It starts with the little things. Fifth Avenue merchants notice the crocodile handbags aren’t moving as fast as anticipated. For-sale signs begin sprouting up on Chappaqua’s lawns in unusual numbers. And all those head-hunters – did they just stop bothering me, or are they not calling anyone anymore?
Those are the first signs. Not massive layoffs or sob stories about bankruptcies and pensions stretched too thin. This downturn is sneaking up on little cubs’ feet, not stampeding in like the bulls at Pamplona.
In fact, measured by the most visible economic thermometer – the nationwide-employment index – the country and the region still remain healthy, even a bit feverish. But by every other gauge, things are falling apart. Rapidly. That 4 percent employment number is not giving an accurate read on the mood of American business. It mocks the underlying weaknesses and, ironically, is creating the kind of false confidence that ensures that we slip into a recession as early as the second quarter of 2001 if the Federal Reserve doesn’t do something to stop it.
You wouldn’t know it from listening to the two guys whose dimpled chads are being recounted down in Florida. During the presidential campaign, both candidates sought to identify themselves with the continual prosperity – now just a hangover from a previous century. The irony, of course, is that while they were beating the hustings and talking about how to spend our newfound bounty, it was disappearing beneath their feet. The protracted postelection recount only prolonged the uncertainty, leading to a more fearful consumer and a harder economic landing.
The economic folk in the Clinton administration understandably seem prouder of what they see in the rearview mirror – deficit reduction galore – than what lies ahead. But from my trading turret, where I have to watch the price of the U.S.’s real merchandise change every day, and from my phone, where I listen to the pleas of hundreds of companies a week in conference calls about the state of their (faltering) businesses, I know what’s happening. I’ve seen this pattern before, mostly in 1990, when no one expected a slowdown. No one. But we got a whopper anyway.
The last straw will come this holiday season.
If it’s that obvious to me, why haven’t you noticed the decline yet? First, business was so robust coming into 2000 that you can’t expect a total about-face overnight.
Second, the instrument of the decline, the six rapid rate increases by the Federal Reserve over the past year and a half, was administered more to slow down the stock market, not to cripple the whole economy. Fewer increases would probably have done the job, and the economy would have had what we call a soft landing, but now a hard landing is in the cards because the Fed became obsessed with the rising nasdaq and feared that it was about to produce a Japanese-style meltdown. (That’s when everybody borrows money to buy stocks, and then the market crashes, destroying purchasing power for a decade and producing a permanent recession.)
The Fed just wanted to clobber the animal spirits in the stock market. By making money more expensive to borrow, it increased the risk for those who were buying high-flying stocks while margined to the eyeballs. Chairman Greenspan had to know that one of the unintended consequences of braking the stock market would be the breaking of the real economy, the economy that needs easier credit to stimulate consumer demand for goods big and small, cars, homes, and everything that goes in them. He knew that higher rates pause the real economy, not just margined stock jocks. But he couldn’t stop himself. He was haunted by visions of the wrong turn made in Japan when its real economy got crushed by stock-market speculation, when yen that should have gone for production or purchasing got channeled into a too-vibrant stock market. The result? A vaporized stock market and a vaporized consumer. Greenspan couldn’t let that happen here. Not on his watch.
Finally, New Yorkers are less likely to see the slowdown coming because the bonuses in New York were so bountiful last year that funds are still buoying the real-estate and vacation-home economy. But wait two months. The real-estate boom will be a thing of the past and so will all the other high prices it brought with it.
You might not want to join the bidding war for that $900,000 house in Jersey they sold for $400,000 six years ago, the last time things got tough in the securities business. I can’t imagine that those Madison Avenue retail leases cut earlier this year will seem so smart a few months hence. And you may not have to call so far ahead for those hard-to-get restaurant tables. In fact, I would suspect that the busy spot market in Nobu restaurant reservations my former assistant once maintained may dry up entirely!
Where is the weakness concentrating? In consumer spending, that’s where, which represents two thirds of our gross domestic product. Retail, as represented by Home Depot, Wal-Mart, BestBuy, Gap, May, and Federated – pretty much every major player there is – has turned radically soft. Every one of these companies has signaled a slowdown. That’s an unprecedented across-the-board cry for help.
Alone, those companies couldn’t knock the economy over. But the car companies are also crying uncle. Ford, with its crushing P.R. problems from the Explorer debacle, can’t be expected to report good numbers. But it is the stunning tail-offs at General Motors and DaimlerChrysler, both of which would have been expected to take some market share from Ford, that have me more worried. GM’s lots are piling up with cars and Chrysler is bordering on double-digit declines in sales. That’s staggering. Particularly disturbing is the stagnation in light trucks. That’s been the cash cow of this group through thick and thin, and supply has finally caught up with demand. And then some.
