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One Year Later:
The American Economy
With James K. Glassman
Investing Columnist
Tuesday, Sept. 10, 2002; 11 a.m. ET
In the wake of the unprecedented attacks on the World Trade Center and Pentagon, many economists predicted a national economic disaster. Early on, it seemed those predictions might be right -- airlines stopped flying, tourism ground to a halt and nervous investors pulled their funds out of the stock market. However, the recession proved to be mild as American consumers went on a spending spree, due in part to a dramatic drop in interest rates as well as tax cuts pushed earlier in the year by the Bush administration.
Investing columnist James K. Glassman was online Tuesday, Sept. 10 at 11 a.m. ET, to discuss investor confidence and how Sept. 11 has changed your economic outlook and decisions.
Glassman is a resident fellow at the American Enterprise Institute, a Washington public policy think tank, where he specializes in issues involving economics, technology and financial markets. He is also host of TechCentralStation.com, a public affairs Web site that concentrates on matters of technology and public policy.
He writes a syndicated financial column for The Washington Post every Sunday. He is also the author of "The Secret Code of the Superior Investor" (Crown, 2002).
Below is the transcript.
Editor's Note: Washingtonpost.com moderators retain editorial control
over Live Online discussions and choose the most relevant questions for
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James K. Glassman: Welcome. Tomorrow, of course, is the first anniversary of the terror attacks of Sept. 11, 2001. The focus of today's discussion is scheduled to be the economic effects of that attack and what happens to the economy and the markets going forward. But, as usual, you can bring up whatever is on your mind. Let's roll... -- Jim
Washington, D.C.:
Mr. Glassman:
Do you think the market will return to December 1999 levels (or whenever the peak was) within 10 years of that peak, or will this ten-year period be the exception that proves the rule that the market always goes u over any ten-year period? Also, have you re-thought your "Dow 36,000" view in light of the revelations of phony accounting that supported the increasing "revenues" of the late-1990s?
James K. Glassman: My guess is that the market will shortly return to its March 2000 peak, but predicting the short-term movements of stocks is fruitless endeavor. The question investors have to ask themselves is whether there is good reason to believe that the future of the US economy will be significantly worse than the past of the US economy. I don't think so, but certainly you could argue that terrorism changes things. As for Dow 36,000 and accounting scandals: no, I have no reason to change the theory Kevin Hassett and I developed because some companies overstated profits and perhaps even revenues. Our theory was based on a 200-year history of stocks, not on a two-year history.
Bowie, Md.:
I have about $5,000 on hand I intend to invest in the stock market. (I already have a stock mutual fund oriented 401K; this is extra investing.) Because the market seems so volatile, I'm investing it through a discount broker at $200/week.
Does this make sense from a monetary perspective, or is the advantage purely psychological? Also, is the market more volatile today than it has been in the past, or is it just an illusion created because it's so high that a 100-point DJIA daily change is common, and no more signficant than a 10-point change was 20 years ago?
James K. Glassman: The latest research I have seen is that the market as a whole has been no more volatile since the mid-1990s than it has been historically. But individual stocks are more volatile. As for feeding money into the market: to do it slowly definitely feels better, but, if the market rises at historic rates, then slowly adding money to stocks is not a smart thing to do. You want to get invested as quickly as possible, since it means that you will have the effect of rising stocks working for you more quickly -- especially at time when money market funds are returning 1 percent or so.
Alexandria, Va.:
Please help me understand what I am missing. The Fed has pushed interest rates to rock-bottom lows. Many other rates of return respond to that. The P/E ratio on stocks is just the inverse of the rate of return to investors in stocks. The lower interest rates go, Economics 101 (which I used to teach) suggests the higher P/E ratios should go. Yet pundit after pundit goes on about P/E ratios being still "too high." Have the laws of arithmetic been repealed, or is there another factor at work?
James K. Glassman: You're right! The pundits are wrong. Think of it this way: Currently, the rate on intermediate Treasury bonds is about 3 percent. The price-to-earnings ratio of the stock market is about 20. The inverse of that is the earnings-to-price ratio, otherwise known as the earnings yield on stocks, which would be 1/20 or 5 percent. So stocks are yielding 5 percent while bonds are yielding 3 percent. And since stock profits rise, on average, each year, the deal gets even better. Now, if interest rates on bonds were 6 percent, it would be quite another story. But you are absolutely correct: when interest rates are low, higher P/E ratios are justified.
San Francisco, Calif.:
What should CPA firms be doing to increase investor confidence in the soundness of the financial statements that they are auditing? Would it help if they denounced the extreme practices at Arthur Andersen at many companies including Enron and WorldCom?
