[Futurework] Monsters from the 1930s

[Karen Watters Cole]

Does the dreaded “D” word mean Diet, Deflation or Depression?  Below, an OpEd piece from Reuters.  Also read Crisis in Prices? By Paul Krugman, NYT, 12.31.02 @ http://www.nytimes.com/2002/12/31/opinion/31KRUG.html.  What do you think?  Karen Watters Cole   Happy Days May Not Be Here Again in 2003 Sat December 21, 2002 04:22 PM ET By Pierre Belec NEW YORK (Reuters) - Don't hold your breath waiting for the stock market to hand you a pot of gold next year. Deflation -- an earnings-eating monster that robs companies of the chance to raise prices -- may hold a gun to corporate America's head.  It will limit the market's upside potential because stock prices, according to the time-tested rule, represent a right to future corporate earnings, which will be sub-par. Indeed, all is not well on the corporate front. Times are tough for the pin-stripped suits.  In today's intensely competitive environment, chief executives have lost their pricing power.  The pricing issue has meant earnings problems for a slew of companies.  And, if profits can't grow, how can the stock market recover? Some companies poked their heads above water in the last quarter.  Profits in the third quarter grew for the first time in two years, inching up by 8 percent from last year's quarter -- when earnings collapsed following the Sept. 11 attacks on the United States.  The reality is the plunge in some sector's earnings had been so severe that a rebound was inevitable.  More easy earnings comparisons are expected in the fourth quarter, because less than half of the companies in the Standard & Poor's 500 index posted any profits in the fourth quarter of 2001. Also helping to paint a rosier picture is that fewer companies issued disappointing results.  But a closer observation shows companies were able to pull it off because they had lowered the Street's earnings expectations.  It's the dumb-down effect. Much of the earnings improvement stemmed from massive restructurings, i.e. jobs cuts, and house-cleaning, rather than from a tremendous boost in the companies' core businesses.  Forecasts call for earnings to leap by 15 percent next year.  But the smart money says don't bet the ranch on any moon-shot earnings improvement.  UBS Warburg says earnings of the S&P companies will inch up by only 8 percent next year, If the economy doesn't fall out of bed.  Going forward, it will be harder for businesses to slim down further without starving themselves to death.  Companies have found that work force cuts have always been the quickest way to rebuild their balance sheets.  The harsh truth is businesses can only fire the same workers once.  They will need to be more creative in the second go-round.  An example of the brutal competition: In the second quarter, revenues of the 400 industrial companies in the S&P were down 3.3 percent from a year earlier.  It was the first negative comparison since the numbers were first tracked in 1958.  Revenues for 2002 are expected to be off 2 percent, with deflationary pressures cutting prices by 0.6 percent.  The unexpectedly large drop of 0.4 percent in producer prices in November, the steepest since May, underscored the risk of deflation. A declining price environment or, at best, a period when prices barely move from year to year, is not good news for the economy because it essentially translates into the same rate of growth for the nation's gross domestic product.  The Federal Reserve, which has always focused on fighting inflation, is now faced with a new script.  Lately, it has gotten religion on deflation, which is the reverse of inflation.  "The minutes of the November Fed meeting were littered with the 'D' word and its possible ramifications," says Kent Engelke, capital markets strategist for Anderson & Strudwick Inc. Post-Bubble Hangover "There is historical precedent that the economy exhibits a lack of pricing flexibility following those once-in-a-generational changes in the economy," Engelke said, referring to the boom of the late 1990s that was followed by the bursting of the speculative bubble in 2000.  In the go-go years, companies over-invested and over-hired.  Now the business leaders are paying for their excesses. While inflation may stimulate the economy and create jobs, marked deflation affects the economy and the jobs market negatively.  "There is little question as to what the Fed is really up to," says Stephen Roach, chief economist for Morgan Stanley. "The Fed threw down the gauntlet with its larger-than-expected 50-basis-point monetary easing on Nov. 6.  The ink was barely dry on the policy statement of that action when Fed Chairman Alan Greenspan went public on the deflation debate in front of the U.S. Congress." The central bank chopped interest rates last month to the lowest levels in 41 years, putting the key rate at 1.25 percent, and warned in typical Fed speak: "....a faltering economic performance would increase the odds of a cumulatively weakening economy and possibly even attendant deflation." Central bankers don't appear to be tremendously worried the economy may be entering a massive deflation spiral, but their concern is over the changing nature of the economy.  Just Thursday Greenspan mentioned the "D" word again, although he couched it in optimistic terms.  In a speech to the Economic Club of New York he said recent evidence showed the economy was working past a soft patch and there was no reason to fear the country was at risk of price deflation. "The United States is nowhere close to sliding into a pernicious deflation," Greenspan said. If a widespread decline in prices did develop, the Fed chief said, policy-makers had ample tools to fight it. Inflation Is Good.... For Businesses Still, there is a clear and present danger the current no-pricing climate in the post-bubble era, which is crimping corporate earnings, will continue for as long as the eye can see, Engelke says. Without inflation, businesses lack pricing power. "A problem exists in the fact the U.S. economy is based on a rising price environment," he says. "People buy a product at today's prices and pay for it with tomorrow's dollars."  The economy is still not out of the woods yet, and at this stage of the game business spending will decide the direction of the economy.  The problem is businesses have become much more dependent on the stock market to finance their growth. With the Dow Jones industrial average down nearly 30 percent from its peak in January 2000, the S&P down 40 percent and Nasdaq index off an eye-popping 70 percent, chief executives have developed a serious case of "caught-in-the-headlights" paralysis and are afraid to move forward.  During the booms of the 1990s, stocks soared to dizzying heights.  With record returns on stocks and fat earnings, this wealth was the biggest driving force behind the high rate of capital spending by businesses.  A lot of the money went into technology spending, which increased at an unsustainable double-digit rate each year. With the market headed to its third straight year of losses, businesses will likely continue to stick their heads in the sand and take fewer risk.  So the prospect for 2003 doesn't appear to be good.  Investors who have been anticipating a return of the good times, may be in for a rude awakening if their rosy outlook does not materialize.  We're talking stock portfolio survival after three straight years of awesome losses. For the week, the Dow Jones industrial average .DJI rose 0.9 percent, the Nasdaq Composite Index .IXIC gained 0.09 percent and the Standard & Poor's 500 Index .SPX climbed 0.7 percent. (Pierre Belec is a freelance writer. Any opinions in the Stocks-Week column are solely those of Mr. Belec. Editing by Walter Bagley) http://www.reuters.com/financeNewsArticle.jhtml;jsessionid=FHGOXHZVYYIUWCRBAELCFEY?type=businessNews&storyID=1947696   Outgoing Mail Scanned by NAV 2002