It is clear that the long awaited US economic slowdown has begun and the issue is now whether recession can be avoided.
No one can predict the next six months for the US economy with any degree of confidence. At the best of times economic forecasting is an inexact science and at turning points accurate forecasting is well-nigh impossible. This is as true for the Federal Reserve and its chairman Mr Alan Greenspan as it is for all of those highly paid Wall Street analysts.
While some commentators are interpreting the recent surprise half-point cut in US interest rates as a sign the Fed is in some sense prescient and knows that a recession is imminent, the reality is more likely to be that the Fed is simply moving a little earlier than expected to ensure the economy does achieve a soft landing. US rates are still higher than euro rates - 6 per cent versus 4.75 per cent - and therefore the Fed has plenty of scope to reduce US interest rates to stave off recession. The next Federal Open Markets Committee meeting is scheduled for the end of this month and the consensus now expects a further half-point cut in interest rates at that time.
The accompanying table shows the performance of US stocks as measured by the Nasdaq Composite index and the S&P Composite index since 1994. Clearly, investors' fears for the US economy were reflected in the decline of 39 per cent in the Nasdaq and the 10 per cent fall in the S&P Composite. Since 1975 the S&P has only endured four years of negative capital returns and we have to go back to 1973/74 when the index last suffered two consecutive years of negative growth.
Looking at the more recent period, over the past decade the S&P fell on an annual basis in two years - 1990 and 1994. On both occasions the index bounced sharply in the following year, recording a rise of 26.3 per cent in 1991 and a more spectacular rise of 34.1 per cent in 1995. If recent historical experience is any guide, the odds seem quite high that 2001 will prove to be a good year for the US stock market.
However, such a conclusion needs to be tempered in view of the extraordinary returns achieved by both the Nasdaq and the S&P over the 19951999 period. During this time-frame the lowest annual return was 19.5 per cent and the highest was 34.1 per cent. This compares with the very long-term historical norm of a 10 to 11 per cent annual return from investing in the broad stock market.
Indeed, a strong argument can be made that US shares had become extremely overvalued and that the fall last year only partially corrects this.
This would certainly have some validity where the Nasdaq, which rose 85 per cent in 1999 following a 39 per cent rise a year earlier.