James K. Glassman: Voltaire, when he was in exile in England, once said (and I paraphrase), "In this country, they hang an admiral every year or two to encourage the others." That is what happened in the Arthur Andersen case. Andersen was completely destroyed as a result of the deceptive practices followed by some of its employees and partners. The other big four accting firms got the message loud and clear. There is no better discipline.
Laurel, Md.:
I know it's not today's stated topic, but I have a question about your "beautiful line" column from a couple of months ago.
Procter & Gamble has about as beautiful a line of earnings (as reported by Value Line, where I suspect you got your data) as one could wish, growing from $0.53/share to $3.12. In the five years 1997-2001 they've earned $20 billion, AND THE VALUE OF THE COMPANY HAS HARDLY CHANGED. Their book at the end of 1997 was $11.7B and was $12.0B at the end of 2001. Where did all those earnings go?
Part of the answer is accountable: They paid $8B in dividends and bought back about $6B in stock. But that still leaves $6B in retained earnings that should have increased the company's book value in some way. Did all that money just vaporize into nonrecurring expenses, one-time write offs and accounting changes?
I just used P&G as an example. A bunch of DJIA companies (whose sheets Value Line puts on the WWW) show the same pattern of earnings disappearing somewhere between their income statements and balance sheets. How should one interpret the earnings of a pattern like that?
James K. Glassman: Here is the deal on P&G. I just gave a speech in Cincinnati over the weekend, so it is fresh in my mind. In one week in 2000, the stock dropped from $88 to $53 (P&G had been over $100 earlier). After two years, it's now back to where it was. What happened? The answer is that managers fell asleep at the switch, and some of the company's best brands were in jeopardy because of tougher competition (toothpaste is a good example) and because of no-name brands. The management crisis was solved when a new CEO arrived, but there was a good deal of doubt for a while. The point is this: even with a beautiful line, there are times in a company's life when investors worry about its future (sometimes needlessly but most often with good reason). But a company that can maintain strongly rising profits will recover and do well in the long run, as it seems P&G is going.
Lorton, Va.:
How did the 9/11 attacks affected the legal economy?
James K. Glassman: not sure what you mean by "legal." Do you mean law firms?
Washington, D.C.:
Are you in the camp that says we are in a housing/real estate bubble? I know here in DC with limited supply, it seems unlikely, but do you see a bubble when you look at housing at a national level?
James K. Glassman: I do not believe that we are in a real estate bubble. A bubble is defined as a period when prices rise without a connection with reality or with rational expectations (my colleague, Kevin Hassett, has written a magnificent book about bubbles, just out, called "Bubbleology"). So the question is not whether RE prices have risen sharply (they have), but whether they should be rising. With RE, it is easier to see where reality lies than with stocks. The question is whether rents have become detached from prices. From what I have seen, the answer is no, they haven't. Again, interest rates play a key role. When yields are low on bonds, then rental returns do not have to be astronomical to compete. For example, what kind of rental return would you want from a property costing $500,000? I would be pretty happy today with 6 percent plus a clause that would increase rents with inflation. But if T-bonds were 8 percent, then I would want something closer to 10 percent. Anyway, I do not see a bubble here.
Somewhere, USA:
Do you think there will be another terrorist attack against our stock market? Could there be possible sabatoge in investments and trading stocks by larger financial organizations that are involved with terrorists that we may not know about?
James K. Glassman: I doubt seriously that there will be attacks against the stock market, per se. Too much capital is needed to manipulate markets. I do believe, however, that our electronic communications systems are vulnerable, and it will almost certainly require an attack on them (which would affect the markets) to bring about serious security improvements.
Washington, D.C.:
An off-the-wall comment on the 9-11 events -- they would have to be considered the best investment in 2001. No where in the legal, ethical, or moral capital markets could one person invest $1MM and get a bang of over $100B. Wow! And to think that most of the $100B is now being mis-invested in scams that provide citizens and normal investors little security in or out side the securities markets.
James K. Glassman: Unfortunately, it is cheaper to destroy than to create. What has always amazed (and gratified) me is that most people in the world buy into the idea of civilized behavior. The terrorist attacks of 9/11 violated the basic norms of humanity. Yes, they had a terrible effect -- not only in loss of human life and property but in the shock that there are some people who flout the idea of civilization itself.
Washington, D.C.:
What sectors do you see having benefited from the cash inflow due to the nation's reaction to 9-11? And which did you expect to see such inflows that never materialized?
