On the economy, Wolman sees continuing excess capacity in manufacturing as a drag, exacerbated by the pinch on spending by state and local governments. And he sees no reason for the housing boom to continue -- in fact, he thinks it had no economic justification in the first place.
Wolman made these comments in an investing chat presented by BusinessWeek Online and Standard & Poor's Nov. 26 on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Following are edited excerpts. A complete transcript is available from BusinessWeek Online on AOL at keyword BW Talk.
Q: Bill, for some time now you've been a skeptic (if not outright pessimist) about the market. After seven weeks on the upside, have you changed your views?
A: I would like to point out that, though I have been a skeptic on the market, I had not been an apostle of a sharp or a sustained decline. On the contrary, I'd been forecasting a market that would be flat during this year. Remember, I offered to start a Flat Market Society to compete with the Flat Earth Society. In that context, I was actually surprised by the steepness of the decline in the weeks after I did my last chat [Sept. 17].
Nothing that has happened leads me away from the view that the market will basically be blah for the remainder of the year -- and indeed, for some years to come.... I'm still extremely skeptical of a return to a robust market -- and my view continues to be that subnormal gains are the prospect for the next few years.
Q: What sector would you put your own money in at present?
A: If I were forced to make a decision -- and fortunately, no one makes me do that in the real world -- I would look at defense stocks, which have come down relative to other stocks in the past few weeks. That is because I'm beginning to believe that the United States really will attack Iraq -- and the defense-spending consequences would be major, even if the war is short.
Q: When are we going to hit an 11,000 Dow again -- if ever?
A: We'll hit an 11,000 Dow at some point, probably in 2004, if my forecast on this is correct. That's given my expectation of a flat market -- that would be my best guess. I would like to make one point: I have been an apostle of stocks that yield good dividends. And those stocks have been doing relatively well in recent weeks, as you probably know. I continue to believe that stock investments should be in high-dividend stocks, since I don't expect a major increase in interest rates over the next couple of years.
Q. What's your view on gold stocks, short- and long-term?
A: I'm simply not an apostle of gold investments. I don't know how to analyze them, and I don't think anyone else does either. If we've seen one thing recently, it's that the Federal Reserve has done a decent job of managing money since its initial mistake in refusing to stop the bubble in its tracks in 1999, 2000, and 2001. A bet on gold is a bet that central bankers do not know the rudiments of managing money. And that's a bet I'm totally unwilling to make.
Q: How will tech stocks fare in the near future? Do you see a comeback?
A: My answer to that question is that if you enjoy the fun of playing the market, tech will be the most fun over the next few years. It certainly has been the most fun during the past five or six weeks of market gains. And I believe that will continue in periods when the market is rising -- or, should I say, in the rare periods in which the market will be rising strongly.
Q: Bill, what's your forecast for the economy, as distinct from the market?
A: My forecast for the economy is continued sluggish growth over the next two, and possibly three, years. There's excess capacity, which shows little sign of being wiped out. The strong sectors of the economy, especially housing, are almost certain to stop growing very rapidly.
When you think about it, a housing boom of the magnitude that we've had for the past few years makes virtually no economic sense. Even if you don't believe there will be a sharp contraction that ends the housing bubble completely, excess capacity in manufacturing -- at least between our shores -- will continue high, if only because China is eating everybody's lunch, including ours in this sector.
One other point that's really critical is the financial pinch on state and local governments that everyone is talking about, which will limit many types of spending. State and local government spending has held up better than I expected during the last few quarters, but I expect that vital sector to begin to slow, at least judging by what the governors are saying. So I simply can't come up with a strong-growth scenario, no matter how hard I try. There are ways, of course, in which I hope I'm wrong, but that is nevertheless my forecast.
Q: It has been said that the financial sector will lead the market higher. How healthy is the financial sector?
