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to the end of the intro –>Ten years ago, when the booming U.S. economy of the mid-1980s collapsed into a recession, many Wall Street watchers believed that the country had lost its competitive edge. The prevailing wisdom was that countries like Japanwhose investors had acquired such American icons as New York City’s Rockefeller Centerhad assumed the world’s economic leadership. Europe, too, seemed to be headed for great heights of prosperity after the Berlin Wall fell. America, it was assumed, was bigbut it was past its prime. Back then, only a few voices could be heard arguing that the U.S. economy would bounce back, stronger than ever.
One of those voices belonged to Abby Joseph Cohen, managing director of Goldman, Sachs and one of the savviest forecasters of Wall Street’s performance. As Japan stumbled, Europe fizzled, and the U.S. economy rebounded with a vengeance during the 1990s, Cohen’s reputation grew as well alongside. In 1998 a BusinessWeek cover story named her "The Prophet of Wall Street," noting that her opinions about the stock market today "carry more weight than anyone’s, with the possible exception of Warren Buffett’s." Cohen has often ranked first among strategists in analyst surveys conducted each year by Institutional Investor magazine and by Greenwich Associates.
Cohen’s formidable abilities were on display on January 21 when she spoke at the 26th annual Whitney M. Young Jr. Memorial Conference at the Wharton School. She spoke with characteristic candor. Asked, for example, whether she believes that Internet stocks are overvalued today, Cohen replied simply: "Technology stocks were undervalued until the last year or two. Now they are not. I’m not sure how to value Internet stocks. When I ask people about how they value these stocks, they tell me, ‘We think about them as a private business model.’ We ask whether the companies will be cash-flow positive, and when we believe that they will, we are very happy to invest in them."
Most of Cohen’s presentation, however, did not deal with Net stocks or the dizzying heights to which they have risen. Instead, she focused on the factors that have driven the recovery of the U.S. economy during the past decade, and what could potentially go wrong in the future.
During the 1950s and 1960s, the U.S. economy did exceptionally well, but its performance declined during the 1970s and 1980s. Spending on R&D slipped, profit margins were squeezed, and the labor market was in an uncomfortable situation. In addition, the country faced a budget deficit that exceeded 6% of GDP. Little wonder that many economic pundits were bearish about the country’s prospects. "But the good news was that this situation was fully priced into the stock market," Cohen said. "The S&P 500 was undervalued in the early 1990s."
By 1991, Cohen noticed that something new seemed to be happening: Spending on new technology, especially on computers and telecommunications equipment, was growing by 25% a year. The reason was that several companies had recognized their problems and decided to deal with them. Another factor that forced this recognition was the end of inflation. While inflation was high during the 1980s, it had provided a smokescreen behind which companies could hide weak performance. When that smokescreen blew away, businesses had little choice but to face reality.
U.S. corporations did this through corporate restructuring, which occurred in two phases, according to Cohen. In the first phase, companies wanted to boost their awful returns. They did this by identifying their weakest operations and hacking away at them to get them off their books. The result: Corporate downsizing. "Shareholders saw returns increase, but as a nation we had great angst," Cohen said. "Jobs were being lost and not being replaced. If that were all there was to restructuring, this boom would have ended."
The reason the boom persisted had to do with the second phase of corporate restructuring. This time around, companies identified their strongest operations and tried to strengthen them even more by investing in what they knew how to do well. "This can be measured in the economic data," Cohen said. "Computer hardware, software, telecommunicationsall these have grown as a percentage of GDP. There still is downsizing, but on a net basis, the U.S. has created 16 million new jobs during the last five years." Europe, in contrast, has lost 1 million jobs and is just getting started on the first phase of corporate restructuring, she added.
Cohen believes that the core strength of the U.S. economy has helped the world economy. Employing one of her favorite metaphors, she referred to it as a "supertankersteady and reliable."
What, then, could go wrong? Could the supertanker become the Titanic, as Cohen’s critics have sometimes alleged? Cohen sees the main danger stemming not from forces inherent in the economy, but from a mismatch between economic needs and public policy.
The U.S. economy is going through a major shift, Cohen said. Economic historians have shown that such shifts occur once or twice in a century. When the U.S. economy began its shift 100 years ago from an agricultural economy to an industrial one, an important shift also occurred in public policy, emphasizing public education. As a result, "We created the largest single group of literate people on the planet," Cohen said.
A similar shift occurred after World War II when the U.S. changed from a smokestack manufacturing nation to a high-tech industrial nation. Again, a corresponding shift occurred in public policy. Policies such as the GI Bill of Rights, which gave soldiers returning from the war access to school funding, opened the door to educational opportunities to vast sections of the U.S. population. Result: "We created the largest single group of college graduates on the planet," Cohen pointed out.
Today, once again, the U.S. economy stands on the threshold of a massive economic and technological shift, "but we don’t see an appropriate shift in educational policy," Cohen noted. By way of an example, she mentioned her youngest daughter, an eighth grader in the New York City public school system. Cohen’s daughter attends a computer lab at her school. Cohen recently asked her daughter what she did at the lab, and she replied: "Today we taught our teacher how to build an Excel spreadsheet."
This, Cohen argued, is a matter of serious concern. If people who have technical skillssuch as building spreadsheetsdo not want to teach in public schools, students will be ill equipped for the tasks that confront them when they join the workforce. If the U.S. wants to sustain its long economic boom, the country must invest in educational skills that the technical shift in the economy demands.
That’s quite a prophecy from the Prophet of Wall Street.