Stocks View: Patience Wears Thin As Weird Recession Wears On

This is the weirdest recession ever to hit the stock market. Consumers are spending thanks to an avalanche of interest-rate cuts, but companies can't plow their way out because bankers are so tight-fisted.

The Federal Reserve chopped interest rates 10 times and flooded the system with a trillion dollars since January but the soft money policy has failed to have an electrifying effect on the economy and corporate earnings.

The betting is that the Fed will take another stab at jump-starting the $10 trillion economy by lowering again at next Tuesday's policy-setting meeting, possibly pushing the key interest rate to 1.75 percent from 2 percent, which was already a 40-year low.

With the economy skidding into a recession, snapping a record 10-year-long expansion, stock investors who have been crushed this year by a falling market, are praying that the 11th interest-rate cut will be the one with the magic potion.

Proof this is not your typical recession is that during the last economic downturn in 1990-91, it took only four rate decreases by the Fed to get the economy back into gear.

Ned Riley, chief investment strategist, State Street Global Advisors in Boston says Wall Street should be patient. Fed Chairman Alan Greenspan is on the right track, he says, and it may take a little longer for the campaign to succeed.

"It's really hard to fight a Federal Reserve that has created $1 trillion in liquidity in 12 months and $280 billion since the Sept. 11 attacks and is willing to push interest rates down to 1 percent to get the economy on track," Riley says.

"All of the cylinders are set to go and all we need is for the battery to be attached to the engine," he says. "Those forces will eventually lead to higher growth next year."

Allen Sinai, chief global economist for Decisions Economics, says the normal medicine of lower interest rates to rebuild the economy has not worked because this has not been a normal recession.

"This downturn has not been typical," he says. "It is the only recession since World War II that has been clearly initiated from the U.S. business sector, which retreated from a boom state in 2000."


This is only part of the story.

A lot of companies have not been able to enjoy the fruits of the Fed's policy. Just about all of the windfall has gone to the American consumers, or so it would seem.

"The Fed hasn't been able to pull off an economic miracle so far because many companies that desperately need to borrow money are being shut out by tougher lending standards," says Riley.

The credit-worthiness woes, which have frozen capital spending, may delay the recovery that is forecast for the middle of 2002.

The reason: Since capital spending is a big part of the stuff that moves the economy, then any sustainable rebound will come when companies again spend on new factories and equipment. Also, because capital spending is driven by corporate earnings, any worsening of the profit-recession would work against recovery.

Even companies with the richest credit ratings are not getting any major breaks from this soft money environment.

Moody's Investor Service's composite of top corporate bonds yielded about 7.8 percent this week, which is almost the same as in early January when the central bank began cutting.

"This is one of the dilemmas," says Riley. "But it's not an unusual circumstance at this juncture of an economic down cycle because banks are always reluctant to lend when credit standards are falling."

A sign that the list of corporate deadbeats is growing is that more companies' credit ratings are being downgraded than upgraded by rating agencies such as Moody's.

The companies' problems in getting their hands on new money could not come at a worse time. Their earnings have evaporated since the fourth quarter of 2000 and this has robbed them of their much-needed cash flows.

Earnings of the Standard & Poor's 500 companies tumbled by 21.6 percent in the third quarter and are expected to drop by 17.8 percent in the fourth quarter.

Still, it would be unfair to say the Fed has been totally ineffective.

American consumers have been very happy about falling interest rates and they've been buying new and old homes and refinancing mortgages at dirt-cheap rates. In fact, lending rates fell to the lowest levels since President John F. Kennedy was in the White House in the '60s. The savings have extended to car buying, and zero financing by automakers could make 2001 the second best sales year ever.

What's happening is that consumer spending, which generates two-thirds of the nation's growth, has offset most of the negative sentiment from the business sector.


"The plunge in interest rates has given Americans an incredible opportunity to increase their discretionary income by reducing the rates on old loans through refinancing at today's rates," says Riley.

The amount of money that has been saved either from refinancing or zero percent teasers by car makers, have amounted to more than this year's $38 billion U.S. tax rebates, he says.

Mortgage refinancing is so brisk that it accounts for 75 percent of loan business, says the Mortgage Bankers Association.

The refinancings, which have freed up a massive amount of money for consumers to spend on other stuff, may give a stronger jolt to the economy than the government's tax cuts because they are unconditionally putting money directly into people's pockets.

Riley is betting on a short recession.

"We are seeing signs that the worst is behind us and companies are slowly upgrading their prospects," he says.

The stock market is betting that things won't get worse.

"Stocks have already started to reflect some of the optimism about an economic turnaround," Riley says.