How low can global markets go? (page 2 of 2)

Therefore, rate cuts in this sort of condition acted as a powerful catalyst for a market rally.

The rate cuts of 1987/88, 1989/90, and 1995/96 also produced stock market rallies in the subsequent 12 months, but these were more muted. In addition, I have to point out that these rate cuts came at a time of 'still' reasonable stock market valuations, and when the stock market capitalization as a percent of nominal GDP never exceeded 100%, compared to 150% now.

Hence on all previous occasions of FED interest rate cuts, with the exception of 1998, the US stock market valuation was far more reasonable than it is at present. Of course, the bulls will point to the 1998 rate cuts, which came at a time of high valuations. They will argue that even though the market may now be expensive by historical standards, it will rally as it did between 1998 and March 2000.

The difference, however, is that we are, unlike in 1998, not in the midst of a high tech boom, but in a phase of a bust. Moreover, we are not dealing with an inventory liquidation, as everybody seems to think, but with the dynamics of a capital spending downswing, which is characterized by excess capacity, weak pricing and decelerating, or more to the point, declining corporate earnings.

And because high tech has been driving the economy since 1998, FED easing could be fighting a losing battle against disappointing or poor corporate profits among high tech companies. It should also be noted that the NASDAQ is still valued at more than 100 times earnings, which is roughly twice as expensive as it was in 1998.

But even if the bulls are right about both the FED and history being on your side, we are, given the high stock market valuation and deteriorating economic conditions by no means in 'the lowest risk, highest reward environment possible.'

Quite to the contrary, we only have Mr Greenspan on our side, a desperado, whose judgement has to be seriously questioned, since his monetary policy created history's biggest-ever stock market bubble. That aside we have, in my opinion, the highest possible risk and lowest possible reward environment on our side.

I should just like to emphasize that low risk entry points into markets arise only after a long lasting and severe bear market, followed ideally by a lengthy base building period, and amidst very low volume, which indicates that all the speculative excesses have been purged. That we are not in such an environment ought to be clear to everyone.

At present no one knows how the economy will perform six, let alone twelve months from now. Personally, I am extremely skeptical of the current consensus, which calls for renewed growth starting in the second quarter of 2001, since all economists failed to forecast the current slump.

In fact, I am leaning toward the view that the first few months of this year may look somewhat better than expected, but that the second half will reveal weakness across almost all sectors of the economy. Deflationary forces are very powerful at this point and could lead to several years of disappointing corporate profits.

This will be true not just for the high tech sector, but also for most of the large multinationals around the world, as competition from companies in emerging economies intensifies, and as patent rights come increasingly under pressure. Excessive monetary easing by Mr Greenspan, however, is preventing deflationary forces and could lead to some kind of stagflation.

In particular in the United States, deflation may not occur through an adjustment in the domestic price level, but through a sharp decline in the US dollar. So both the US dollar and US equities remain vulnerable to further setbacks.