What’s Ahead for 2002?Published: January 16, 2002 in Knowledge@Wharton
What’s next? Will 2002 be like 2001, with unemployment going up, stock prices going down, the trade balance worsening and tech industries in turmoil?
No one knows for sure, of course. But Knowledge@Wharton asked several Wharton professors for their best predictions about issues and trends in four key economic areas: the stock market, employment, international trade and technology.
To the extent there is a common theme, it is that a dramatic turnaround doesn’t seem likely. While there may be some economic improvements, lingering problems dog each area and a fragile recovery could be undermined easily by another terrorist attack or other shock.
The Stock Market
It’s rare for the major stock indexes to decline two years in a row, as they did in 2000 and 2001. What are the chances of a third consecutive down year?
“I would say unlikely, but certainly it’s in the realm of possibility,” said finance professor Jeremy Siegel. Though the major indexes were down for 2001 as a whole, stocks surged in the fall and early winter, as they often do in the months before the end of a recession.
“There’s no question the stock market is predicting a very robust recovery,” Siegel said. “There’s where it could really be disappointed, in the sense that [corporate] earnings don’t bounce back as fast as the economy bounces back.” Nonetheless, he added, “the market could eek out a gain somewhere between 5 and 10% ….My feeling is that we’ll see a decent year.”
Though indexes such as the Standard & Poor’ 500 are still well below their all-time highs, stock prices remain high relative to corporate earnings. Analysts’ recent earnings projections for S&P 500 companies would result in a price-to-earnings ratio in the low 20s, Siegel said. While that is higher than the long-term average P/E of about 15, a low-20s level is probably reasonable in today’s market, given factors such as low inflation and interest rates.
The Nasdaq market, dominated by technology stocks that have been pummeled over the past two years, remains extremely risky despite a strong rebound in the past few months, Siegel noted. The average Nasdaq company has lost money, so the index has no P/E ratio. “I know money is pushing into the Nasdaq, but I think it’s risky,” he added.
Will the Enron debacle hurt the broader market? So far, investors seem to view Enron as an isolated problem, and it doesn’t appear likely Enron’s collapse will infect the market as a whole, Siegel said, noting, however, that the Enron case may cause investors, regulators and politicians to wrestle with some important issues: whether accounting and financial-disclosure standards are tough enough and whether too many workers have too much money tied up in employer stock in their 401(k) plans.
Generally, said Siegel, investors seem to have “tremendous faith” in the financial markets despite the losses of the past two years and jolts like the Enron scandal. “The fabric of trust has been maintained.”
Over the next seven to 10 years, stock-market investors are likely to enjoy returns of 5 to 7 percentage points above the inflation rate, compared to an average of 6.9% after inflation for the past 200 years, he said. While 5% would fall below that long-term average, it still beats the main alternatives – bonds and cash.
Stocks, Siegel said, will continue to be the best long-term investment.
Though unemployment surged in 2001, management professor Peter Cappelli, director of Wharton’s Center for Human Resources, believes conditions will not get significantly worse, and probably will improve in 2002. “It looks like this is going to be a reasonably short-lived recession.”
Many employers, he pointed out, began cutting workers last March and April, just as the recession was starting, because they anticipated a fall-off in business. Compared to past recessions, this was a relatively early response, and it could mean that the cutting cycle will be over earlier than usual.
Although some recent high-profile lay-offs, such as those at Ford, have attracted attention, Cappelli suggested that many employers are now reluctant to shed workers even though they may be suffering depressed revenues. Not long ago, companies were struggling to find good workers, and they don’t want to be in that position again if the economy does recover soon, he said.
Nonetheless, Cappelli added, workers are not likely to soon enjoy the benefits that were starting to come to them in the tight labor market of the late ‘90s – higher wages, career development programs at work and new family-friendly policies on leaves and work schedules. “It’s pretty clear companies are cutting most of that stuff back now.”
According to Cappelli, among the questions yet to be answered is just how tight the labor market has to get before workers can successfully demand higher wages and other benefits. It was only at the very end of the tight market of the ‘90s that benefit improvements started to flow. It is not clear exactly why this was, Capelli said, but it is possible that pressure for higher wages was not as great because low interest rates, low inflation and rising stock prices gave people a sense of well-being that made raises seem less important.
While there has been some Monday morning quarterbacking about Congress’s failure to pass an economic stimulus bill, Cappelli thinks this probably has little effect on employment rates. Tax cuts and the tax rebate were already in place before the September 11 attacks, and the Federal Reserve already had pushed short-term interest rates very low.
In fact, Cappelli said, the recession might have been over by now had it not been for the attacks. Inventories had bottomed out before September 11, setting the stage for a manufacturing recovery. An economic recovery and a reduction in unemployment will depend to a great extent on consumer confidence, he added. If corporate executives feel that consumers are becoming more eager to buy, they will add workers to produce products to sell.
Typically, the balance of trade improves in a recession. Imports fall as consumers and business buy less; exports can strengthen if prices are attractive to foreign buyers.
