With so much economic news expected today, Inquirer staff writer Joseph N. DiStefano asked a local institutional money manager for his thoughts. The following are e-mailed responses from Michael Hogan, head of equity investments at Delaware Investments, a $150 billion money manager based in Center City. Please note that his responses were sent before the release of the fourth-quarter gross domestic product report which showed the U.S. economy grew by 0.6 percent.
Question: What do you expect from today's GDP release?
Answer: We believe [today's] report will show that US economic growth slowed significantly in the fourth quarter. We expect the range to be between 0.5% and 1.5%. It is likely that the positive economic momentum experience earlier in 2007 did continue into the fourth quarter but that the strains within the housing sector and the US financial sector are causing a sharp deceleration in growth. The GDP report will likely continue to point in the direction of continued Fed easings.
Q: Do you expect the Fed will cut 50 basis points from the Federal Funds rate this afternoon? What will happen next?
A: Although we believe that the there is a better than 50/50 chance the US economy will remain out of recession - the severity of a downturn - if one should in fact happen, could be exacerbated as financial distress in one part of the economy spills over into other parts of the economy. If left unchecked - it would likely lead to a rapid deterioration in financial conditions within the economy as a whole and deepen the recession.
Because of this potential - we expect the Federal Reserve to remain particularly aggressive with monetary policy until there are strong signs that the health of the financial sector has begun to improve. We expect a further rate cut tomorrow of between 25 [basis points] to 50 bp.
Because of the complexion of the current economic weakness, it is also likely that Fed actions in the next several months are going to be far more driven by conditions in banking sector and other parts of the financial system than would be normal even if other economic indicators are producing conflicting signals.
Q: What sectors could benefit in a slowdown of the U.S. economy?
A: We do not think that the US economy is technically in a recession - but growth will likely remain significantly slower in 2008 than we have experienced in the past several years. Under this environment the unemployment rate is likely to creep up, the employment market in general is likely to remain weak and the financial sector will remain under stress.
In an environment like this it can be very tempting to look for sectors that are likely to benefit. But this is in fact very difficult to do. The problem is that the stock market has already recognized that US economic growth will likely slow significantly and that the financial sector is likely to remain under considerable stress. Stocks of companies that are negatively exposed to this type of environment have already traded off significantly and may now be priced at relatively attractive levels.
In the current environment, the various Delaware Investments equity teams are looking for investment opportunities across the entire equity opportunity set. This type of environment can produce interesting investment opportunities when an individual stock gets hurt by "guilt through association."
Q: How is this like, or different from, recent slowdowns?
A: All economic cycles have their own nuances, but there are often times important underlying similarities. The problems in this economic cycle have their roots in an environment of overly easy lending terms. There was clearly far too much capital pumped into the housing sector, leading to over building and rapidly escalating home prices. But many other areas also benefited by overly aggressive lending. The strains that began to appear last year in housing spilled over into many other areas. Investors grew increasingly concerned about deteriorating economic and financial conditions and withdrew a large amount of liquidity from the financial system. It became hard if not impossible to sell many complex financial instruments. And housing sales dropped sharply.
The problem now is that credit conditions may have become overly tight. In other words, worthwhile investments may not be undertaken. This can have very negative effects for short-term economic growth - but can also have negative implications for future economic growth as well. In some respects this is a classic "liquidity cycle." In earlier days these types of problems materialized as a "run on banks." So from that perspective we have experienced this before. But every liquidity cycle has its own nuances. Part of the problem this time around is the use of leverage and complex financial instruments that spread risks around the world and greatly increased financial market liquidity. The most effective way to deal with this type of cycle is through aggressive monetary policy and other Federal Reserve actions that are designed to alleviate financial market stresses. This is what is going on now.
Q: What will the government likely do to ease the pain? Will it work? What should the government do?
A: We do not have a strong view on the efficacy of last week's agreement between the White House and Congress on the outline of a fiscal stimulus package. The government already has automatic stabilizers in place, such as unemployment insurance, and those are currently at work. We would generally prefer the government focus on policies that increase the flexibility in the US workforce and leave it in a stronger position to deal with the inevitability of the surge in unemployment that sometimes accompanies economic restructurings, like what we are experiencing today. But these are long-term strategies and not short-term stimulus packages. We feel that the Federal Reserve is the best equipped to handle the challenges in the current economic slow-down.
Q: Will the dollar likely continue to weaken? How does this hurt, and benefit, industrial sectors?
A: We believe that the dollar will continue to decline relative to other major currencies. The large imbalances in global capital flows around the world point to a continued weakening of the dollar - but we don't foresee a rapid deterioration in the dollar's value as some feel could happen. The US has had an extremely low savings rate and as such we have been borrowing capital from other countries. But the countries that have been supplying capital to the US have generally been running extremely high savings rates. Unless their saving rates drop sharply, which we do not think is likely to happen, the dollar will continue to decline in a controlled fashion.
The weaker dollar is a mixed blessing for US companies and consumers. To the extent that US companies are competing on the world market place - the weaker dollar will tend to give them a competitive edge. But many US companies are importing raw materials and intermediate stage components used in the production process. The weaker dollar will put upward pressure on these important inputs.
