Going backwards
The optimism about a rapid recovery from the global downturn has begun
to dissipate, say Alan Beattie and Peronet Despeignes
Published: June 22 2001 18:42GMT | Last Updated: June 22 2001 18:51GMT
Edward Robertson, managing director of Peterson Springs UK, is
discovering the hard way how US economic gloom can spread round the
world. "January and February were good months for us but things turned
bad in April - and in June the bottom has dropped out," says Mr
Robertson, whose company is a subsidiary of a US-owned manufacturer.
Mr Robertson is not alone. The air of modest optimism among companies
and investors in Europe and the US about the ability of the global
economy to recover has begun to dissipate. Share prices are once again
on the slide and a series of profit warnings from companies has cast
doubt on the likelihood of a rapid economic recovery.
On Friday the Ifo survey of confidence among German employers reached
its lowest point for two years. Forecasts for euro-zone growth in
2001, collected by Consensus Economics, have dropped steadily from an
average of 3 per cent in December to 2.3 per cent in June and are
likely to fall further. Mr Robertson, whose company exports 30 per
cent of its output, says: "The US slowdown has affected German
confidence; that has affected us and hence there is a general
malaise."
The US is clearly the key. A run of profit warnings in the past two
weeks has battered equities, in a reminder of the gloomy run-up to the
first-quarter earnings season. Companies as diverse as McDonald's, the
fast-food chain, JDS Uniphase, the fibre-optics parts supplier, and HJ
Heinz, the food manufacturer, have issued warnings. They were on
Friday joined by Merck, the US pharmaceuticals group.
Stephen Weiting, an analyst at Salomon Smith Barney in New York,
titled his latest report on the US economy: "Help! I've fallen and I
can't get up." He predicts two years of zero earnings growth for US
companies after several years of rapid rises. The S&P 500 share index
rallied to reach 1,312 on May 21 but has since slid 6 per cent.
Thomas Mayer, an economist with Goldman Sachs in Frankfurt, also
notices a distinct deterioration in euro-zone investor sentiment over
the past few weeks. "In conjunction with the US, and on the back of
worries about the local situation, investors are pretty scared," he
says. Euro-zone stocks have followed US shares lower since the end of
May, as have those in the UK.
The pattern of the decline in sentiment shows this is more than just a
correction in new technology sectors. Weakness in such shares has
spread to old-economy stalwarts. Thursday's profit warning from the
German chemicals giant BASF showed that companies reliant on a
cyclical upswing in the global economy were no longer a haven for
investors.
The atmosphere is reminiscent of the start of the year, just before
the US Federal Reserve quickly cut interest rates to give markets and
companies a boost. "This is deja` vu all over again," said Ken
Goldstein, an economist with the Conference Board, the New York-based
business research organisation.
The Fed is expected to cut rates again next week, which may once again
boost confidence and put a floor under stock prices. But with the
gloom spreading, some fear that central banks may be reaching the
limits of their ability to prevent a prolonged global slowdown.
The worry is that the Fed's interest rate cuts have failed to solve
the economy's underlying problem. Consumers remain heavily in debt and
companies wallow in unsold inventory in spite of big write-offs by
technology companies. Business inventories of unsold goods are larger
than at any time over the past two years and the share of US
production capacity lying idle has risen to its highest level in
nearly two decades.
The Bank for International Settlements recently published a sobering
report noting that falls in private-sector net saving on the scale
that the US has experienced - minus 6.5 per cent of gross domestic
product in 2000 - have almost always been followed by sharp falls in
economic growth two years later.
Interest rate cuts from the Fed may yet pull the US economy out of the
dip, particularly if productivity growth holds up and new investment
opportunities are created. Fed officials have signalled that they
expect to keep cutting rates until the economy shows signs of
responding - and markets expect another quarter- to half-point cut.
But the Fed is constrained by the prospect that it could reignite
inflation if it acts too aggressively.
There is little sign of either Japan or Europe taking on the role of
driving global growth. Junichiro Koizumi, Japan's prime minister, has
announced ambitious plans for economic reform and restructuring. But
Japan's partners in the Group of Seven industrialised countries fear
that while these reforms may be good for the country's long-term
health, they reduce the chance of a short-term recovery.
"The weakest global link is likely to be Japan. Their intentions are
good but their timing is bad," says Edward Yardeni, chief investment
strategist at Deutsche Banc Alex Brown in New York. Heizo Takenaka,
the economy minister, in effect warned this week that Japan could not
be expected to be part of the solution to the world's economic woes
for two years.
The euro-zone also faces difficulties in taking up the slack. Wim
Duisenberg, the European Central Bank president, has shown signs of
wanting a cut in interest rates later in the year. Up to now, the ECB
has been held back by the need to keep euro-zone inflation below its
target ceiling of 2 per cent. But recent rises in inflation in the
euro-zone have largely been caused by one-off price rises in food and
oil prices.
But some economists doubt whether Germany in particular is capable of
resuming strong growth without being led from the US. Mr Mayer says
the German government has been too timid in fiscal and labour reforms
aimed at making industry more dynamic. "Germany is too old-fashioned
an economy to cope flexibly with shocks. Monetary policy has in fact
not been too bad but it is keeping the patient alive and stable while
open heart surgery needs to be performed."
The UK is displaying similar symptoms to the US economy. Consumer
spending is strong and the trade deficit is rising, in spite of
continuing weakness in manufacturing. Sir Edward George, governor of
the Bank of England, this week warned that the economy's trade and
debt imbalances were unsustainable and interest rates might have to be
raised to stop them getting worse. Markets expect UK interest rates to
start rising again before the year-end.
The key to global confidence over the next few weeks is how investors
and companies react to the likely combination of bad news about
profits from companies and interest-rate relief from the Fed. Until
now, most analysts have reacted to each bout of gloom by pushing the
predicted recovery in earnings growth a little further into the
future. Optimism about this future recovery has prevented a worse rout
in equity markets.
The average predictions for US earnings per share, collected by
Thomson Financial/First Call, show that analysts expect US corporate
profits to fall by 1.6 per cent this year, while those in Germany will
fall by 8.2 per cent. But the same analysts predict a huge rebound in
2002: 25 per cent growth in US corporate profits and 27 per cent in
Germany.
"This will be the third quarter in which the market has been looking
for a recovery two quarters out. In each case, by the time we got to
the end of the quarter, that euphoria had given way to the realisation
that the two-quarter recovery would take another quarter at least,"
says Chuck Hill, research director at First Call. But as the months go
by since the Fed first intervened and policymakers confront the spread
of economic weakness, even the most optimistic of investors may be
having second thoughts.
