A Dangerous Inflection Point Redux

• February 4, 2002
• Peter Navarro

A nice
little macroplay stock pick will conclude this column, but the savvy macrowave
investor always begins the trading week with an assessment of the broad market
and sector trends.

Make up Your Mind!

We
remain at a dangerous inflection point in both the economy and the stock market,
and therefore, a dangerous trading environment for the macrowave investor. 

On
last week’s good news front, the unemployment rate came in lower than expected
— but maybe due to a statistical quirk. The
purchasing manager’s index rose from 48.1 to 49.9 and is nearing the range
when expansion is signaled. And Fed
chairman Alan Greenspan issued positive remarks about the recovery — albeit,
refusing to lower interest rates one last time. Still, the Dow,
Nasdaq and S&P 500 all were down. The question is why.

The Enron Accounting Macrowave

Current
stock prices are based on expectations about the future flow of profits. This has two types of impacts.

For
those companies that have been caught with their hand in the accounting jar, the
market immediately revises profit estimates sharply downward and, with this, go
stock prices. The list of companies
guilty of such creative accounting include Tyco
(
TYC |
Quote |
Chart |
News |
PowerRating), Global Crossing
(
GX |
Quote |
Chart |
News |
PowerRating), PNC
Financial
(
PNC |
Quote |
Chart |
News |
PowerRating), the
Williams pair and AOL
(
AOL |
Quote |
Chart |
News |
PowerRating). The problem
here is that the list is likely to grow, and no sector is more vulnerable than
the already downtrodden telecom sector.

The
second type of impact is the most serious macrowave. The specter of accounting manipulations creates a much larger band of
uncertainty around virtually every stock — as well as the broad market. Since increased uncertainty means higher risk, investors have to discount
such risk by bidding down the price of individual stocks AND rebalancing their
portfolios AWAY from stocks. This
puts tremendous downward pressure on the markets.

So,
even as good economic news is trying to buoy the markets, the Enron accounting
macrowave drags it down.

The Bush Deficit Macrowave

Main
Street loved George Bush’s State of the Union speech but, methinks, Wall
Street hated it. Stripped of
rhetoric, it signaled a new era of budget deficits that are likely to stretch
for more than a decade.  

Bush’s
situation is eerily similar to that of LBJ during the 1960s when that president
tried to fight both a war in Vietnam and continue spending on the Great Society
welfare programs. Now, too, Mr.
Bush wants both his guns AND butter — and the guns equation is even further
complicated by the need not just for weapons for foreign wars, but resources for
“homeland security” as well. Wall
Street knows this will be expansionary in the very short run, but inflationary
— and perhaps stagflationary — in the longer run.

One
big concern from the Bush Deficit Macrowave is a collapse of the housing market
and a bursting of the housing price bubble. Rising deficits could raise mortgage interest rates and spark a
“distribution cycle” among housing asset holders.

The Consumer Deficit Macrowave and a Double Dip?

The
Economist magazine is on a rampage of the dangers of an overly-leveraged
American consumer. Check out the
latest issue. Here’s the
dangerous scenario:

The
current attempt at economic recovery is now being fueled by an “inventory
rebound.” That is, many
businesses have now worked off their high recessionary inventories to the point
where they need to begin boosting them, and this provides a short-run boost to
the economic.

If,
however, there is no follow through from the consumer at the retail end,
inventories will build again, businesses will once again cut back, and we will
have the ugly double-dip recession that has been a feature, according to
Barron’s, of five of the last six or so severe recessions.

Japan’s Currency Woes and Deflationary
Pressures

Don’t
underestimate this bad boy and blame it on China. Here’s the deal. With the
lowest wages among the big Asian players, China is steadily expanding its
exports at the expense of the market share of every other Asian country. The
ONLY way Singapore, Taiwan, Korea, Hong Kong, et al, can defend
themselves against the Chinese threat is to begin to devalue their currencies.

No
country is in a worse position than Japan. With
a faltering economy that seems immune to any kind of Keynesian stimulus and
beleaguered by its low-wage rivals, Japan sees a weakening of the yen as its
only way out — a move that will lead to an export-led recovery, or so the
thinking goes. If Japan is
successful, however, it will essentially be exporting deflation to its trading
partners. (I’m not yet convinced
deflation is a bad thing, but more about it in other columns.)

The
Greenspan Macrowave

Fed
Chairman Alan Greenspan signaled what is likely to be the end of the interest
rate cycle by demurring on another cut. He
further expressed bullish optimism about the recovery.

Holding
other things constant, one important implication of this macrowave will be for
investors to move funds from bonds to stocks. The macrowave logic: Interest rates can only go up now. Since bond prices move inversely with interest rates, bonds will become a
relatively losing proposition as interest rates begin to rise. 

The Macro Data Week Ahead

It
will be a quiet week in Lake Woebegon. Productivity
will be out on Wednesday — but it’s hard to sort out the productivity crosscurrents in a recession. Thursday,
look for consumer credit — a notoriously irrelevant report. BUT, per our discussion above, watch for any additional credit pressures
on the consumers at our inflection point. Friday,
another tepid report — that on inventories — comes out. Just be mindful of the flow of data and watch the market’s reactions.

Macroplays of the Week

Viewpoint
(VWPT) — This stock has more than doubled since 12/03/01, so it may seem a
little frothy. But a favorable
mention in Barron’s this week will surely give it a pop — market trend
permitting. Plus, it’s going to
surf a nice little macrowave in its niche, which is software that creates 3D
imagery and dynamic animation for web applications.

The
big application VWPT stands to capitalize on is advertising. The company just inked a deal with AOL which will allow it to earn
royalties on Viewpoint-powered advertising.

Technicals
look very good when the downward weight of the market trend is discounted. Plus, it resides in a sector with considerable strength. Just be careful. Viewpoint
won’t fly in a down market and the company may catch a little cold if AOL gets
some accounting pneumonia.

Thanks
to all the beta testers out there! And
remember, I want to hear from you. Send
me an e-mail at pnavarro@uci.edu or go
directly to my web site https://www.peternavarro.com.