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How Fast Will The Markets Rebound?
Two Views of How Fast it Will - or Won't - Be
Whether or not we've actually suffered a recession, investors are looking for brighter days ahead. Two Russell money managers share their outlooks for the economy and the markets — and urge investors to be more realistic.
On February 27, US Federal Reserve Chairman Alan Greenspan told Congress that he saw a subdued recovery ahead. On March 5, US Treasury Secretary Paul O'Neill wondered if America had suffered a recession at all. The next day, Mr. Greenspan announced that the recovery had started. The Bank of Canada's governor, David Dodge, was so optimistic about a spring rally that he recently suggested it could even warrant a rise in interest rates.
For investors warming to the recent stock market rally, the real question is, "What lies ahead?" Ultimately, the speed of the recovery may depend on whether there actually was a recession. Critical, too, will be the ways in which the future will differ from the past.
So what might we expect? We asked the opinions of two Russell money managers - Bob Turner, CIO of Turner Investment Partners and Paul McCulley, Managing Director of Pacific Investment Management Company (PIMCO). Both managers commented on the influential US economy.
Turner Investment Partners is a growth manager in the Russell US Equity Fund and the Sovereign US Equity Pool.
PIMCO is one of three managers that over sees the Russell Canadian Fixed Income Fund and the Sovereign Fixed Income Pool.
A Matter of Degree
One of Newton's laws of physics states, "For every action, there is an equal and opposite reaction." Historically, a deep recession brings a big recovery as pent up consumer and business demand turns from cold to hot. Milder recessions thus bring milder recoveries.
Bob Turner is bullish on the economy, although he sides with Paul O'Neill. "Technically we may not have been in a recession if fourth-quarter GDP stands as is." Why? "Consumers increased spending 4% last year, and consumer confidence remains high as does spending on housing."
PIMCO's McCulley acknowledges recovery - principally in the manufacturing sector - but is skeptical about its size. "It will be difficult to have a strong recovery beyond the sunny side of the inventory cycle which is kicking in right now."
Three factors make McCulley cautious. First, the consumer sector did not go through a recession. Consumers kept spending - the housing and auto industries had a robust year - while corporations cut way back. Therefore, a "snap-back type of recovery" cannot, by definition, occur. "We'll be lucky to keep the consumer sector as sturdy as it has been recently," he warns.
McCulley also believes that excess capacity built up during the bubble years will put pressure on corporate profitability. Previous high levels of borrowing and investing raised levels of debt, as sales and revenues in many sectors, including technology, declined. Corporations will not be inclined to spend significant dollars in the near future.
Finally, global demand is not likely to help stimulate the North American economy. "Europe has the wallet but doesn't have the will to spend more," says McCulley. "Japan has neither. The emerging markets have the will but not the wallet. Imports would deteriorate their trade balances."
Turner thinks the vitality of the US economy stimulates global growth, which is eventually beneficial for the North American markets, "Typically, the US starts in a recessionary pattern and the rest of the world follows suit." An improved US economy stimulates the global economy that affects the US economy in turn.
Reading History
While neither Turner nor McCulley foresee a boom, each takes a somewhat different view of the historical approach to predicting the future of the markets. "In the past," says Turner, "every time the Fed quit cutting rates, the S&P 500 went up an average of 19.4% in the next 12 months. After the market bottoms - we think it did on September 21 - it typically rallies about 25% on average before the economy shows signs of improvement. The S&P 500 did that through early December. And after an early year slide, the market has moved to levels not seen since last summer. Everything points to stock prices going up."
McCulley is wary that the past may mislead recovery boosters. "Recoveries have been major in the past," he explains, but investors "are not thinking about what's different this time." The recent recession was different because of a "bubble equity market, bubble business market and bubble business leverage." Recovery may take a different shape.
Redefining Reality
How are investors reacting? McCulley now sees "rational exuberance" which could "morph into irrational" since recession in the manufacturing sector appears to be over, according to several respected indexes. Turner points to money that had been piling up on the sidelines beginning to flow into the markets because, "Investors are not comfortable getting 1.5% on money markets or 5% on long bond funds."
Returns? Both see more modest growth than in the recent past.
Turner states, "We all got a distorted vision in the 1990s. Moving forward we can expect more normal 10-12% market returns."
McCulley urges investors to become more realistic, referring to the second half of 1990s as "a bubble in faith in unfettered capitalism." Investors should expect "equity returns in the mid- to high-single digits in a good-case scenario."
What should investors do now? Turner advises diversification and patience. "If you stay balanced between growth and value, you could get good returns. But you have to reallocate as warranted." McCulley emphasizes reviewing your risk tolerance and determining whether you are overweighted on the equity side after the boom of the 1990s. Like Turner, he advocates periodic portfolio rebalancing for a prudent level of volatility and return.
We'll see what the future brings. But if Bob Turner and Paul McCulley are right, increased prudence and reduced expectations will make most investors' lives calmer.
Date of first use: 3/21/02.
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Frank Russell Company. Russell Investments Canada Limited.
The opinions expressed by the professionals featured in the above article are not necessarily those held by Frank Russell, its affiliates, subsidiaries or distribution channels. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed. The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
Diversification does not assure a profit or guarantee against loss in declining markets.
Source: S&P 500 Index
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