Uncertainty is economic poison: CEOs rely on best guesses about the future to make decisions about how many people to hire, how much to spend on new plants and equipment. If no one dares even feign confidence in forecasts, business tends to grind to a crawl, which is happening all over the world. Even though the memory of 9-11 is 12 months dimmer today than it was last January, the sense of fear and confusion in global markets is just as pronounced, if not more so. Many companies announced wildly optimistic earnings outlooks in early 2002, expecting a recovery that never came. Global stock markets have now closed lower for three years in a row, the first time that has happened since the last years of the Depression. Richard Bernstein, chief quantitative strategist for Merrill Lynch, calculates that quarterly earnings in the past three years were the most volatile in 60 years (chart). “Many people say the market can’t be down for a fourth year. Well, why not?” he says. “Earnings are the least predictable they’ve been since 1943.”
The New Year started with a mini-rally on Wall Street that created a brief illusion of confidence, but it was quickly wiped out by earnings reports. Companies were either cautious about their prospects, or they were greeted with great skepticism. Tech survivors like Microsoft, Intel, Yahoo and eBay all beat Wall Street expectations, which normally sends stocks upward. Instead, investors focused on the caveats, like Intel’s warning that it plans to cut capital spending by as much as 25 percent this year, and tech stocks fell backward. Wall Street is starting to ignore company “guidance” on earnings, even from companies with no black marks on their accounting credibility: when Ford predicted earnings of 70 cents a share in 2003, analysts barely revised their own forecasts, which hover around 45 cents a share. “In a flat market there are no prizes for getting ahead of yourself,” says Peter Blackmore, a vice president of Hewlett-Packard, which has not yet reported earnings. “It’s just sensible.”
Others no longer dare look beyond the short term. Asked whether the rather conservative forecasts offered by companies for the first half of 2003 will hold up through the year, Charles Hill, director of research for Thomson First Call, responded, “I don’t know, I just don’t know!” Why not? For one, says Hill, companies have been sustaining earnings by cutting costs or rebuilding inventory, but they can’t do much more. The new driver of profits has to be sales, and those depend on the future of the economy, which remains foggy in part because of uncertainty over events in the Middle East. The range of economic forecasts for the U.S. economy is also unusually wide (though not quite as wide as it was immediately after 9-11), according to Consensus Economics of London. At the World Economic Forum in Davos last week, Morgan Stanley’s bearish chief economist, Stephen Roach, warned that the 2002 recovery was “pathetic.” “The U.S. economy is effectively at stall speed,” he said. “The engine of the world is struggling.” Even some of the “dollar bulls,” who thought a dollar rally inevitable given the basic strength of the U.S. economy, have fallen silent.
Similar jitters grip Europe. Layoffs and losses announced by Italian insurer Generali last week hurt the shares of other European financial companies. When German travel giant TUI announced its earnings, it refused to give any kind of forecast for next year. One reason for the murky outlook is that the world is suffering the aftereffects of a rare business-spending binge, which produced a bigger hangover than a consumer-spending binge would have. Only after business finds a way to use the stuff it bought in the 1990s (think of all those miles of unused fiber-optic cables) will it start spending again. And without capital spending by companies, worries Kit Juckes, global strategist for the Royal Bank of Scotland, “It’s difficult to get enough traction to move forward.”
The possibility of war in Iraq remains the greatest unknown. Last week Bush warned that “time is running out” for Saddam, which erased any bounce that the U.S. market got from word of good housing starts in December. The price of oil has already risen from $10 a barrel in late 1998 to $35.20 last week, reaching a 26-month high. Roach thinks a war could cause a mild recession if oil prices go to $35-$40 a barrel for just three to four weeks. “Markets are poised to bounce, but they hate uncertainty.”
At least for now, though, the word is part of the business lexicon. “Uncertainty is still a commodity, but the flavor is changing from corporate-dominated to geopolitical-dominated,” says Philip Barleggs, head of asset allocation for Rothschild Asset Management. In other words, what happens after Iraq is now a bigger worry than what happens after Enron. He thinks that stock-market investors can expect just a 7 percent return on their money this year, only three points above the bonds, so the reward is not really worth the risk. “Who wants to take a big gamble now?” Barleggs says.
Given how wrong the market majority has been in recent years, it may be worth giving a skeptic like Lehman Brothers strategist Joe Rooney the last word. He thinks all the fuss about uncertainty is “rubbish”: balance sheets are getting stronger, and it’s getting easier for companies to borrow money again. Even if you accept the idea that the world is somehow less predictable than it once was, says Rooney, that’s not necessarily a bad thing. The last time the experts were in overwhelming agreement was in February 2000, certain of the lasting rewards of the New Economy. And we all know how that bout of confidence ended.
