Market Advisory Features
Withdrawal of U.S. Holdings by Saudis
War Fears and Market Jitters
What has happened since July is puzzling: American stockmarkets have rallied by almost 20%. Is this because individual investors have returned to shares, or mutual funds? Estimates of their behaviour will not be available for another week or two, but this seems unlikely, given their behaviour over the past few months. Institutional investors may have decided that stockmarkets had fallen too low, or professional fund managers and speculators may have been forced to buy shares to meet short-term investment targets or to adjust portfolios. Whatever the reason for the recent recovery in prices, it cannot last without the support of individual investors. So what they do next is crucial.
As of the end of July, they seem to have decided to sit out the market after experiencing more than two years of stockmarket declines. Some $31 billion was transferred to money-market funds—very liquid funds that are close to cash in their behaviour. They offer little chance for capital appreciation, but also little risk of capital erosion. A further $19 billion was invested in other fixed-income products, mostly bonds.
Certainly, watching the progress of American shares over the past couple of years has not been a happy experience for investors. The three broad American indices have fallen steeply from records set two years ago, even allowing for recent rallies. The Nasdaq index, chiefly made up of once-fashionable technology stocks, fell by around three-quarters from its giddy peak to trough; the broad S&P 500 index fell by more than 40% and even the narrower and, so far, more robust, Dow Jones hit a low more than one-third below its peak. And if this is the average experience, there are plenty who have seen their savings wiped out: employees of the likes of Enron, for example, who put their entire retirement savings into the now bankrupt energy trader.
By selling in July, many small investors seem to be adhering to the converse of the old dictum: “Buy low, sell high”. For net flows have seemed to follow the market’s course. In February and March 2000, as stockmarkets peaked, monthly inflows into mutual funds were five times the average of the previous two years. It now appears as if outflows peaked as stock prices hit a low point. Of course, this is not entirely a surprise, for the two are not unrelated. One of the factors that sustained the rally was the growing amount invested by individuals, which helped send shares ever higher. This was exacerbated by rules about how stockmarket indices were put together. These weighted companies by calculations of their overall market capitalisations, even when they actually had only a limited numbers of shares in circulation. This, in turn, forced index-tracking funds to bid for these few shares, driving them, and the index, still higher.
Optimists who argued that the record withdrawals from mutual funds in July are a sign that markets are ready for a rebound, because the last remaining bulls had left the market, appear to have been vindicated—in the short term, at least. Pessimists, however, fear that individuals will continue to flee the stockmarket, and they maintain that this month’s rally is only a brief respite. They argue that shares, particularly in America, now look overvalued again, particularly as recent economic indicators point to, at best, an anaemic recovery all over the world. Quite apart from so-called technical factors, such as the amount of money being put into pension funds every month, or being withdrawn from other funds by nervous investors, there are fundamental reasons to fear further falls in American stocks.
For one, despite the falls to date, American shares are still quite highly valued in historic terms. For example, the S&P500, the broadest of the three most common measures of stockmarket performance, is currently valued at 38 times historic earnings, compared with a post-war average of 15. Moreover, America is running a huge current-account deficit. If foreigners slow down the rate at which they are investing in America, the dollar will fall, as it has already begun to do. Lastly, markets tend to overshoot. So, even if one believes that stocks are fairly valued, it would not be surprising if they fell again before moving into a recovery phase again.
IN AN unusually important but typically bland announcement this week, China ended months of uncertainty by naming the date for the start of its 16th Communist Party Congress. Held only every five years, the congress is where the party’s (and thus the country’s) top leaders are formally selected, and where broad new policy proposals are launched. The sessions are usually held in September or October, and the delay in planning this year’s event gave rise to speculation, among citizens and analysts alike, about infighting at the highest levels of Chinese politics. Now everyone can mark their diaries: the session will begin on November 8th and, state television assures, “all preparatory work for the congress is progressing smoothly at present”.
The suspense, however, is far from over, as little is yet known about who will be staying or going. There had been for years an implicit understanding that the party chief, Jiang Zemin, would use the 16th congress to step aside gracefully and make way for a man long ago anointed as his successor, Hu Jintao, vice-president and fellow member of the Politburo Standing Committee. Indeed, having reached the age of 76 and after serving for 13 years as China’s top leader, Mr Jiang is at the point where many politicians would start gathering their papers and scouting out book contracts for their memoirs.
