Market Advisory Features

Driven to the Same Depths?
Koizumi Abandons Economic Reforms A Global Game Of Dominoes
Philippine Agri Modernization Taking Off Trading As APerformance Sport


Driven to the Same Depths?
Sep 6th 2001 | NEW YORK AND TOKYO
The Economist

Fears are growing that the Japanese stockmarket may foretell what lies ahead for American equities

WHEN the Nikkei stockmarket average touched its all-time high of 38,915 on December 29th 1989, the Dow Jones Industrial Average stood at just 2,753. This week the Nikkei fell to a 17-year low of 10,410, closing in fast on the Dow which, despite a half-hearted attempt at a traditional post-Labour Day rally, has been bobbing around 10,000 as it too loses its fizz. Shares in the rest of the world have followed their downward lead; the Morgan Stanley Capital world index of stockmarkets is down by 7.6% since July and by 17.9% so far this year. How much worse can things get?

On Wall Street, hope springs eternal, and not everybody thinks the game is up. Abby Joseph Cohen, a notorious bull at Goldman Sachs, still expects the market to be significantly higher by the end of the year—ie, she expects the S&P 500 index to rise to 1,500 from today's 1,100. The bulls even have some better economic news to support them: this week, the National Association of Purchasing Managers' index of new orders was at a 16-month high, suggesting that manufacturing at least may have bottomed out.

On the other hand, corporate profits show no sign of touching bottom. American unemployment is rising and that may dampen consumer spending, which is what has kept the economy alive over the past year. Moreover, economic growth continues to slow in the rest of the world, particularly in the big economies of continental Europe and Asia.

Japanese manufacturers' pre-tax profits dropped by 21.2% between April and June, according to a survey published by the Ministry of Finance on September 5th. How to value Japanese shares remains almost as controversial as it was during the bubble, not least because accounting measures of profit and assets often bear little relation to reality. Although the stockmarket has dropped sharply in recent months, price/earnings (p/e) ratios still average around 34.

As ever in Japan, prices are being moved by things that have little to do with fundamental valuations. Japanese banks have been aggressive sellers of shares, in part because they will be required to mark their assets to market at the end of September, and they want to cash out as much as possible before the true state of their capital (in)adequacy becomes clear.

Foreign investors have been quite keen on Japanese shares too. According to Avinash Persaud of State Street, which tracks international portfolio flows, overseas investors have bought the equivalent of 1% of Japan's market capitalisation since the end of July, making it (proportionately) their fourth favourite market. One reason may be that Japan is no longer any more bubbly than markets elsewhere, including America's and Europe's, where shares have also been falling. Moreover, foreign investors may be taking advantage of locals selling at distress prices.

Forever bursting bubbles

Japan's continuing troubles nearly 12 years after its bubble started to deflate should be a salutary lesson to any investor tempted to think that the bursting of America's own bubble is largely over. No two bubbles are alike. Indeed, history suggests that bubble is not the perfect metaphor, at least for the end-game. The quick pop is less typical than the prolonged sickness, remission and relapse of a cancer victim.

After the crash of 1929, share prices did not bottom for three years. And when the long bull market peaked in 1965, it did not bottom in real terms until 1982. The fall in American share prices over the past 16 months, particularly in the Nasdaq, may be only the beginning.

Even at current levels, American shares remain expensive. They have not tumbled as far as profits, at least as measured under generally accepted accounting principles (GAAP). By this measure, the average p/e of the S&P 500 index exceeds 37, an all-time high. Even using operating profits (adjusted to ignore claimed one-off costs), the average p/e is 23. In 1929 and 1965, the peak p/e was 21. Today's ratios are well above the average for the past century (of 14) or the 17-18 which Jeremy Grantham of Grantham, Mayo, Van Otterloo, a fund-management firm, reckons is now the trend ratio.

His firm has enjoyed spectacular success in the past 16 months because of its bets that the bubble in American shares would burst, and that key price ratios that were out of line would revert to their long-run means. In April 2000, the firm calculated that the Nasdaq—then near its peak—would need to fall by 70% to reach its “fair value”. It also expected that the historical
relationship between value and growth shares, which had never been further away from trend, would reassert itself, which it now has.

If anything, the Nasdaq is now less overvalued—at around 1,700, compared with a fair value of 1,250—than the bigger company indices, such as the Dow and the S&P 500, says Mr Grantham. Assuming that p/e ratios return to 17-18, profit margins slip from 8% to 6%, and that sales per share grow at (an optimistic) 3.6%, it would require the S&P 500 to deliver annual real returns of -0.5% in each of the next ten years, or else record an immediate 40% decline, to return to fair value. Mr Grantham thinks it will get there in the end, though maybe only after a short-term rally of up to 20% as investors get excited by evidence that the economy is turning up—and before they realise this is not delivering much in the way of profits.