James K. Glassman: There's an excellent piece by Mark Zandi, published yesterday on one of my favorite websites, www.dismalscientist.com (unfortunately, you may need a paid subscription to access it), that goes through the pluses and minuses since the attack. Clearly, the largest beneficiary after the attacks was the defense sector. One thing that's interesting in Zandi's analysis is that, for 9/11, total aid from government and insurance cos. covered nearly the entire loss (92 percent is his estimate). That's very unusual. In the Los Angeles and Loma Prieta quakes, the midwest floods of 1993, hurricane Hugo, etc., the coverage averaged only about 60 percent.
Arlington, Va.:
How will any possible war with Iraq affect the economy?
James K. Glassman: In general, war is a bad thing for an economy. On the other hand, if a war can increase security going forward, then its effect on the stock market and on future growth can be very beneficial. That was true with the Gulf War and World War II, and I think it will be true of the military action that we inevitably take against Iraq. We will see lower oil prices but, more important, greater stability in a key part of the world. I believe that a war against Saddam has already been discounted (that is, taken into account) by the stock market. Unless our military operation is an utter disaster, it will be good for stocks and the economy.
Scotland:
What percentage of the American GNP is spent on arms/defence/military, etc.?
James K. Glassman: Defense spending in the US is currently $340 billion. The US GDP is roughly $10 trillion a year. So we are spending a little over 3 percent of GDP to protect ourselves against foreign adversaries. That low point for defense spending was about $265 billion in 1995. Clearly, spending will rise, but it is doubtful it will exceed 4 percent of GDP any time soon. In my opinion, that is certainly not too much.
Mt. Rainier:
Mr. Glassman,
I note that the chat is listed as 'economy' rather than stock market, but that you and the chatters seem to identify this as one and the same. Part of the general economic woes, I feel, is this incredible stress placed on the stock market which represents only a portion of the economy of the United States. But as far as the public and economists are concerned, if the stock market is in the doldrums than we are economically in bad shape - even when the economy as a whole is quite stable! Wouldn't it be healthy for us to stress that distinction - that the market is PART of the economy, and the most volatile part at that?
James K. Glassman: An excellent point!
I would put it a little differently: The stock market values American businesses based on their future potential to earn profits -- and the most important element in profit-making is the health of the economy. Those market valuations are sometimes right, sometimes wrong. The economy, however, is a here-and-now entity that we can measure. Sometimes, as today, there appears to be a disconnect between the market and the economy, but that is only because investors are worried about the future.
So let me answer the unasked question that's at the heart of our theme today: How is the economy doing in the wake of 9/11? I will quote Mr. Zandi of dismalscientist.com: "America's rehabilitation from the terrosit attacks has been astonishing." Absolutely. The total US loss from the attacks was about $70 billion -- a big number, which does not include, of course, the psychological effects. Yet over the past nine months, the US economy has grown at an average rate of 3 percent, or about the post-World War II average. We are not completely back on our feet, but we are doing remarkably well.
Washington, D.C.:
If stocks are such a great investment, why won't the market trend? If I owned any stocks and saw the way the market has responded to all the doctoring it has received, I'd be very worried right now.
James K. Glassman: Not sure what you mean by "doctoring."
The stock market has fallen sharply this year, but the Fed has taken no action to cut interest rates.
We suffered a mild recession in 2001, one that probably would not have occurred absent the terror attacks of 9/11. It was the first recession in the US in 10 years (a record) and it followed a period of eight years without a recession (a near-record). I am very optimistic about the US economy going forward, and I think it is incumbent on the bears to make the case for sharp slowdown in long-term economic growth. The only possible cause I can see is terrorism, which I take very seriously.
Laurel, Md.:
A couple answers ago you expressed doubts about a real estate bubble. What about a consumer debt bubble?
Is there an important vulnerability to either an increase in unemployment (and hence personal bankruptcies) or interest rates (catching people or buisnesses with large outstanding debt)?
James K. Glassman: Consumer debt is actually increasing at a very moderate pace right now. It is not a concern currently, but it could become one -- definitely -- if, as you say, unemployment or interest rates rise sharply. Unemployment is low by historic standards, and it is particularly low at this stage in the business cycle (just 5.7 percent and down at last report). Interest rates are at rock bottom. Unless we go into a serious recession in the next few months, consumer credit is not a big worry.
Washington, D.C.:
Where is the best place to invest my money (approx. $50K) now? Has the stock market settled down?