Instead, Mr Jiang appears to be scouting around for ways to hang on to power. He holds three posts: state president, head of the Communist Party and chairman of the Central Military Commission, which in effect makes him commander-in-chief of the armed forces. He will have little choice but to give up the presidency early next year, since he will by then have served the maximum of two five-year terms specified by China’s constitution. Keeping his military job will be easier. His predecessor as paramount leader, Deng Xiaoping, held on to that job for more than two years after leaving all his other posts, and finally gave up his de facto leading role in Chinese politics only when disabled by old age and senility. However much Mr Hu and the other up-and-coming leaders would prefer Mr Jiang to step aside entirely, the precedent set by Deng will make it hard to object if Mr Jiang follows suit, especially since it was Deng who elevated Mr Hu into the party’s top tier.
The key question concerns the party job, which Mr Jiang had been expected to yield to the 59-year-old Mr Hu, in order to comply with an unofficial but widely publicised prohibition on renewing the terms of leaders above 70 years of age. By allowing Mr Hu to meet visiting top-ranking foreign dignitaries and make high-profile official trips to Europe, Asia and the United States, Mr Jiang appeared to be grooming him for the expected promotion. But at the same time, Mr Jiang has refrained from making any public commitment to standing down. On the contrary, he has in recent months been orchestrating, or at least tolerating, a series of letter-writing campaigns within the bureaucracy aimed at building support for a “Keep Jiang” movement. State-run media, which are mostly under his control, have also been singing Mr Jiang’s praises in what looks like an effort to portray him as indispensable.
But others have been writing as well, and in decidedly contrary tones. Bao Tong, a former official who was the highest-ranking figure to be jailed for supporting the 1989 Tiananmen Square protest movement, this week released a stinging essay attacking the “three represents” concept put forth two years ago by Mr Jiang to help keep the party in tune with China’s fast-changing social and economic landscape. Mr Jiang calls on the party to represent “advanced productive forces”, “advanced culture” and “the broad interests of the public”. According to party sources, Mr Jiang hopes to insert the “three represents” into the party constitution at the forthcoming congress; he may also seek to put it into practice by allowing wealthy private businessmen—undeniably the leaders of China’s “advanced productive forces”—to hold high-level party posts.
In his essay, Mr Bao, who was a leader of the liberal reform faction that was purged after the turmoil of 1989, writes that the party represents only its own interests, and offers nothing to China’s peasants and workers who were promised the moon in 1949 when the Communists came to power. Speaking on the phone from his Beijing home, where he lives under constant surveillance, Mr Bao urged that Mr Jiang should step aside entirely. He rubbished the notion that Mr Jiang should stay on for the sake of stability. “If China’s stability actually depends on any single person, then the situation must be very dangerous already, and very tragic.”
Of course, the possibility remains that Mr Jiang intends to step down after all. Some analysts suggest the congress has been delayed so that Mr Jiang would remain the nominal top leader when he makes his proposed visit to George Bush’s Texas ranch in late October. He may also be withholding his decision to retire as a bargaining chip to elevate his chief protégé, Zeng Qinghong, to a place in the Politburo. Mr Zeng is hugely unpopular within the party. David Bachman, an American China expert, says that if Mr Jiang stays on, or merely succeeds in elevating Mr Zeng against the opposition of virtually every other top leader, the result will be instability among the political elite deprived of orderly succession. But if Mr Hu is allowed to move up as planned, it will demonstrate a level of political maturity that the West should give it credit for. That may serve as a more profound political legacy for Mr Jiang than the “three represents”.
of U.S. Holdings by Saudis Could Affect Lebanon
27 August 2002
THE United Nation's summit on sustainable development, now under way in Johannesburg, is a rallying point for a plethora of causes, some more deserving than others. The latest to join the throng—with some justification—is Transparency International (TI), a non-governmental organisation that fights corruption worldwide. But those striving to break the cycle of poverty and graft in the developing world will find little to encourage them. TI’s latest Corruption Perceptions Index, a listing of 102 countries ranked according to the perceived levels of corruption among their politicians and public officials, makes dismal reading.
No less than 70 countries score less than five out of a possible total of ten, according to TI’s poll. There are few shocks, except perhaps that so little has been achieved in stamping out the problem. Corruption is still perceived to be rampant in Indonesia, Kenya, Angola, Madagascar, Nigeria and Bangladesh—all countries at the bottom of the pile with a score of less than two out of ten. The politicians’ gain is their peoples’ sacrifice. “From illegal logging to blood diamonds, we are seeing the plundering of the earth and its people in an unsustainable way,” laments Peter Eigen, chairman of TI.
