Markets: Two Big Questions
New York: March 01, 2004
By John R. Stephenson

The two big questions over-hanging the stock markets this year are, 1) is the Fed going to raise interest rates later this year and 2) will the dollar reverse trend and trade higher? My answer to both questions is "no."

My rationale is based on a combination of economic reasoning and political reality. With the US electorate set to go to the polls this November, a key issue that is starting to shape up is the issue of jobs. Perhaps it is Lou Dobbs' persistent pounding on the table about "the exporting of America" or perhaps it is the economic reality that this has been a "jobless" recovery. What jobs have been created are largely in the low wage construction and retail sectors (and many are being performed by illegal immigrants - as reported in the Dobbs report - week of Feb. 23d). Add to this the most likely mistaken promise by members of the Bush White House that the economy would create some 2.6 million jobs this year (around 200,000 per month) and you have the central political issue for the year ? jobs.

With surging productivity domestically (reducing the need to hire) and a clear trend towards outsourcing of jobs overseas (including highly skilled work) it seems unfathomable that the US economy could "create" 2.6 million new jobs. Add to this a softening in consumer confidence and slowing retail and housing data and you have a recipe for slower, not more robust, future job growth.

The Fed (US central bank) could raise interest rates to protect the US economy from the scourge of inflation. But with capacity utilization rates nowhere near the level necessary for demand increases to run into supply constrictions, don't look for the Fed to raise rates any time soon. The only price increases that the US economy is seeing have come in the form of higher oil and energy prices, which act as a tax hike on the US consumer. Of course, higher interest rates could help support a falling dollar, but a lower dollar can help out the political agenda at home by increasing the likelihood of a rise in employment numbers.

So could the US dollar rally? This, too, is unlikely. The economics here are simple. More capital has to flow into the US than is being sent abroad by the enormous current account deficit. This was the case in the 1990's when the US stock market was surging (think tech stocks). But with experts around the world agreeing that valuations (stock prices) look more attractive in virtually every other foreign stock market, the likelihood of increased capital flows to the US equity markets is minimal. In fact, the only serious investor in the US has been foreign central banks which last year poured some $300 billion into US treasuries and nearly half of that again in the first two months of 2004.