James K. Glassman: For long-term money (at least five years and better ten or more), the best place is the stock market. There are many bargains out there (though, of course, no guarantee that prices may fall in the short term, creating even bigger bargains). I would be happy and eager, if I were you, to put $50,000 to work in a diversified portfolio of stocks, a good mutual fund or an index fund -- but only if it is money that I would not have to touch for at least five years.
Virginia:
Were there more dot.com closing after 9/11?
James K. Glassman: The dot.com meltdown began in early 2000 and was largely completed by the time of 9/11. There are still some shaky high-tech companies out there, and the terror attacks did not help, but, in general, tech companies that survived 2000 and 2001 are stable, deserving firms with good ideas and good managements. There is nothing like a recession to weed out sloppy, insubstantial businesses.
Virginia:
Where should people be investing? This year has been terribly unpredictable. First the attacks, then the scandals. For a small investor, where should we put our money or should we revert to hiding it under our mattresses?
James K. Glassman: Investing requires strategy and discipline. My own strategy comes from history. The data could not be clearer: over time, stocks vastly outperform bonds. The average annual return on stocks, after inflation, has been 7.6 percent; on intermediate and long-term Treasury bonds, 2.2 percent. Even if you buy the now-popular inflation-protected T-bonds, the real return is about 3 percent. The point is that stocks have returned two to three times as much as bonds. BUT stocks are more risky than bonds in the short term. Stocks bounce up and down like crazy over periods as short as a year, two years, even three or four years. They lose money; they cause heartache. But in the long run, stocks clobber bonds. Or at least they have. It is my strong opinion that the trends of the past 75 years -- indeed, the past 200 years -- will continue. Putting your money under the mattress is a sure way to lose purchasing power. At 3 percent inflation (the US average since 1926), your purchasing power gets cut in half every 25 years or so. Who needs that?
Ashburn, Va.:
I understand your point about the economy being strong and the exellent potential for an upswing in the stock market, but, like many Americans, I look at my retirement portfolio and my children's college funds and shudder at the 1/2 to 2/3 losses in value from their highs. Luckily, I am young enough that I fully anticipate recovering those losses in the long term. But I'm sure that making the distinction between the market and the economy does not fully lessen the pain for a lot of people.
James K. Glassman: Definitely.
I have a huge amount of sympathy for people who have lost money in the stock market. But understand that no one gives you 11 percent returns (that's the stock market average since 1926 including inflation) for free. You have to earn the money. The way you earn it in the stock market is by hanging on during tough times, or by buying more at good prices.
Stocks don't go straight up, never have, never will.
And there are certainly alternatives for people who do not want to take the risk: You can buy Treasury Inflation-Protection Securities (TIPS) and make 3 percent plus inflation; you can buy Treasury bills, money-market funds, CDs. All of these will keep you a little ahead of inflation.
But remember that it is precisely at times when investors are sick and tired of stocks and are scared as hell of the market, that stock prices tend to start rising again. No guarantees. We could be entering a terrible time, much different from the bulk of the 20th century. But, if not, then stocks are the place to be.
Somewhere, USA:
Will war with Iraq cause any economic shakes such as with oil prices and stocks?
James K. Glassman: As I said earlier, I think that much of the negative economic effects of a war with Iraq have already been priced into the stock market. Everyone knows that, sooner or later, we will be fighting Iraq and that within a year or so, Saddam Hussein, as vicious and dangerous a tyrant as the world has ever seen, will go to his just reward. Still, my guess is that the markets will react negatively at first when military action begins. When it is successful, they will rally strongly, as they did in 1991 when we won the Gulf War.
Rockville, Md.:
How have changes in our economy affected other global financial systems? I'm thinking that the war would have a negative impact with foreign business relations.
James K. Glassman: continued:
That should change dramatically with our success against Saddam Hussein. Countries such as Saudi Arabia and Egypt, with smart and energetic people, will join the economic and political mainstream (maybe not immediately but with time) and the world economy will benefit.
James K. Glassman: Well, that's all for today. Please continue reading my column in the Sunday Washington Post. Thanks for your excellent questions. -- Jim
washingtonpost.com:
That wraps up today's show. Thanks to everyone who joined the
discussion.
Stay tuned to Live Online:
One
Year Later: Government Since 9/11 at Noon ET
One
Year Later: Richard C. Holbrooke on Diplomacy at Noon ET
What's
Cooking with Kim O'Donnel at Noon ET
Gene
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Strength
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Levey
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Primaries:
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One
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Sally
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One
Year Later: Presidential Adviser Karen Hughes at 1 p.m. ET
One
Year Later: State Dept. on Global Diplomacy at 4 p.m. ET
Marc
Fisher: 2002 Election Special at 10 p.m. ET
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