Far from improving, he says, standards have slipped in many parts of the world, particularly in places where democracy is under threat or economies are in decline. In this category TI includes a large swathe of South and Central America—including Panama, Honduras, Guatemala, Nicaragua, Venezuela, Bolivia, Ecuador and Paraguay, all of which score three or less out of a possible ten. Even Argentina, whose economy has crumbled since the government reneged on its debts to international lenders and was forced to devalue its currency, is now included among this bunch.
Although Russia has recently made strides to combat corruption—President Vladimir Putin has introduced a welter of tax reforms and new measures to fight money laundering—most of the former Soviet Union remains seriously corrupt. Azerbaijan, Georgia, Kazakhstan, Moldova, Ukraine and Uzbekistan all manage scores of three or less. There are some bright spots, even in eastern Europe. Slovenia, a former communist state, is perceived to have a cleaner record than either Italy or Greece.
TI’s list is by no means exhaustive. As a rolling survey of polls carried out by other organisations between 2000 and 2002, and involving interviews with local residents as well as jaundiced expatriates, it includes only those countries which have featured in at least three such studies. So the list covers barely half the 200 or so sovereign nations in the world. It is a fair bet that some of those excluded because there are too little reliable data on them are as corrupt, if not worse, than those caught by TI’s Corruption Perceptions Index.
Predictably, the countries that come out of the survey best are, by and large, those with the most developed economies and the most established democracies. But there are a few surprises. The United States—recently beset by its share of corporate sleaze if not by wrongdoing among politicians—appears 16th in the table, just above Chile but below Austria and Hong Kong. Ireland, at number 23, narrowly pips Botswana, which ranks higher than France or Portugal. The top spot is reserved for squeaky-clean Finland, which is followed by Denmark and New Zealand in joint second.
War fears and market jitters
THE CURRENT gyrations in the oil price are a reminder of one possible side-effect of any American war against Iraq. With fears mounting that the American economy may relapse into a “double-dip” recession, the last thing it needs is a higher oil price. But, just as the price of West Texas Intermediate, the benchmark for American crude oil, was subsiding after a surge last week, a speech by Dick Cheney, the American vice-president, on Monday night, calling for action against Iraq, sent the price soaring again. Matters were not helped by a statement from Venezuela last Friday that the Latin American oil producer would oppose any relaxation of supply quotas at next month's meeting of the OPEC oil producers cartel in Japan. The combination of talk about a possible war against Iraq and continuing supply concerns is likely to keep the oil market jittery in the short term.
Iraq sits on the world’s second-biggest oil reserves, well over 100 billion barrels—or 100 years of production at current rates. So there are understandable fears about the interruption of supplies if America launches a war to depose Saddam Hussein, the Iraqi dictator. However, those fears may be overstated. This is not because the Iraqis are—somewhat optimistically—claiming that the war would not interrupt supply. (The Iraqi planning minister, Hassan al-Khattab, insisted on August 29th that the country would continue to export even if attacked). It is rather because Iraq's production is already a fraction of its potential. The effects of United Nations sanctions and Mr Hussein’s own disastrous economic policies have already sharply reduced Iraq’s oil exports to an estimated one million barrels per day (bpd).
Of more concern is what may happen to the oil fields of Kuwait and Saudi Arabia. Iraq suffers UN sanctions as punishment for the invasion of Kuwait in 1990 and because of fears that it retains the sort of weapons of mass destruction that it has used in the past. Kuwaiti and Saudi officials are both, in contrast to their countries' stances during the 1991 Gulf war, distancing themselves from American opposition to Mr Hussein. In the volatile atmosphere of the Middle East, with widespread resentment of repressive regimes across the region, disruption of supplies in neighbouring countries cannot be ruled out.
There is also a small chance that American policy towards Saudi Arabia may change. While it has long been America’s closest ally in the Middle East, the relationship has recently come under strain. No fewer than 15 of the 19 suicide hijackers responsible for the attacks on New York and Washington were Saudi citizens, as is Osama bin Laden, the assumed mastermind of the atrocity.
Worried about unrest on the street—many Saudis seem to prefer the elusive Mr bin Laden to the corrupt ruling dynasty—the Saudi government gave no support to America’s campaign in Afghanistan, and it has refused to allow America to use its bases in Saudi Arabia for attacks on Iraq. On the contrary, the government has instead been talking of revitalising trade with Iraq, and of reopening a border crossing closed since the Gulf war.
In turn, one researcher from the Rand Corporation, a think-tank, recently told a Pentagon briefing that Saudi Arabia was America’s true enemy and that its oil fields should be seized. While the administration officially moved to distance itself from this briefing, Donald Rumsfeld, America’s defence secretary, seemed to confirm that at least some officials shared the dismay at Saudi policy by saying that the views expressed were not dominant” in the administration.
