Little New Year Cheer for Investors?


If you were a member of President Bush's new economic team, what policies would you promote? William Wolman, longtime economist for BusinessWeek as well as a commentator on CNBC, has his own answer. He would give a short-term tax cut to the average American in the form of a temporary cut in the payroll tax, give business an investment tax credit for new capital spending, and consider giving more aid to state and local governments. And he would not make the Bush tax cuts permanent.

Wolman sees a stagnant economy, and a stagnant market, in 2003 and thinks the best return an investor can expect in the new year is 2% to 3% -- with the risks on the downside. And while younger investors could ultimately benefit from stock investments, he suggests that bonds are a safer haven at the moment. The place where he sees the most promise is Asia, especially China, though he also admires the growth potential of the European Union.

These comments were among many Wolman made in a chat presented Dec. 17 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Bill, the audience is already full of questions for you, but first I want to ask whether the smile on your face reflects optimism about 2003 for investors?

A: The short answer, Jack, is no. I think there are many problems in the economy which will not be easily resolved, and there are some signs that a certain number of potholes have appeared on the road that the Bush Administration has taken, both in domestic and foreign policy. So while I do not expect anything resembling a sharp market decline in 2003, I expect the market to continue stagnant.

Q: Can the upward trend continue?

A: My answer is simply to ask you a question -- what upward trend? We did have something of a rally that lasted for about six weeks, but that hardly constitutes an upward trend. I must remind you, if you need reminding, that the market will have declined for three years in a row when this year is over. There should be nothing surprising about this to anybody. The facts are that in the wake of the three great stock-market bubbles of the 20th century -- the ones that peaked in 1901, 1929, and 1966 -- there were long periods of market decline or at least stagnation.

Q: What's your opinion on gold stocks? How about that gold price! Dollar in major trouble.

A: On gold stocks, it seems to me that the geopolitical situation has become incredibly complex, with Iran and North Korea appearing as more threatening powers than Iraq. The U.N. weapons inspectors, as Frank Rich [of The New York Times] has suggested, have all the characteristics of the crew in Gilbert and Sullivan's The Pirates of Penzance. Under these circumstances, gold has obviously responded to its role as the exposed nerve of the financial system and is rising.

I have never been a gold fan, and I'm still not, but I do think that its strength will continue for at least several months to come. And if the dollar continues its swoon against the euro, the rise in gold could be quite sharp and prolonged. I would dearly love to be wrong about this, but prudence suggests that optimistic talk about the economy or the international situation is premature.

Q: Do you agree with this audience comment? "Interest rates will remain low and possibly nudge lower -- deflation is the overriding concern now."

A: Along with Chris Farrell, who works for Minnesota Public Radio and is a BusinessWeek contributing editor [and BW Online's Sound Money columnist], I was one of the people who argued the possibility of widespread deflation as long as three years ago. We never said that it would be a general problem, but that it would affect commodity-producing industries. There's no reason whatever to change that point of view.

For a long time, the American consumer benefited from commodity deflation. But with the dollar now falling, the price of commodities will get some upward impetus. So while deflation will continue to be a problem in corporate earnings, it may not be able to prevent an upcreep in the consumer price index. So it's not good news.

Also, it's important to understand that two prices that are critical to the consumer are under upward pressure -- medical care and government services, as state and local governments raise taxes to deal with their deficits. So price trends will not benefit the consumer nearly as much next year as they have for the past couple of years, which is one reason I believe that the average economic forecaster is being far too optimistic about 2003.

Q: What's your opinion on the terrible trade deficit, and what do we need to do about it?

A: My opinion is rather simple: The fall in the dollar will help put limits on the size of the trade deficit. But it's a fact of history that in eras where America flexes its military muscles, like Vietnam and Korea, the U.S. trade deficit tends to rise because of military spending abroad. Our military spends the money in foreign countries, and then the foreign countries spend it in places other than the U.S.

Jay Leno is always joking about the country Djibouti, which is, as you know, on the horn of Africa and is a U.S. staging area for war in the Mideast. It is, however, not a joke that if I could buy the Djibouti currency, I would bet that it will appreciate.

Q: Why is the dollar going down against the euro and the yen?

A: The fundamental answer, of course, is the trade deficit. But it's also the case that the investment demand for dollars by foreigners to invest in stocks and bonds is falling, or at least the rate of growth is falling. Together, the two forces are hard on the U.S. currency. I have argued in these chats that the EU has enormous potential for growth, and I think the consequence of that is that the dollar could fall quite a bit more.