Investors still have a lot of faith in equities. Most American institutions have allocations to shares of around 70% of their portfolios. Flows from individual investors into equity mutual funds have slowed, but would probably accelerate if the stockmarket were to show signs of life. Past bubbles have not ended until most investors have not just turned bearish, but given up. It may, alas, take a lot more pain before it comes to that.

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Dark shadows
Sep 7th 2001
The Economist Global Agenda

Finance ministers from Asia-Pacific countries, gathering this weekend in the Chinese city of Suzhou, will be preoccupied with the gloomy outlook for the global economy. So widespread and so synchronised is the slowdown that there are worries it may prove self-reinforcing: recovery in one big economy may be thwarted by the slump in demand elsewhere

THE release, on September 7th, of quarterly GDP figures for Japan and an unexpectedly high unemployment rate in America cast yet more shadows over the already sombre prospects for the world economy. Stockmarkets around the world are in retreat.

Japan’s economy shrank by 0.8 % in the second quarter of this year, and 3.2% on an annualised basis. Japanese GDP statistics are erratic and unreliable. But most economists believe that the economy did contract painfully between April and June and that it will probably do so again in the third quarter, thereby meeting the most commonly used technical definition of a recession. Indeed, so bleak are most forecasts that the latest GDP figures were in fact better than most
private economists expected.

This is depressing news for the other 20 members of the Asia-Pacific Economic Co-operation forum (APEC), whose finance ministers are meeting in China. With the big exception of China itself, most face stagnant or falling demand at home and are suffering from the simultaneous sharp downturns in the three big rich-country economic blocks: Japan, Europe and America. In previous global recessions in recent decades, demand has remained buoyant in at least part of the world. In 1991, for example, the American economy sank, but Japan, Germany and East Asian emerging economies continued to boom. Since then, the worldwide impact of prolonged stagnation in Japan has been mitigated by the strength of the American and to a lesser extent European economies.

For East Asia in particular, Japan’s troubles are menacing, especially since there is no immediate prospect of their coming to an end. Even government ministers in Japan are admitting it will be hard to avoid a fall in GDP for the year as a whole. And Junichiro Koizumi, the prime minister, has promised to forswear the mechanism by which his predecessors have averted even more painful contractions: massive government spending, much of it on unnecessary infrastructure projects. Within an hour of the publication of the GDP figures, the cabinet did approve the preparation of a “supplementary budget”. But Masajuro Shiokawa, the finance minister, insisted that it would not be the traditional boost to public-works spending. Mr Koizumi came to office on the back of promises—which he as yet shows no sign of delivering—to tackle the underlying structural reforms to industry and finance that most economists agree are essential to long-term growth. But without sustained government spending in the short term, Japan’s deflationary slump may be exacerbated.

The fear that slowdowns in different parts of the world may be mutually reinforcing is a worry even in America, itself a member of APEC. On the eve of his departure for China, Paul O’Neill, America’s treasury secretary, reverted to a common theme of recent months: that, despite its current troubles, the American economy is sound and will recover soon, but “it isn’t enough for the US economy to be the only engine of economic growth in the world.” He was speaking just after some relatively encouraging data had been published by the National Association of Purchasing Management (NAPM). Its index of manufacturing activity for August, based on surveys of 400 industrial firms, was still below 50%, indicating that manufacturing industry was still shrinking.But this was the highest reading since November last year, and the steepest month-to-month rise for more than five years. This led optimists to declare that the recession in manufacturing might have found a bottom, as consumer-spending remains resilient and firms’ inventory levels sink.

But recent survey data suggest that the American consumer, whose heroic determination to keep on spending has been a prime reason behind the economy’s ability to avoid a recession, may at last be losing confidence. A stream of bad news from companies reporting on projected job cuts will not help. The figures published on September 7th showed that the unemployment rate jumped to 4.9% last month, much higher than expected. And falling demand elsewhere in the world could also act as a brake on any incipient recovery. In June, the value of its exports of goods and servicesfell by 2.0% compared with May; the fall for goods alone was even sharper, at 3.2%.

Hitherto, America has succeeded, in effect, in exporting some of its recession. Places such as Taiwan and Singapore, which manufactured the electronic components sucked in by the information-technology bubble, have been especially hard-hit. (Singapore’s non-oil exports fell in July by a staggering 24% compared with the same month last year.) But even Europe, which at first thought it might weather the American downturn because of the strength of internal demand within the euro area, is now struggling.

