Dan Fuss thinks corporate profits could more than double in the next decade-good for stocks. Meanwhile, watch China.
Editor's Note: On January 2, Financial Advisor Editor Evan Simonoff talked with Loomis Sayles Bond Fund manager and fixed-income guru Dan Fuss about his views on the U.S. economy, interest rates and where stocks and bonds are headed. For someone who has spent more than 40 years working the capital markets, Fuss is surprisingly optimistic, even after the last three years.
Simonoff: An article in the Wall Street Journal this morning predicted an accelerating rebound led by business capital spending. I was wondering if these guys hadn't stopped partying on New Year's Eve or something. What's your take?
Fuss: So much depends on what you count when you get to capital spending. Now, a report out today did show quite an increase in new orders. But again, month to month, these can be fluky numbers. My take on it is that I think we're in for another moderate year for the economy. I don't see capital spending really starting to spark. Still too much excess capacity, number one. Number two, now we're shifting a lot of manufacturing to China.
So the combination of those two factors indicates to me that we're not going to get the real push from capital spending. On the other hand, it's not going to get any worse. So, capital spending more or less flat, consumer spending up a couple of percentage points, and government spending is certainly up. You get a 2.5% or maybe even 3% real GNP number, that's not bad. It's not a boom.
Simonoff: Two years ago, almost exactly to the minute that we are speaking, the Fed began aggressively easing. And it cut rates at an unprecedented pace. Yet it's really failed to produce the kind of rebound that one would expect from such aggressive action. My first question is why? And then, if rates stay down here, how long will it take before they kick in?
Fuss: This could take a little more time. This downturn was led by a decline in capital spending. And we've had two huge capital spending booms in the post-war era. A long one in the 1950s, and a long one in the 1990s, which crescendoed in the Y2K build-up of the fall in '99. In the first case, in the 1950s, it took a good three years to recover from that. You still had a recovery in the economy, but it was moderate, just like what we're having, it was inventory-driven. Which means it sort of rippled or, as someone in France used the term, the corrugated recovery. So, there's no real boom because you don't have the capital spending there, which is the leveraged spending you get. That went on for three years or a little more before the economy started to really recover. I think the same thing is happening this time. We've had a couple of slow years now for capital spending, and we'll probably have another slow year. Now, this time is a little different in that one part of the capital spending will never come back in the U.S.-and that's where we've shifted capacity to China.
The other thing is the big spurt in capital spending was in the technology area and particularly in telecom and power generation. Now, both of those areas still have ample excess capacity. And they're both in situations where there is price competition for the products or service they provide. So it's not reasonable to expect that the capital spending will come back yet.
Now, the other part where you would anticipate some sort of recovery here fairly soon, it's probably not going to happen. And that's in the process industries, paper, petrochemicals, things like that, oil refining. It's probably unreasonable to assume that we're going to have much if any recovery.
Now there's one other huge area of capital spending that I really question whether it should be called capital spending or not, and that's the whole information technology area.
They get written off in three years, you know, which is more than the one-year threshold. So they get called capital spending. And yet it's really sort of like a maintenance level thing now. Every third year, by God, they show up like clockwork to cut out the computers and leave you with the new ones. Well, that's been slowed down in some areas right now, but essentially that's more of an extended maintenance type spending. So, that's what's different this time.
The world is globalized, so we put off-shore some of the production. It's a much more integrated economy. But this time, it looks like we're facing a military build-up. And that's going to alter the equation somewhat. And we'll just have to see.
Simonoff: Aren't we're shifting some people from private payrolls to public payrolls? We're calling up reserves.
Fuss: And that is actually going to be an economic stimulus.
Simonoff: Would that mean some of those workers getting called up will have to get replaced?
Fuss: Yes.
Simonoff: Do you think unemployment will be higher or lower a year from now?
Fuss: Lower.
Simonoff: Significantly?
Fuss: Probably not. Put it this way: The number of people unemployed and looking for work will be lower.
Simonoff: The rate could be like 5.5% or something?
Fuss: That's a kind of number that gets rather difficult to deal with. But the total number of people working, if you count the military, is going to be going up. If you don't count the military, it's probably still going to be going up, but not as much. It's the military where the big growth is coming.
I don't know what's going to develop as far as the political front. Right now it looks to me like we're probably going to wind up doing something in Iraq. And maybe elsewhere in the world, too. This is far broader than just Iraq.
Simonoff: There's only so much one superpower can control control.
Fuss: Right.
Simonoff: Some people now say the Fed won't raise interest rates until 2004 at the earliest. Because even if the recovery picks up a little bit of speed, it's not going to pick up enough speed to get the Fed worried about inflation.
Fuss: Right.
Simonoff: And they're still more worried about a double-dip than an overheating. What's your take on when the Fed feels the need to bump its interest rates up? Will it be severe or pretty minimal?
Fuss: When it finally comes, it's going to be reasonable in size. But I think it's likely to be quite some time. What we have now is a slow economy in the U.S. Canada is OK, but the U.S. is slower. A slow recovery. Same thing in Europe, and Japan is really not doing much. And as long as that's the case, the newspaper articles say, "Wow, we have to worry a lot about deflation." And the Fed has to be concerned about that. I can't imagine that they're going to tighten money.
Now, here's where the problem comes. And the same is true, I think, in Europe and certainly in Japan and the three major currencies around the world-when it comes to trade. But over there, and China being the best example of that, production has shifted from being just for export to consumer goods for internal use. Both soft goods and hard goods, TV's and cassettes, the whole bit. And so per capital consumption of consumer goods is rising rapidly in Asia. And that's where the people are. They're developing a consumer-based economy. They've never had that before. A lot of people are there, and they now watch television. They see the goods available. Then there's the Internet. Technology has made a lot of the modern world at least visually accessible for them.
And it's feeding on itself. Rail lines are going in to better access the interior of the country. So that's starting already to put some pressure on raw materials. Now, where this gets really interesting is you have this demand growth in Asia for goods. Some for services too, but it's goods that are out of focus.