Saturday, January 3, 2009

Dollar Up, Oil Down

Three economists discuss the rising dollar, declining commodities prices, falling corporate prices and the severity of the global recession.

A conversation with:

Alexander P. Paris, president and founder, Barrington Research Associates, Chicago, Ill. Barrington Research is a full-service investment firm, providing research, brokerage, investment banking and asset management services.

Stanley A. Nabi, vice chairman and chief economist/strategist, Silvercrest Asset Management Group, New York, N.Y. Silvercrest is an investment firm that operates primarily as a "family office" catering to high net-worth families and select institutions.

Kenneth Safian is president and founder of Safian Investment Research, a division of Burnham Financial Group. Located in White Plains, N.Y., Safian Investment Research provides investment strategy to institutional investors and manages money.

What state is the U.S. economy in right now, and where is it headed over the next two quarters?

Nabi: The U.S. is definitely in a recession, which will likely last through 1Q'09 or perhaps 2Q'09. The largest negative growth will probably be registered in 4Q'08.

Safian: The state of the U.S. economy is one of major transition with varying degrees of recession among sectors. The next two quarters should be weak, but new government policies by the new Administration could create less consumer pessimism and soften the decline.

Paris: The U.S. economy is in the later stages of a long, modest, overall downturn that began three years ago, but the downside momentum accelerated starting late in the third quarter of 2008 and continued into October. It will see negative gross domestic product growth (1%-2%) for the fourth quarter and into the first quarter of 2009 with a sluggish recovery beginning in the second quarter of 2009.

Do you believe that a severe recession or inflation should be a bigger concern right now for the Federal Reserve?

Nabi: For the next 12 to 18 months a severe recession should be the key concern for the Fed, particularly in the face of the global slowdown currently in progress. Inflation will likely take the top billing in about two to three years as we attempt to finance a ballooning deficit.

Safian: I believe a deeper recession will be of much greater concern to the Fed since it has already reduced rates and provided more funds for the system.

Paris: The Fed has already done enough to keep what is going to be a short period of modest negative GDP growth for the U.S. from becoming a serious recession. But it has laid the groundwork for significant inflation two years from now, which will become the challenge.

Do you expect the U.S. dollar to continue to increase in value versus the Euro over the next two quarters?

Nabi: The U.S. dollar should continue to appreciate, although further gains are expected by us to be moderate. We believe a value of $1.10 to $1.15/euro to be an equilibrium point.

Safian: I believe the dollar will be a relatively strong currency since the Fed stimulated early, and I think a new administration will be favorably viewed at the early stages of a new presidency.

Paris: The dollar is ahead of itself because of its safe-haven role and could correct. But the underlying trend over the next six months should still be up.

Where do you think the price of gold and oil are headed over the next two quarters, and what will be the impact on the U.S. economy?

Nabi: With the dollar seemingly as a "safe haven," gold should take a back seat. A 10%-20% decline in the price of gold (to about $600-$625) is a distinct possibility. Oil has further downside, perhaps to a range of $50-$55 per barrel, as global consumption declines moderately. The unknown on the oil front is how producers with fiscal needs (Iran, Venezuela, Nigeria, etc.) will behave in a period that calls for lower production and lower revenues.

Safian: I believe both the value of the dollar and the price of oil will be firm due to the increased stimuli by the government.

Paris: The price of gold and oil will settle in at levels around or slightly above the current prices. The positive dollar, together with lower oil and food prices, will be a plus for U.S. consumers and the overall economy.

Will the slowdown in economic growth in China have a big impact on the U.S. economy in 2009?

Nabi: China's slowdown should have a moderate but not decisive impact on the U.S. economy in 2009. Many U.S. manufacturers have established beachheads in China, and hence any slowdown will be shared on both ends.

Safian: I don't believe a slowdown in China will have as great an impact on our economy as will the domestic forces within our economy. Reduced Chinese exports to the U.S. may slow the Chinese economy, but it may be a positive for U.S. business conditions.

Paris: It will not have a substantial impact on the U.S. economy. The dollar will not strengthen against the non-Japanese currencies and therefore exports to the region will still remain healthy even with slower growth in China. Any slowdown will also help to keep oil and other commodity prices from rebounding very strongly and that is a plus for the U.S.

What period in our history, if any are applicable, would you compare our current economy to?

Nabi: There are no significant similarities between current economic conditions in the U.S. and those encountered any time in the past 100 years or more. The stagflation of the late 1970s/early 1980s was spawned by the very high and unsustainable interest rates of the period. It was also a time when the U.S. was in the process of rapidly losing its smokestack industries. Finally, even with high inflation and equally elevated interest rates, the financial system managed to function better than at present. (Parenthetically, invoking similarities to Japan of the past 16 years misses many differences).

Safian: I don't believe there was any prior period that was similar to the current environment. The 1987-1990 period was similar in some respects since corporate debt was over-extended, speculation existed and a recession unfolded later.

Paris: It is probably more comparable to the 1973-1975 period, which had a jump in oil prices and a severe housing correction. The recent U.S. bear market was also about the same size.

What year-over-year rates of change do you expect in corporate profits in 2008 and 2009, excluding banks and insurance companies?

Nabi: We expect corporate profits (after-tax) on a National Income Account basis to decline about 8.5% in 2008, with a further decline of 4%-5% in 2009, both year-on-year. Standard & Poor's operating earnings are forecast by us to decline by about 17.5% in 2008, with further decline of about 4.5%-5.5% in 2009--in the latter case mostly registered in the year's first half. Non-banks and non-insurers will likely report a 4% increase in 2008 and a 12% decline in 2009.

Safian: Your question about profits is interesting because U.S. nonfinancial corporations experienced a drop in domestic profits and an increase in foreign nonfinancial earnings. In 2007, such domestic profits were $868 billion compared to $939 billion in 2006. U.S. nonfinancial affiliates abroad had $261 billion in profits in 2007 compared to $202 billion in 2006.

These profits are before taxes. Nonfinancial corporate profits, as reported in the GDP accounts before taxes, were $1,006.5 billion in 2007 and $1,042.5 billion in 2006. In the second quarter of this year, those profits were $796.8 billion. Needless to say, we could expect profits to be down for 2008 and expect a moderate rebound at the end of 2009. The sector profits will be the story for 2009 and we need to await the new administration's ideas before making estimates with conviction.

Paris: We don't do detailed earnings forecasts for the market averages. Generally, the bulk of the heavy estimate reductions are in the process of switching to nonfinancial stocks. Since we don't expect a severe U.S. recession for 2009, we would only look for a single-digit decline in earnings, down in the first half but recovering in the second half.

What do you expect the annual change in the Consumer Price Index (including food and energy) to be in 2008 and 2009?

Nabi: The CPI is expected by us to increase 4% in 2008 and 2.2% in 2009, both year-over-year basis.

Safian: We would expect the year-over-year figure for the CPI to continue to decline as it did from August (5.4%) to September (4.9%). The December figure could be in the 4% area. As far as December 2009 is concerned, it's just a guess since new administration policies will be a major factor.

Paris: The CPI will be up around 4% in 2008 and up 1.5% in 2009.

Michael Ozanian, 11.07.08, 06:00 AM EST


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