A: Well, one important point on the financial sector is that it has a rich daddy of a kind that virtually no one else has (except maybe the defense industry). And that daddy is, of course, the Federal Reserve. So it's hard to imagine that the sector will get into severe difficulties that the Fed can't prevent. Accordingly, I tend to regard the financial sector, especially the banks, as a safe investment in difficult times.
I think the brokerage houses are more problematic, since they make their money from investment banking, which will not be a strong activity for at least a few years to come. Remember that the kind of bubble that we saw around the turn of the century tends to cast a shadow on activity for a long period of time. That was one of the main messages of the book of which I was a co-author last year, The Great 401(k) Hoax. And I do expect that the great stock-market bubble will continue to hurt the financial sector, and indeed the entire economy, for some years.
I'm also not convinced that the scandals that have hurt Wall Street are over. History would suggest that there are still plenty of bombs around in the corporate sector. It's also extraordinarily difficult for a company to shake off the aura of corporate malfeasance once it has gotten started. Witness what has happened in the aromatic case of Jack Welch -- the smell just doesn't go away for a long period of time.
Q: How will the addition of seven new NATO countries affect our trade? The same question would apply to the larger EU.
A: That's a good question. I would point out that the new NATO members are mainly nickel-and-dime economies, to take a realistic view. I believe that the U.S. investment community underrates the importance of the things that the EU has done to unify the Continent's economy. Some of us might remember, from our days in college, how hard it was for the U.S. itself to form a customs union in its early days.
I think Europe, given its history, has done a truly remarkable job in pulling itself together as a single economy. And I think that the European markets and the European economy will benefit in the end substantially. In the shorter term, I'm more bullish on the European markets than I am on the U.S. market, partly for the reasons that I already discussed, and partly because the European Central Bank has more scope for easy money than does our Federal Reserve, since their rates are still relatively high, as compared to ours.
Q: If the Japanese market has hit bottom and starts up, will that have a good effect on Wall Street?
A: I do believe that signs that Japan is coming out of its doldrums will be helpful. One thing that's kind of interesting is the fact the strength of the Chinese manufacturing economy is even harder on Japan than it is on us -- and is holding back their recovery to a surprising degree. If I can advertise for a second, there's a neat article about this in the current BusinessWeek, which is very well worthwhile reading (see BW, 12/9/02, "Greater China").
Q: Have we seen the bottom of interest rates for this go-round?
A: The Fed's problem is getting really interesting. They've already cut their federal-funds rate, which is the basic rate they use to manage money, to a point where they obviously don't have much ammunition left for a conventional monetary easing, but that doesn't mean that the Fed has run out of ammunition.... The Fed's charter allows it to buy not only Treasury bills but also long-term government bonds, or anything else it wants to buy, for that matter.
That means -- and this is very important -- that the Fed can continue to ease money even though the federal-funds rate is coming close to zero. They would do this by buying long-term bonds rather than short-term bonds. This kind of thing has happened in the past -- it has gone under the name of "Operation Twist" in the sense that the Fed sort of twists the yield curve and pushes long-term rates down relative to short-term rates. Some Federal Reserve governors have been yapping about this kind of thing in their recent public statements.
Q: I believe the possibility of deflation is becoming more apparent all the time. Do you agree?
A: I have for some years been much more of a deflationist that most of my colleagues in economics. I continue to take that position. There are, however, some sectors of the American economy, notably health care and education, which are very important to most Americans. I believe that rising prices in these sectors will be a depressant on economic growth, because they will limit the amount of money available for spending in other areas. That's the major vulnerability of the economy over the next few years, particularly under Republican Administrations, which have little taste for pressuring the drug companies to keep prices down.
Q: Bill, can you refresh us with your thumbnail forecasts for the economy and the market?
A: Yes, I expect growth to continue to be slow next year. I do not foresee a strong stock market, despite the last few weeks of rising stock prices. I like high-dividend stocks, and despite the ridicule of some people on Wall Street, I still like long-term bonds because I think there's a very good chance that the Federal Reserve will indulge in another Operation Twist, which will put upward pressure on the prices of long-term bonds, even though short-term rates are very low.