But that’s not the case this time, says finance professor Richard Marston. “Our export sector has just collapsed,” he said. “That’s because it’s more of a global recession.” Around the world, economic weakness is so pervasive that Marston sees little chance of significant improvement in the U.S. trade balance this year. “Things will get worse before they get better,” he predicted.
Among the problems is the weakness of the euro relative to the dollar, making American goods expensive for Europeans. “There’s no clear sign that that’s going to reverse anytime soon,” Marston said. “I have a strong belief that it will reverse, but I just don’t have any confidence about when.”
Ironically, an economic recovery in the U.S. could worsen the trade balance if other countries stay in recession longer, as seems likely, he noted. Americans would buy more foreign goods while foreign consumers and businesses would not increase their American purchases. American goods are not likely to be cheap for foreigners if an American recovery spurs domestic demand.
At some point – though Marston won’t predict when – international currency traders will react to the overly strong dollar and see bargains in other currencies. That will bring the dollar down and make American products more affordable for foreign buyers.
Post-September 11, security procedures may add to the costs of international trade, adds finance professor Richard Herring. Not only are shipments being checked more closely, sometimes causing greater delays, but electronic money transfers are under more scrutiny as well. And foreigners who want to work or study in the U.S. may have a tougher time getting visas. “All institutions are going to have to spend more in compliance. There will be much stronger know-your-customer laws.”
Herring, too, feels that the dollar will weaken at some point but adds: “All we know about forecasting exchange rates is that we don’t know how to forecast them.”
Though the euro has been used for business transactions for several years, Herring thinks it may gain credibility now that it’s used for cash transactions as well. The psychological effect may make the euro more competitive with the dollar.
So far, the economic crisis in Argentina has not spilled over to affect other countries, the way the Mexican and Thai crises did some years ago. But Herring said there is a danger that other countries will come to see Argentina’s collapse as a repudiation of the free-market reforms that Argentina implemented at U.S. urging. The world economic situation, he noted, will not benefit if Argentina and other countries revert to “the really terrible economic policies that were pursued in the ‘70s and ‘80s.”
The most certain statement that can be made about the tech sector is that it will continue to be wild and unpredictable – and that consolidation will probably continue in the phone and cable industries, says Gerald Faulhaber, professor of management and public policy.
In recent years many telecommunications companies invested too heavily in fiber optic cable and related equipment in expectation of explosive growth in the Internet and a blossoming of opportunities to offer local phone service. Neither market has grown at anywhere near the rate the optimists had expected. “It looks like we’ll have a lot more fiber than we’ll need for a long time to come,” Faulhaber said.
Hence, he sees little likelihood of a quick recovery for tech equipment makers, who are heavily dependent on growth in the markets they serve.
When telecommunications was deregulated in 1996, many expected an explosion of competition to offer local phone service. It hasn’t turned out that way. In fact, says Faulhaber, a reconsolidated industry may come to look more like the old Ma Bell.
According to Faulhaber, as rules governing competition were implemented, the regional Bells were allowed to charge other firms enough for access to the local networks to effectively keep them out. A company that controls a bottleneck, such as the local phone system, will always find ways to block competition, regardless of regulators’ intent. “They are going to find a way not to sell it to you, and that is in essence what they did,” he said.
Most of the start-up local phone companies have therefore collapsed, leaving the regional bells standing. At the same time, it is not expensive for the local phone companies to get into the long-distance market. Long-distance lines are cheaper to acquire than local switching stations and distribution webs, and there’s a glut of fiber cable for long-distance service. So the regional bells are likely to move strongly into the long-distance market, Faulhaber said.
The big long-distance carriers such as AT&T, Sprint and MCI will most likely be acquired over the next five years, “maybe sooner, by the regional bell companies. They just can’t make it on their own,” he said.
Many experts had predicted the cable TV companies would soon begin offering phone service. While some have, Faulhaber does not expect much advancement in this service in the next few years. Put simply, cable systems, which were not built around switching ability, aren’t as reliable as phone systems. Moreover, cable companies are giving their attention to more promising opportunities: digital cable, video on demand and high definition TV.
One of the busiest groups in the tech world this year will probably be the regulators. “I see merger activity being big in telecommunications,” Faulhaber said. Already, he pointed out, there is a great deal of discussion in “policy circles” about how to allocate wireless spectrum, given the growing demand for cell phone and other services. “Everybody knows spectrum is going to be the next big thing,” he noted. “This issue is just going to get tougher and tougher.”
International electronic trading systems will probably draw a close regulatory look after the Enron debacle. Many of the derivatives and energy-related contracts for which Enron created an international market are currently free of the kind of regulatory scrutiny common on Wall Street.
Finally, Faulhaber said, technological change is likely to provoke an intense reexamination of intellectual property issues this year. Last year’s Napster controversy was just a hint of the debate to come. Copyright law, he noted, “is in a state of enormous ferment.”