The View From The "Flat Market Society"

Stocks may be rallying, but the overall trend will continue to be flat. That's the view of William Wolman, longtime BusinessWeek economist, author, and TV commentator, who styles himself a member of the Flat Market Society. And he looks for no more than 2.5% growth in the economy in 2003's second half. One of his concerns is the severity of competition in high tech between the U.S. and Asia, particularly China and India. He also points to the decline in U.S. employment, which he describes as the biggest since the demobilization at the end of World War II. And he worries about the twin deficits in the budget and in the balance of trade. "A clear unmitigated disaster" is how Wolman describes the recently enacted Bush tax cut as a stimulus for long-term growth. For one thing, he notes, corporations can reap the same tax benefits for investing outside the U.S. as in. These were a few of the points Wolman made in an investing chat presented June 3 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk. Q: Do you think this market rally is for real or a bear trap? A: It's simply foolish to say that this rally has not been for real, and it may last a while. But as you may remember, I'm a member of the Flat Market Society -- a doctrine which I pronounced when the market was about where it is now, and perhaps a little higher. It's my belief that the flat market will turn out to be essentially correct as of the time that I announced it. My expectation is for about a 2% inflation-adjusted rate of return on investment in stocks. And if that's the case, the market is not about to embark on a vigorous run. Q: What's going to happen with our bond funds now that the market is making a rebound? A: I believe that interest rates will continue low for a considerable period of time. That's not to say that there might not be some small increase in rates from existing levels, which would obviously hurt money invested in bond funds, especially Treasury bond funds. What's striking, of course, has been the spectacular rise in the prices of junk bonds as the risk premium has declined. I would be a little worried about those bonds right now, since I do believe that that the expectation of recovery is a little too strong to be justified. Q: What's your best guess for growth in the third quarter and for the year? A: It's clear that we're having some kind of a mild uptick at the moment, but I don't expect economic growth to continue strong through the second half of the year. I'm essentially a 2% to 2.5% growth man for the second half of 2003. Can I make a couple of points? By accident I tuned into Charlie Rose on PBS last night -- not something I often do. But he had an interview with Andy Grove, the famed chairman of Intel (INTC). Grove argued that the position of the U.S. in world high-tech production is eroding and will continue to erode simply because the quality of the competition from China and India is growing very rapidly. [Grove] also pointed out that the pool of young engineers and technologists, from whom creative ideas will come, is growing very rapidly in those countries simply because some 30% to 40% of their college graduates are in this field. The figure for the U.S. is 5%. I noticed another thing this morning, which is simply that we had the longest sustained decline in employment since one that began when the U.S. began to demobilize as a result of V-E Day. That was a profound change in the economy. The loss of jobs to countries that are doing better in educating a highly motivated tech workforce is also a profound change in the prospects for the American economy. Nor will we be saved by the kind of deferred demand that stimulated U.S. growth after World War II. There's simply no way that autos and housing, which have sustained the economy for the past couple of years, will show rapid growth rates over the next couple of years. We're in a period of fundamental change, which is not widely appreciated -- and which is being attacked in exactly the wrong way by the Bush tax cuts. Q: Bill, what did you make of Greenspan's comments today? A: He did say there were "dramatic" signs that the economy is reviving. But he also said the prospects for the economy continue to be uncertain. It's apparent that the market was not deeply influenced by his thoughts. There is, however, an overwhelming degree of belief among the Wall Street pros that the Fed will cut rates once more sometime over the next eight weeks. Q: I can't understand why the bond market seems to be ignoring the ballooning government deficits. Why? A: That's an excellent question. And I can't explain it too well, either. I would point out several things. First, the private demand for funds is relatively weak. Second, many people and particularly institutions are still spooked by the possibility of a market decline. Third, there's fear among sensible people that the fall in risk premiums in the corporate market and the state and local bond markets is overdone. Under those circumstances, there's still a very strong demand for the safety of U.S. government bonds. One further point: We're running huge balance-of-trade deficits, which means that money is piling up in the hands of foreign countries. And on some fundamental level, they are even more spooked about the prospects for the American economy than are conservative American financial institutions. So the demand for government bonds continues strong. Q: Where would you be putting your money now and for the next three months or so? A: That's a very good question. My standard argument on this -- the one