually tightened monetary policy in 2000 to slow the economy
— an economy that was already about to suffer a technology-spending
hangover. This tight monetary policy accelerated a deteriorating
economy — but the Fed remained a worshipper of technology at
the altar of corporate productivity. The Fed just didn’t anticipate
the collapse of the technology sector.
Another culprit
in the economic downturn was the innocent-enough looking budget
surplus. Nearly all politicians became enamored with the enormous
budget surplus — a surplus that was going to cure all of our fiscal
problems. Plans were formulated to pay off the national debt, to
cut taxes, and to preserve Social Security. The only problem: budget
surpluses are contractionary, especially when the government effectively
raises taxes to pay off the debt. The Clinton tax increase of 1993
did exactly that.
The interaction
of these factors virtually guaranteed a long and painful recession
beginning in 2001 and lasting, well, until something changes.
The bullishness
of early 2000, a time when investors poured enormous amounts of
money into technology growth funds right at the top of a bull market,
characterized the greed factor that emerged when the majority of
investors thought that the market had only one way to go —
up. The bearishness of late 2001, characterized by substantial withdrawals
of money from equity mutual funds both before and after the declared
war on terrorism, reflected the fear factor. Market prognosticators
feared a Dow of 6,000 or below while the old bulls revised down
their forecasts for market expectations for the next 12 to 18 months.
Just as greed
characterized the market top in early 2000, fear characterized a
market bottom in late 2001. Is there reason to believe that there
is an economic boom around the corner? If ever there were the ingredients
for an economic turnaround, they are certainly in place.
Monetary policy
has been extremely accommodative. Once the Fed realized the tight
money mistake of 2000, it lowered interest rates rapidly —
and substantially all during 2001. Easy money and lower interest
rates were the necessary ingredients to get things rolling. Short-term
interest rates, as measured by the Fed funds rate, are at their
lowest level since May of 1962 and long-term interest rates, as
measured by the thirty-year treasury bond, are near record lows
as well.
Fiscal policy
remained contractionary until September 11, offsetting the effects
of monetary stimulus. The terrorist attack and the subsequent dramatic
effect on the economy — primarily impacting the traveling public
— triggered a dramatic turnaround in fiscal policy. No longer
were politicians talking about saving Social Security or maintaining
a budget surplus. Discussions shifted to another round of tax cuts
and spending increases — a combination that might undoubtedly
turn the surplus into a stimulative deficit. The experience of the
enormous budget deficits during the 1980s, a time when the economy
was a lot smaller, indicated that we have the capacity to dramatically
increase both tax cuts and spending to make sure the recovery is
sustainable.
The technology
hangover would appear to be almost over. There is a normal demand
curve for technology and related equipment, a curve that was temporarily
depressed in the aftermath of Y2K and the Internet bubble. Spending
on technology should get a big boost from government spending to
prosecute the war on terrorism and bio-terrorism.
Are stock-market
booms and busts easily anticipated? Not really. In 1994, market
forecasters saw little potential for a stock-market advance based
on their valuation models. In November of 1994, the market began
a bull run of historic proportions anticipating the continuation
of a strong U.S. economy. In early 2000, the successful market forecasters
looked for continued economic growth and further major gains in
the bull market. Instead, we experienced the greatest bear market
of our lifetimes and the beginning of a serious economic downturn.
Ugh!
If history
is a good guide — and we can see through the short-term tech-industry
problems and envision the real impact of government fiscal policies
(both spending and tax reduction) — we will be well on the
way to a surprising economic boom and a bull market in stocks. It
could be just around the corner.
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