Quite apart from its diminishing value as a military ally, Saudi Arabia has worked to maintain discipline in the OPEC oil-producers’ cartel, and to keep prices up, at around $25 a barrel, well above what many economists think would be their market level in the absence of OPEC. This clashes directly with the interests of America, the world’s biggest oil importer. Prince Turki al-Faisal, until a year ago the Saudi head of external intelligence and brother of the foreign minister, said last month that Saudi would never use oil as a weapon against America. But Saudi’s oil minister, Ali al-Naimi, spent last autumn on a tour of oil-producing capitals, trying (unavailingly) to bully producers into production cuts. OPEC recently admitted that its members had exceeded their production quotas by 1.8m bpd in July. On August 30th, Alvaro Silva, OPEC's secretary-general, said that the cartel's output policy would be linked to demand, implying that there would be no increase in quotas that are at the lowest level for a decade, given the current world economic slowdown.
The current overproduction suggests that, whatever the short-term war-influenced gyrations may be, the trend of the oil price may be downwards over the medium term. After the late-1990s boom, economic growth around the world has slowed dramatically, with a corresponding impact on the demand for oil.
The supply of oil is no longer controlled as tightly as it was during the 1970s oil shock. Russia has emerged as an important producer—it is now the world’s second-largest exporter, and its need for cash is such that it routinely undermines OPEC’s attempts to limit global production. This in turn reduces the incentive for other non-OPEC producers, such as Norway and Mexico, to agree to production cuts. Besides losing revenue, they might also lose market share to the Russians.
Even Saudi Arabia itself must be tempted to produce more oil, to pay for its extravagant public sector. While its oil is the cheapest in the world to produce—it costs just $1 per barrel to lift it from the ground—it is estimated that the country’s bloated bureaucracy requires a price of $15 a barrel to sustain itself. It is a sign of how much the world has changed that America may now be looking not to its old ally, Saudi Arabia, to keep the oil flowing through a war, but to the old Cold War enemy, Russia.
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CAPITALISM is ever prone to cycles. Back in 1837, Lord Overstone, a British economist, described the economy's “established cycle” from a “state of quiescence” through “growing confidence...overtrading, convulsion, distress” finally “ending again in quiescence”. Over 150 years later, his description remains apt. But what if some parts of the economy grow in confidence prematurely, before the economy as a whole has returned to quiescence? Lord Overstone had no term for it. Today's market watchers do: “the double dip”.
Double-dippers, such as Stephen Roach of Morgan Stanley, believe the springtime recovery was a false start—the economy will contract again before a sustainable recovery begins. They have history on their side. Five out of the past six recessions featured more than one dip; the long recessions of 1973-75 and 1981-82 turned out to be triple-dippers. Why should the current cycle escape with just one?
Lord Overstone could describe the vicissitudes of commerce as an “established cycle” only because the economy's vast ensemble of markets and industries keep roughly in time—they rise and fall in concert. A double dip occurs when one section of the ensemble, usually inventories, gets ahead of the score. Inventories fall fast in a downturn: why refill the warehouse when you're worried about clearing the shop shelves? But they also bounce back early—no manager wants to forgo sales because his shelves are empty. The hasty rebuilding of inventories will pull the economy out of its initial dip, but if the rest of the economy has yet to hit bottom, the reprieve will be temporary. Inventory demand will peter out just as the final demand for goods has what Mr Roach calls a “relapse”. Inventories have to be cut: the economy dips for a second or third time.
Have inventory managers got their timing wrong again? Certainly, the current cycle is peculiarly difficult to read. Most post-war cycles follow a clear rhythm conducted by the Federal Reserve. Recessions begin when the Fed raises interest rates to kill inflation, subduing labour, housing, and stock markets at the same time. But Alan Greenspan, the Fed chairman, did not orchestrate the last contraction, and the cycle is not so tightly synchronised. Business investment collapsed but Americans mostly kept their jobs, and what they lost in the stockmarket, they partly regained in a property boom. Until now the American consumer has kept up a merry jig in counterpoint to the sombre tempo of the rest of the world's economy.
Last year's recession, Mr Roach argues, was a mild leeching, not a full purging of the excesses of the 1990s. Household saving rates are still too low, house prices too high, and the current-account deficit too wide. A double dip gives a second chance to “correct” these imbalances. It may take another spell of convulsion and distress before America's defiant spendthrifts become the “quiescent” savers Lord Overstone and Mr Roach would like to see.