The automakers are all in hope mode, betting that sales will come back. But all that does is put more unsold cars on the lots, forcing lower prices and lower profits than expected. I suspect that sometime, hopefully after Christmas, they will come to their senses and address the markets in their own time-honored way: with massive layoffs. Just two weeks ago, we saw our first auto-plant idlings in ages, and our first are never our last. Maybe then it will become obvious to others, especially the Fed, that the economic landing will be the kind that comes when the landing gear gets stuck in the up position.
Normally, as important as autos and retail are, we would simply hide behind the strength in tech. That’s been the real driver of the economy. Just not this year. The personal-computer complex – all the companies that devote themselves to that market – has faltered badly. The Net, last year’s savior, now seems like a bad joke. And telecommunications?
Well, let’s talk about telecommunications. For the past two years, we have been in the midst of an unbelievable spending boom, as fourteen different telephone companies sought to build out their networks with the hope of selling you their data services. They all got financed with cheap debt because the capital markets were so robust last year after the Fed turned on the liquidity spigot – creating billions of extra dollars – to make sure we didn’t falter during the Y2K transition. (Remember Y2K?)
Turns out, of course, that these companies then declared price war after price war, to the point where they are virtually giving away their voice lines to get your data business, but there isn’t enough data business to go around. Now they need more money to finance their build-outs. And the capital markets, which were so generous to them for so long, are today, thanks to tight money, closed to anybody who needs money to grow. These markets financed more than $200 billion in high-yield bonds for telco build-outs in the past seven years, and now they are choking on the stuff.
In fact, these bond markets have almost stopped functioning for anybody because of the prospect (and reality) of massive defaults by these fledgling telco systems. It’s a crisis that’s not as grave as the S&L fiasco of the late eighties, but it has paralyzed the corporate debt markets far worse than anyone in that market ever expected. We wouldn’t feel the pain of the investment houses over this telco paper if we didn’t live in this area. But the debt market’s woes will crush this year’s bonuses throughout Wall Street.
I can’t stress enough the tsunamilike effect this decline in corporate bond issuance and corporate bond trading may have on this area. This was the worst year ever for the old Masters of the Universe crowd, those once-titanic bond traders and salespeople featured in The Bonfire of the Vanities. When I was a young pup at Goldman Sachs, at about the time Bonfire was written, I can recall tortured trips in the elevator that we equity paupers shared with these Masters of the Universe bondies. They would brag about how much money they were printing as they collateralized everything but their mothers and sold them to pension, mutual, and savings-and-loan funds with massive fees built-in. I would moan about our lowly exposed stock commissions as I would watch these folks rake in ten times my take with hidden points that they buried in all their transactions. Fixed income ruled! That’s always where the big money was. (You think Jon Corzine got all that walking-around money trading stocks for a living?)
Not everyone’s going to make it to the next trench.
But that market’s been in an extended tailspin that started when Robert Rubin put an end to the massive Treasury auctions that used to so disrupt our financial markets on a regular basis. (He could do that, of course, way back in the nineties, because the government didn’t need to borrow so much anymore, and because spending had at last slowed, and because taxes had finally been raised.)
The bond market took another hit when once-lucrative municipals turned into a small retail business because the government changed the rules and every two-bit metropolis couldn’t issue them anymore.
But the real blow to the bond market came when Long-Term Capital, the biggest account on the street, collapsed along with all of its me-too counterparts at every major brokerage house. (These brokerages were often their own best clients!) When the Greenwich geniuses went bust, they took with them a whole echelon of people who did nothing but buy and trade bonds with leveraged capital supplied by the brokerages. When you take giant clients out and shoot them, you don’t have any place to put the bonds you want to sell. So they don’t get created. This year everything in the bond market came unglued because the biggest issuers, the telephone companies, ran out of money, and the biggest holders, the junk-bond mutual funds, lost their appetite for anything telco after a couple of large-scale bankruptcies.
Thousands upon thousands of people make their living in this city creating, trading, and moving bonds back and forth from one account to another. They are all simply trying to look busy these days. They have nothing to do.
Their suffering will spread to all those who work in fixed income at all of the big brokerages, and the equity side won’t be able to offset the losses this time, because the initial-public-offering market, so vibrant just nine months ago during the height of the dot-com craze, is now moribund.