Just this week, leaked reports from the International Monetary Fund showed that its economists have revised their forecasts for Europe’s largest economy downwards for the second time in a month. They now expect Germany to record growth of only 0.9% this year. In consequence the IMF has also cut its forecast for annual GDP growth in the euro area as a whole, to 1.9%. This will strengthen the arguments of those urging the European Central Bank (ECB) to do more to stimulate growth by further reducing interest rates. In contrast to America’s central bank, the Federal Reserve—which has reduced interest rates seven times this year—the ECB has acted only twice.

Doubtless Mr O’Neill had the ECB in mind when he gave his warning about America’s inability to carry the world economy entirely on its own shoulders. And at least in the case of Europe, the outside world has a clear prescription: a more proactive and aggressive use of monetary policy to stoke demand. More problematic will be trying to shed some light into the immediate gloom hanging over the meeting in Suzhou–the looming recession in Japan. Having, for a decade, urged its policymakers to take on the sort of root-and-branch structural reform Mr Koizumi has promised, foreign economists and finance ministers may now be worrying about what will happen in the unlikely event their advice is taken at last.

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Koizumi Abandons Economic Reforms


In the face of record high unemployment, and with the Japanesestock market at a 17-year low, Prime Minister Junichiro Koizumi has abandoned the economic reforms that might have helped his country turn the corner. As a result, Koizumi is expected to embrace Japanese nationalism to maintain his popularity and hold on power.


Japanese Prime Minister Junichiro Koizumi won election last April promising a radically new way of dealing with the country's economic problems: unrelenting reforms and an avoidance of debt. Unlike his predecessors, he bluntly warned that the process would be excruciatingly painful and Japan would not experience real economic growth for at least three years.

But due to the feared political backlash, Koizumi is now backpedaling on the few positive policies that his predecessor, Prime Minister Yoshiro Mori, actually managed to put forward. His reaction to the country's economic problems will only add to Japan's already historical economic meltdown and lead the prime minister to adopt a more nationalist stance to in hopes of staying in power.

Japan is facing record high unemployment, and its stock market hit a 17-year low on Aug. 30. Even by the time Koizumi took office five months ago, Japan's economy -- the world's second largest -- had probably already fallen too far to be salvaged by the prime minister's proposed reforms. Koizumi is already backing away from his campaign promises, which if enacted would inflict pain the likes of which the Japanese have not known for more than a generation.

For example, the government is now refusing to force Japanese banks to write off their mountain of bad loans. This debt is crushing the banks, and since their assets are predominately stock holdings in companies that should be declared bankrupt, they are finding it impossible to generate the capital needed to function as lenders. Writing off those loans is essential if Japan is ever to have a healthy financial system, and it is the one thing that might be able jumpstart new economic activity.

The Mori plan, which Koizumi embraced as his own, would have forced write-offs on most of those bad loans within three years. Now, only half of those loans will be dumped in seven years, turning a plan of limited efficacy into a worthless one.

Koizumi's employment initiative is equally underwhelming. Japan's current unemployment rate of 5 percent is the highest of its
post-World War II history. Since the government's method of collecting statistics masks underemployment, the actual rate is
probably underestimated by at least half. And for a consensus- based society like Japan's, the impact of 1 in 20 people being
out of work is far greater than in individualistic America.

Instead of trying to retrain workers or promote reforms that would boost businesses, Koizumi last week announced a policy that will pay companies 300,000 yen ($2,500) for every unemployed person older than 45 that they hire. The government is in effect subsidizing the rehiring of middle managers who were let go because they weren't productive in the first place.

That's hardly the type of "reform" Japan's arthritic economy needs, but it will help Koizumi pacify the Japanese electorate as
the economy continues to contract.

There is, however, one potential bright spot for Japan's future. Of the nearly 20,000 positions Toshiba is eliminating, 17,000 are in Japan, demonstrating that the company recognizes its home operations are among its least efficient. If companies start
reforming on their own, the trend might force Koizumi to engagein more realistic policies.

Finally, there's the debt issue. At the core of Tokyo's inability to resuscitate the economy is the nearly $6 trillion in debt the federal government has accrued. Much of the debt originated as "supplementary budgets," stimulus packages directed to Liberal Democratic Party allies in the construction sector for wasteful infrastructure projects.

Koizumi has now decided for political reasons to continue with the supplementary budgets. The new spending, weighing in at a mere $15 billion, allows the prime minister to keep his promise for now to limit bond-financed deficit spending.

But $15 billion certainly won't be enough to defibrillate the dying $4 trillion Japanese economy. More spending must eventually flow, which would wash away the last of Koizumi's campaign promises.

No democratic leader can break all of his major pledges and preside over an economic crumbling, without severe political
consequences. It is highly likely Koizumi will start looking for some scapegoats.