that is made in The Great 401(k) Hoax, which I co-authored with Anne Colamosca last year -- is that the best investment was in the government's TIPs, the inflation-indexed bonds issued by the U.S. Treasury. There wasn't much inflation last year, but those bonds still paid almost 4%. The point involved here is that the real rate of return on those bonds is guaranteed to be about 3%, or a little higher, and I still like them. Q: Bill, long ago you were something of a deflation hawk. Is it on the way -- or here? Suddenly it's on a lot of lips. A: I did begin to express the opinion that the possibility of a falling inflation rate was far greater than the possibility of a rising deflation rate. And that has certainly been true over the past three years or so. I still think there's a huge amount of excess capacity in the world economy. And, more important, that highly effective competition from workers abroad will continue to keep wage income down in the U.S. -- it actually declined for the average worker over the past year. Wages will continue to be very weak. However...I do have some concern that the weakening of the dollar partly because of the Bush tax-cut program will, in fact, put a certain amount of inflationary pressure on the U.S., simply because of a rise in import prices. So I do believe that, at least in the short run, we are in for something of a reversal, and we might begin to see some price up-creep next year. The U.S. is a country that is blessed in many ways, but no country can run huge twin deficits in the balance of payments and in the government's budget without paying some price at some point. Q: Do you think capital spending will send techs higher? A: If Andy Grove is to be believed...there ain't much of a revival of capital spending in sight, especially in tech. I would also add, very importantly, that the tax cut makes no distinction about where corporations invest in order to get their tax cuts. They get them just as surely for investing in the Cayman Islands as in Cleveland. Q: You referred a minute ago to the Bush tax plan -- what do you think of it, now that it is law? A: I do think the American economy does need some stimulus, but as a growth package that looks to the long run, it's a clear unmitigated disaster. I say this because, like Andy Grove, I believe that the future of the American economy is bound up in creating an effective, competitive high-tech workforce. And basically, forced cuts in state and local spending, including even at the level of state universities, are doing great damage. Nor is there any evidence of serious scholarship programs in high tech being paid for by the government. So I believe that essentially the "let's-party" attitude embodied in the Bush tax cuts is exactly the wrong thing to do. Q: What about foreign markets? Is it a good play to invest in closed-end foreign bond funds? A: The answer to that question is that it may well be. I would point out, however, that as I see the world, the real engines of growth over the next 10 years will be India and China.... Under those circumstances, the rational places are in the stock markets of those countries. Q: What, pray tell, does affect the market these days? It seems extremely fickle. A: The same things that have affected it since the first trades were made under the buttonwood tree in the first days of the market. I really do believe that for the serious investor the real issues surround global competition, particularly the high-tech competition between us and the big dogs of continental Asia. Q: Having recently returned from euro territory, how much further will the dollar fall? A: That's a complex and intriguing question. I'm not sure that the dollar ought to be falling against the European currencies, against which it has fallen the most. What it should be falling against is the Chinese currency, the Indian currency, and certain other currencies of Southeast Asian countries where it has fallen the least, if at all. The notion that the falling dollar will somehow stimulate American exports is gravely undercut by the fact that America's main competitors in crucial industries have not devalued their currencies very much but tend to peg them against the dollar. It seems to me that a certain disequilibrium is created by all of this and that the beneficial effect of a cheaper dollar are grossly overestimated, especially by Treasury Secretary John Snow. Q: As we move away from a manufacturing base to a service base, who cares about a high-tech workforce? A: That's an excellent question. It allows me to make another point, which is at least very important at least to me, and the point is that many service jobs are also moving abroad via the Internet.... You will find that your bank records are being maintained abroad, that credit-card hounding is being done from abroad, and that a great many pink-collar, so-called service jobs of this kind are being done abroad. Q: You're bearish on tech in the U.S. What industry do you like, going forward? A: I'm not bearish on tech. I'm relatively bearish on tech. I also believe that at some level, the U.S. has great comparative advantage on tech if it does the right things. This is not to be taken as a definitive statement of anything, but in case you haven't noticed, satellite radio has been one of the great market winners of the past couple of months. There is also, of course, the whole issue of biotech, which unquestionably holds the promise of a revolution that will make the electronic revolution look paltry by comparison. That's an area which most serious investors must get to know relatively well.