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A number of signs, most significantly the employment numbers, point to a slowing economy, according to William Wolman, chief economist of Business Week. As a result, he expects the Federal Reserve to hold off on raising interest rates at its June meeting -- but look for another increase in August in response to a summer uptick in inflation.
However, Wolman personally opposes even an August increase, because he is concerned that the Fed will overdo restraint, in which case "we go into recession." Longer term, he retains his concern over deflation. Meantime, he expects a "blah" stock market -- and sees investment opportunities in Europe as industry there restructures.
These were among the points Wolman made in a chat on June 6 on America Online, presented jointly by Business Week Online and S&P Personal Wealth. Here are edited excerpts of his answers to questions from BW Online's Jack Dierdorff, the moderator, and from the online audience. For a full transcript on AOL, go to keyword: BW Talk.
Q: Bill, the market was off today, in what some called a "regrouping." How do you view this market's tone?
A: Clearly, the market has been buoyed by the signs of a slowdown in growth, particularly the surprising fall in employment. This has led to a change in the market's perception of what the Federal Reserve will do at its June meeting. The view now is that the Fed will not raise rates. And the market sure likes that...
Q: Are we in a bear-market rally?
A: That's the $64 million question. My own guess is that the markets have seen something like their highs for the year.... My basic outlook, as I have said many times already this year, is for a "blah" performance for the market as a whole -- as, for example, measured by the Wilshire 5000, which covers some 92% of total market capitalization.
Q: What level do you think the Nasdaq will bottom at this summer?
A: 3000 is a good, round number -- but it will end the year higher than that.
Q: Bill, what's your reaction to the extreme market pessimism in Robert Shiller's Irrational Exuberance?
A: ...My position is that it's a very important book. But I also argued [in my BW review] that Shiller did not take the character of recent technology into account in what he said. Nevertheless, all investors have to come to terms with Shiller's basic point: Price-earnings ratios early this year were higher than at any time in the 20th century. Each time in the past when p-e's rose to anything resembling their early-2000 levels, the market stagnated for more than a decade...
Q: Is the economy really slowing? Are we flirting with recession with the higher interest rates?
A: Yes, the economy is really slowing. I think that the jump in the unemployment rate exaggerates the degree of slowdown, but there are lots of other indicators that also imply a slowdown, including the purchasing managers' survey, new orders for durable goods, chain-store sales, and the recent housing-market data...
Q: Do you think the Fed will allow rates to remain the same at their June meeting with a wait-and-see approach?
A: That's what everybody is guessing these days, and that is probably correct. The real problem, as I said, will be an acceleration of inflation during the summer. That will test the mettle of the Fed at its August meeting just two-and-a-half months or so before the election. My guess is that the Fed is likely to raise rates at that meeting in August.
Q: Commodity prices are low -- could that keep a lid on interest rates?
A: That's a good point. You have correctly noticed that some of the key commodity indicators are beginning to fall, but be careful about reading too much into this. Oil and natural gas are still soaring, and more important, the dollar has been declining...so the fall in commodity prices may be giving a false signal of tame inflation.
Q: What is wrong with a rising level of the cost of employment. Couldn't a case be made that workers are making the economy go without getting the benefits of it?
A:...I think that the Fed reacts too nervously to signs of wage inflation. I myself am opposed to any rise in rates in June, and as far as I can see, the Fed has no case to raise them in August either. But that does not mean that they won't. By the way, the increase in employment costs in May was extremely modest -- wages actually only increased by 0.1%. That is trivial and is the strongest possible reason why the Fed should go easy on raising rates.
Q: Is it appropriate for the Fed to be targeting the major stock indexes -- shouldn't it simply target inflation?
A: The answer to that question is yes. But, as you know, Alan Greenspan, chairman of the Fed, worries about the wealth effect. That means he sees stock market moderation as a way of moderating economic growth. Therefore, although he won't quite admit it, Greenspan does worry that the market can get too high, stimulating high levels of spending and threatening inflation.
Q: Is the China deal good for the U.S. economy or bad?
A: It's good. And I'm sure glad that it seems close to being enacted, even though the Senate is a little more recalcitrant than people expected. That is not to say that the union movement and the environmentalists had no point in their opposition to the bill. But it seems to me that their concerns could be addressed in some other way than limiting trade with China -- or with any other country, for that matter.
Q: Would inflation in the U.S. suggest investing in Europe, or would inflation be endemic?
A: There are lots of good reasons to invest in Europe, because it is still in the early stages of restructuring its economy. I do not believe that concerns about U.S. inflation are a good reason to invest abroad...
Q: The rise in natural gas is probably permanent, but do you really think oil prices are going to stay high forever?
A: I do believe...that something like the current price will prevail for some time to come. OPEC likes it, the oil companies like it, and the producing countries are showing an unaccustomed reluctance to cheat on their quotas in a major way.
Q: Some of us recall when your big worry was deflation, Bill. Are you more worried now about deflation or inflation?
A: You have a good memory. I am still a believer in secular deflation. That is to say, I believe that global competition and the new technology are powerful forces keeping inflation in check over the long run.... I do believe, however, that this summer will see an uptick in the inflation rate...And that is why my main worry is that the Fed will overdo restraint in the long run...
Q: What happens if the Fed overtightens?
A: We go into recession. The situation is quite risky in that sense, since we're very dependent on new investment in technology to keep growth going. Much of that investment has necessarily to be venture capital and private equity for relatively small and new companies, and this kind of financing is very vulnerable to recession...
Q: Bill, any personal suggestions for asset allocation in the current market and economy?
A: The answer to that is that I would be more cautious about stocks than I was for most of the '90s. I also like a good portfolio of foreign stocks, because my instinct is that the dollar will be lower, especially against the euro, later in the year than it is now. Also, both Europe and Japan are way behind the U.S. in restructuring their economies, so they could be getting big payoffs over the next couple of years...especially in Europe.
Q: What about Asia?
A: I worry a little that they did not take fundamental steps to improve their economic performance or clean up corruption or do other good things after the last Asian crisis.... By the way, in case you haven't noticed, the Russian stock market has been performing very well so far this year. I am cautious about saying it, but that may be telling investors something.
EDITED BY JACK DIERDORFF
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