Economic Perspective
Editor’s note: Mutual of America Capital Management
Corporation presents the following review of economic trends prevailing in the
first quarter of 2001. Comments reflect conditions as of March 15, 2001.
The Economy
Our country’s once
flourishing economic euphoria has hit a rocky stretch as consumer confidence
sputters, capital spending declines, and corporate profit growth turns negative
in many sectors, causing stock market investors to sell off. Consumer spending,
which accounts for two-thirds of U.S. economic growth, remains the economy’s
key linchpin. Measurements of consumer confidence and durable goods orders are
in free fall, dropping to levels associated with past recessions. Corporate
profit warnings are on a pace to exceed those of last year’s fourth quarter.
The resulting uncertainty has caused companies to cut or postpone capital
spending, further tightening the vise. Consensus is that the economy will be
slow throughout the first half of 2001, before recovering in the second half,
but this may prove overly optimistic as corporate layoffs, energy costs, and
declining stock markets continue to erode consumer confidence and spending.
Interest Rates
The Federal Reserve (the Fed) responded to the slowing economy by lowering the target funds
rate on January 3 by one-half of one percent. The move was highly unusual,
coming as it did between the Fed’s regularly scheduled meetings. The Fed
followed with an additional rate cut of the same amount at its regular January
31 meeting. These moves are substantial, but if the economy is really in
recession, the Fed will need to do more. Since World War II, the average
recession has led to rate cuts of 5.5 percent by the Fed. Meanwhile, inflation
appears to be rising. From a low yearly rate of 1.4 percent in 1998, the
Consumer Price Index is now rising at 3.7 percent, much higher than the markets
anticipated. Despite rising inflation, the Fed will be forced to focus on the
economy and continue to lower rates.
The Stock Market
Declines in capital spending have delivered a series of body blows to the technology
sector, with the malaise spreading to other sectors. The result is evident in
the record number of negative profit warnings for the first quarter. When the
Nasdaq Composite Index finished down at 2151.83 on February 28, the
record-setting gain of 85.59 percent for 1999 was swept into the dustbin of
history. That also represented a 57.4 percent decline from its March 10, 2000
high of 5048.62. Smaller-capitalization stocks have held up best, most likely
due to the fact that larger cap stocks were trading at higher valuations, which
investors have fled in favor of more reasonably priced steady growers. The
market remains leaderless, as no sector has stepped forward to assume the
position occupied by the tech sector until 12 months ago. Without a clear
trend, investors are likely to move in and out of sectors quickly, taking out
profits as soon as possible, which will lead to further volatility. The market
will look to the Fed for further rate cuts, but rate cuts alone are unlikely to
stabilize the equity markets. Successful investing will be based in solid
fundamentals, strong managements, and proven products.
The International Picture
Decreasing capital investment in technology-related equipment has hurt component-producing
countries, especially those in Southeast Asia. This is most evident in Japan,
where exports are sinking, industrial production is plummeting, and housing
starts are virtually nonexistent. The Japanese economy is in its third quarter
of negative growth, and the stock market there is plunging as a result. On top
of all this, the G7 group of industrial nations has given Japan a virtual
ultimatum to resolve its bad-debt problem. Japan needs a bold step to add
liquidity to its economy and stimulate the moribund consumer sector. Weakness
is not confined to Japan. Since December, there have been over 30 separate
central bank easings around the world. Turkey was forced to devalue its currency,
a fairly insignificant event in itself, but sometimes an indication of worse
trouble to come.
The
above article is for general information only and is not intended to provide
specific advice or recommendations for any individual. Consult your attorney,
accountant, or financial or tax advisor with regard to your individual situation.
Mutual of America Life Insurance Company is a Registered Broker-Dealer.
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