Q: What do you think is in store for the bond market?

A: It seems to me that the long decline in rates has to be close to over. But if I can get a little technical for one second, I believe there's a good chance that the Federal Reserve will begin to buy long-term securities for its portfolio. If that's the case, long rates could come down some -- and that, of course, means that bond prices on longer issues could be firm over the coming year. There are, I believe, some longer bonds and bond funds that still represent decent investments.

Above all, investors should not go rushing into stocks -- no matter what their brokers say to the contrary -- just because rates have fallen. I would still keep a very large proportion of my investments in bonds rather than stocks. It has been a great strategy for the past three years, and I don't think that the value of holding bonds will vanish on January 1, 2003.

Q: In light of the last three years, is it a mistake for the average investor to be in stocks?

A: The answer to that question is that it has been a mistake for the past three years for investors to have added to their stock portfolios. The conventional wisdom is correct. At my age, you want to be very heavily in bonds, even though you're taking a beating on interest rates when you renew. For younger people, there's still an argument for a diversified portfolio of stocks run by some money manager who does not charge high fees.

Q: Bill, what are your feelings toward Asia as a value play?

A: That's an excellent question. People do not realize how far China has come in many ways. I recently was on a panel with a law expert on China whom I appeared with before a congressional commission on U.S.-China relations. I was absolutely bowled over by his description of how far the Chinese legal system had improved in enforcing strict and solid regulations on commercial transactions. I was bowled over by the implications for economic growth in China.

Under these circumstances, I think the potential for growth is simply enormous. And I therefore think that China is a great value play. I also like the tigers, although the situation with Korea is getting tricky. And to top things off, I think Japan's slumber party could be coming to an end. So I like Asia.

Q: How do you think the underfunded-pension issue will affect stock-market performance?

A: That's a very important point to discuss. There has been a lot of talk about companies buying stocks for their pension funds in the last couple of weeks of this year. It may even be a reason for the runup in the market, during the period when it was moving higher.

Believe it or not, I do have friends who are traders and whom I greatly respect, and they tell me that replenishing pension funds has been an important prop to the market for the last little while and that it will come to an end on Jan. 1. If that's right, 2003 might start with a pretty bad first act.

Q: If the housing market slows and prices come down, how badly will the consumer be hurt? And the economy?

A: The answer is obviously very badly. But I don't believe that we'll have a housing crash.... I do believe that the housing market will slow, and it will impose burdens on the economy, which will make predictions of a relatively stagnant economy next year turn out to be correct.

Q: Do you think investing in REITs for 2003 would be a good hedge?

A: The idea doesn't turn me on, although I do think that noncommercial REITs are still pretty safe. I must say that the story of this week that surprised me the most was on the financial problems of FAO Schwarz. There also are other problems of that kind -- Sears (S) is in pretty bad shape. So I would be very careful about REITs that focus on malls and other kinds of commercial properties that have to do with retailing.

Q: Do you think a lot of people are waiting to get back into the market because of the Iraq situation?

A: Possibly. If the situation resolves, it certainly can't hurt the market. But what has happened in the last couple of weeks are an indication that the world is a much more complex place than the Bush Administration possibly thought. So I'm not convinced that the international tensions can be easily resolved.

Q: What's reasonable to expect for growth in an investment portfolio for 2003?

A: That again is an excellent question. My answer is 2% to 3% -- and the risks are on the downside, not the upside.

Q: You spoke of state and local finances -- how will the crisis in state budgets affect the stock market?

A: The basic answer is adversely. We've just seen an 18% increase in property tax in New York City. Many states are under severe financial pressure, and they can't print money the way the federal government can. So we're either going to get tax increases or spending cuts. And these will be forces slowing the economy. I also have to say, although I shouldn't, that many state and local governments are almost exquisitely inefficient -- and what's frustrating, of course, is that improvements are very hard to come by when it comes to productivity.

Q: Bill, we have new names for the Bush economic team in Washington. If you were one of them, what would you do about U.S. economic policy if you could?

A: My answer to that question is very simple. I would give a short-term tax cut to the average American in the form of a temporary cut in the payroll tax. I would give business an investment tax credit for new capital spending. And I would consider giving more aid to state and local governments, where the problems really worry me. I would not make the Bush tax cuts permanent. And that's my answer.


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