Those equity folks aren’t going to have much to do either. They used to plug their account base full of New Economy stocks that now look surprisingly like Old Economy stocks, meaning that they go down just as much as those fuddy-duddy industrials. Companies that venture capitalists fought over to invest in now go begging. The idea of tapping the public for funds for early-stage start-ups now seems like some sort of charming Disney fantasy. Unfortunately, the reality is that it happened 300 times in the past two years, and nobody has anything but losses to show for it. The real embarrassment is that Silicon Alley, which did its best to put itself on the map of New York’s consciousness, today seems positively Blind, if not outright Tin Pan.
And it’s not just our markets that are feeling the pain. During the past decade, whenever our economy went soft, we could always count on some of our overseas trading partners to help us out. But this time we have two macro concerns working against us: the euro and the price of oil. Ever since Europe switched to the euro, it has gone down, cutting off the purchasing power of a whole continent. And the source of that weakness? The high short-term rates the Fed put in earlier in the year, which make dollars a much more valuable commodity than euros. As long as those rates stay up, the euro stays weak and the appetite for our goods stays low.
We could handle that handicap if oil weren’t so darned high. The rise in oil acts like a tax for everyone, but its pain is felt disproportionately by our Asian trading partners, who are all huge crude importers. As long as oil stays up, we can’t count on Asia to take more of our exports than it is buying already.
Now we come to the inevitable result of all this, the weaker consumer spending that comes from the feeling – wholly created by the cooling stock market – that we just aren’t as rich as we used to be. Sure, the stock averages are right about where we left them last year at this time, but the pain of knowing how high we were just eight months and 2,000 nasdaq points ago seems to hit us right in the pocketbook.
The last straw will come this holiday season, which now looks as if it might be the weakest in years, and prospects are getting weaker as confidence is sapped by the presidential-election fiasco. Those companies that are hoping for a strong December to bail them out look increasingly like deluded dreamers unwilling to recognize that the now yearlong decline in the stock market is going to keep spending much lower than it was in the previous five Christmases past.
And what of the future? Next year, look for serious price wars in the retail sector as the great ones, the Home Depots and the Wal-Marts, try to finish off the competition. In housing, supply will catch up and finally overwhelm demand, though the superrich sellers will feel it worse. (Unless Bush manages to get into the White House after all, and he gives them all that tax relief!)
Does it have to be this bad? Could something be done right now to put us back on course? Absolutely. If the Fed were to lower rates, it would correct just about every course that is going awry right now. The automakers could finance their inventories more easily, foreigners would have stronger currencies, the brokerage houses would have looser credit to help growing businesses, and the equity markets would be refreshed. But as long as employment – that great camouflage that papers over the real weakness – remains strong, it just won’t happen. So the hard landing beckons and the recession that the U.S. has eluded so well in the past decade will hit us when we least expect it.
The consumer is no dummy. Without a positive signal from the Fed that it is more worried about a slowdown than it is about overheating, we all have to pull in our horns. We have to sideline our capital until the Fed undoes what it did to brake the stock market in the first place – by taking rates down to more reasonable levels.
But as long as the Fed is more concerned with inflation, as it reasserted this week, and the slowdown accelerates into a recession, we’re going to need every penny we have to get through the short term and prepare to take advantage of the upcoming bargains. Because those who didn’t plan for the future are going to be stretched too thin, and they’re going to have to sell. Eventually, the Fed will change course and loosen the purse strings again. But not everyone’s going to make it to the next trench.
In New York, it will never be as dire for the great middle as it will be for the upper end, because the thriving part of this economy is a cash economy, fueled by low-end job growth and a shortage of available workers to do the gritty jobs. The glut is at the highest end, the top corporate folks and their high-level associates who sold financial products.
My advice: Save a little more. Spend a little less. You will be able to get bargains in everything from stocks to homes, at prices that would have seemed like gifts just three seasons ago. Frankly, after the frenzied pace of the home-bidding wars and the nonstop rise in rents, a dose of tough Fed medicine may be what this economy needs to keep from pricing out all but the world’s most affluent 30-year-olds. You may have to take less for your house when you sell it, but it shouldn’t be too drastic, since there will always be anxious foreigners who want into our local markets.
I’ll be riding out the storm by staying liquid, keeping my powder dry for when the Fed comes to its senses. That’s when you’ll need every penny, because that’s when fortunes will be made in a very short time. If there’s political gridlock, well, the markets love gridlock, so just hang in there, choose your moment well, and, if you can just manage to time it right, everything will turn out fine.
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. His fund often buys and sells securities that are the subject of his columns and articles, both before and after they are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer’s writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites comments at firstname.lastname@example.org