LOM Weekly Perspectives

The huge inventory sell-off last year has raise hopes for a decent pickup in U.S. economic activity in the first half of this year. There is a lot of sense in this viewpoint because the scale of the destocking means that even if consumers are not ready to splash out, there has to be some ramping up of production to meet continuing demand. Indeed there are indications of firming in order books. Also, without getting too excited, we should note a few signs of life in capital spending, on the technology side. At the same time, it is unlikely that inventory accumulation will reach previous levels because firms are still cautious about the vigour of sales growth. Indeed, currently, CEO’s are less ebullient than economists are, about the prospects for the economy. However, given tight cost controls, an increase in productivity should show up in greater operating leverage and higher profit margins -- though, bottom-up analyst expectations are still a shade too rosy.

The main question that remains is whether this evolving scenario can be sustained into the second half of the year, with increasing vigour. Consumer sentiment has been quite positive recently, but this has been largely due to the "expectations" component, rather than the "current-conditions" component. A lot depends on the employment situation. It looks like conditions on the job market may have stabilised, but it is too early to be sure about that. Corporations may have to continue in a cost-cutting and layoffs mode, in order to shore-up the bottom line. So until we get a better read on corporate behaviour with regard to cost-cutting, as well as capital spending, it is better to remain open-minded about the prospects for the latter half of 2002.

Accounting issues continue to overhang equities and this has had a positive impact on the Treasury market. Earlier concerns about larger budget deficits have been set aside as the safe-haven status of government bonds has attracted investors to Treasuries. We are witnessing a valuation adjustment between bonds and equities, though it is not a dramatic one, and government bonds have not traded significantly outside the ranges set in the past three months. Currently, the behaviour of the Treasury yield curve is in response to anxiety in the equity market, and we are in for a spate of volatility as optimism waxes and wanes. Meanwhile, it is no surprise that corporates have been hurt badly by the accounting concerns. Credit analysts will be hard at work reassessing various bond issues about which they may have reservations. At the same time, the credit rating firms, such as Moody’s and Standard & Poor’s, have had their image tarnished because they were quite slow to act in the Enron case. To regain confidence they may be forced to exercise greater vigilance in the future.

For a long time it has been wither gold, as prices have been on a broad down-trend. Traditionally, the two main drivers of gold prices have been inflation and political uncertainty. In the past dozen years inflation has been generally on the decline and political problems have not been sufficiently scary to cause a large number of people to migrate to gold. In a relatively stable environment you get a better return from investing in financial assets than in the yellow metal. Substantial quantities of gold have always been held in official reserves and many central banks have been gradually reducing their stocks in favour of more productive investments. But they still hold very large reserves and remain in a selling mood. In the gold market supply comes from production and out of inventory, while demand is for industrial uses, jewellery, as well as a financial store of value and possible medium of exchange. The problem for gold prices is that even relatively small changes in desired inventory levels can significantly change market conditions.

Global political and economic uncertainty has increased somewhat since September 11 and this has led to greater volatility in gold prices. Often, the increase in demand is restricted to local conditions in a particular geographical region. The recent spike in price appears to be supported by Japanese buying in response to a perceived deterioration in the financial system. But, more importantly, support was provided when at least one major producer announced that it would change its hedging practices, by curtailing sales of borrowed gold. In sum, under current conditions of uncertainty, there is modest upside for gold prices but not a strong up-trend unless we experience a number of unpleasant systemic financial and geopolitical surprises.

Somebody said that the problem with Argentina is that it has Third World levels of productivity while it aspires to First World living standards. This is an unkind statement, but unfortunately largely true. The current nasty economic denouement was predictable, and there is more pain to come. It explains why there has been so little surprise among astute investors. However, the less sophisticated, including a number of pension funds, have paid a price for misjudging the country's social and economic dynamics. Argentina provides a good example of the importance of an adequate understanding and assessment of a society and its institutions. A more in-depth analysis than the standard political risk models run by the big banks.

Argentina has failed to develop stable, viable, efficient organisations and institutions. The surplus provided by a rich agricultural land has not been transformed into sustainable progress. The country has been surpassed by others, less fortunate and less well endowed. There is a saying in Argentina: "God puts right at night the mess Argentines make by day". It seems that even God’s patience has run out. A case of imported ideas, technologies and people that have failed to take root. The sadness of dashed expectations and the lack or realism that leads to the edge of conflict. Easy flow of rhetoric to blame the IMF, the World Bank and Spanish investors. Make the foreigners pay, plunder their banks and pension funds. Hope that their memory is short and they will return. One of Eva Peron's favourite words of abuse was "mediocre". She used it to destroy the myth of Argentina as an aristocratic colonial land. Unfortunately, no other vision or myth has been found to replace it.