NEW YORK — "This could be a tough year" for US financial markets, says George Jacobsen, chief investment officer for financial firm Trevor Stewart Burton & Jacobsen, in New York.
How tough? Very. Mr. Jacobsen believes the Dow Jones Industrial Average (DJIA) could end the year at about 8100 points. The S&P 500 index could sink to about the 1000-point level. That would be a drop of about 20 percent and 10 percent respectively.
To understand why conditions are less than favorable for equities, you have to look back a tad, Jacobsen says.
"In the late 1990s, the US was in a cyclical expansion based on heavy spending for capital goods, propelled by a booming stock market and corporate profits that were well ahead of expectations," he says.
Moreover, a number of economic policies were playing into the boom-to-bust days of the late '90s.
"Tax policies favored domestic service companies over manufacturers," says Jacobsen. US trade policy "encouraged importation of finished goods." Monetary policy was designed to lower inflation. All of these factors put intense downward-price pressure on manufactured goods, he says. As output and higher capacity exceeded demand, profits were increasingly threatened and reduced.
The upshot was a severe inventory contraction. This resulted, as Jacobsen sees it, in the current recession.
"Most recent recessions have been the result of tighter liquidity shortages dampening demand. Not so this time," Jacobsen says. Declining profitability is not only sinking spending on capital goods, but also spurring layoffs, he says.
The average consumer, for his or her part, is pretty well played out financially right now, Jacobsen says. Many consumers find themselves heavily in debt.
In addition, consumers satisfied just about every known material need during the long expansion of the 1990s. Beyond necessities, he wonders, what do they now need to buy? Bottom line: The average consumer, Jacobsen reckons, is not going to suddenly "wake up, and say: 'Let's start buying.' "
For manufacturers, the current disinflationary economic climate is especially onerous. "In an inflationary environment, you can always raise prices and get away with it; but in a disinflationary environment, such as now, you can't get away with prices increases."
Price hikes not only stand out, they are ultimately self-defeating, as competitors undercut them.
As if all this were not bad enough for the underlying US economy, globalization is also putting downward pressure on profits, both for manufacturers and service firms, he says.
Services sectors facing tough global competition include insurers, banks, tax and accounting firms, and the advertising industry, he says.
What's needed is an upsurge in demand, either from consumers or the US government, Jacobsen says. But consumers, as noted, appear unable by themselves to boost the economy. Moreover, Congress and the White House have failed to agree on a new economic stimulus package. Overseas growth in Europe and Asia appears stalled.
Since the profit decline for companies is not over, says Jacobsen, neither is the US recession.
What then about the recent rise in the stock market, which has seen the Dow lurch up more than 20 percent since mid-September? Traditionally, that would be considered the sign of a new bull rally.
But Jacobsen believes the recent gains in market indexes may be what economists call a "bear trap" - that is, a short-term gain in a long-term down, or bear market.
"The market is somewhere between fully valued and rich," Jacobsen says. That means investors buying at current prices could face sharp losses if the market begins to swing back downward, as he thinks it will in the months ahead.
Given the huge losses in the Nasdaq index during the past two years, Jacobsen believes the Dow and the Standard & Poor's 500 indexes are the most vulnerable to market downdrafts.
"Investors should remain very cautious," he says. That would be especially apt if a new consensus emerged in the months ahead that the US is mired in a more extended recession.
If a person does enter the market, selectivity is crucial, Jacobsen says. "Investors should buy only high-quality companies."
Moreover, it would be wise to retain a position in fixed-income instruments - such as bond products - until it is clear that the economy and stock markets are on an upward trajectory, he says.