Koizumi may first purge some of the more incompetent members of his Cabinet, but not all of the scapegoats need to be domestic. Koizumi has already laid the groundwork for whipping the public into a frenzy against outside powers and there is no shortage of candidates.

Diplomatic clashes that would grant Koizumi huge amounts of political capital are brewing with South Korea over historical revisionism, with Russia over the status of the Russian-occupied Kuril Islands, and with the United States over security issues. The juiciest target, however, is China, Japan's traditional bugaboo.

Using nationalism to increase his popularity is a far more attainable strategy for Koizumi than his economic reform plans, and falls into his populist image. Everything from Koizumi T- shirts to CDs indicates the prime minister is becoming a cultural icon.

The mix of nationalism and populism may not be the best way to manage Japan's economy, but it will be more than enough to keep Koizumi in power -- at least until the Japan economic bedrock collapses under him.

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Philippine Agri Modernization Taking Off
Thursday 6 September
(Full text of statement. Contact details below.)

MANILA, Sept 6 PRNewswire Asia-AsiaNet - The completion later this month of a US$650-million irrigation and power project initiated by CE Casecnan Water and Energy Company is bolstering the efforts of the Philippine government to modernize agriculture in the country and cut rice importation.

The Philippine government has proposed expenditures amounting to US$368 million under the country's Agriculture and Fisheries Modernization Act to be used for irrigation, post-harvest facilities, infrastructure, and agricultural research.

The government hopes the increase in funding will enable the Philippines to increase rice production by 1 million metric tons and corn production by 100,000 metric tons.

MidAmerican Energy Holdings Company, the parent company of CE Casecnan, said the impending completion of the Casecnan Multipurpose Irrigation and Power Project shows the dynamic public and private sector cooperation in the country. The Philippine government's National Irrigation Administration (NIA) is CE Casecnan's co-proponent for the project.

"The synergy between the Philippine government's agricultural modernization thrusts and the increased private sector participation will fuel the expected rebound of the Philippine economy,"said David Sokol, MidAmerican chairman and CEO.

Sokol stressed that the leadership of President Gloria Macapagal-Arroyo and her focus on foreign investments to spur the Philippine economy have helped buoy investor confidence in the Philippines.

"President Arroyo is taking the issues very seriously, and I think she recognizes the need to maintain a very consistent economic climate for future investment," Sokol said.

The Casecnan project, a Build-Operate-and-Transfer project initiated in 1995.

Ownership will be passed on to the Philippines after 20 years at no additional cost to the Philippine government, and NIA is envisioned to run the facility for at least another 30 years.

The Project construction is complete, and commissioning is under way. The 26-kilometer underground tunnel is in the process of being filled with water from the Project's intake weirs -- small dams that divert water from the Casecnan and Taan rivers in Nueva Vizcaya into the tunnel, on to the NIA-managed Pantabangan Reservoir in Nueva Ecija.

Testing of the power component of the Project is also under way. An underground powerhouse capable of generating a total of 150 MW of renewable hydroelectric power has been completed, and testing is being done on the facility's generating units.

Sokol said that the commissioning was progressing well and that the facility would be ready for inauguration on September 28.

MidAmerican Energy Holdings Company has invested heavily in the Philippines since 1994. Includingthe Casecnan Project, the company presently has US$1.4 billion worth of investments in the Philippines. It has three geothermal power plants in Leyte province, providing 540 megawatts to Luzon and Cebu.

"We've been here eight years, and I can say that President Arroyo has brought in one of the best administrations we have seen in the Philippines. We are pleased to be here, and we are confident that the business climate is on its way back up," Sokol said.

CE Casecnan Water and Energy

Robert Eugenio CE Casecnan Water and Energy Tel: +63-32-892-0276



A Global Game Of Dominoes
Aug 23rd 2001
From The Economist

The world economy is probably already in recession. How bad might it get?

ONE by one, economies around the world are stumbling. By cutting interest rates again this week for the seventh time this year—the Federal Reserve hopes it can keep America out of recession. But in an increasing number of economies, from Japan and Taiwan to Mexico and Brazil, GDP is already shrinking. Global industrial production fell at an annual rate of 6% in the first half of 2001.

The picture may soon look even worse. Early estimates suggest that gross world product, as a whole, may have contracted in the second quarter, for possibly the first time in two decades. Welcome to the first global recession of the 21st century.

So far, America itself has escaped a technical recession, defined as two quarters of falling GDP. But on August 29th revised figures are expected to show that America's GDP growth in the second quarter was close to zero or even negative, rather than the 0.7% annual rate originally announced. With GDP growing well below trend for several quarters, profits tumbling and unemployment rising, it now smells horribly like a recession.

As yet there is no sign of a V-shaped bounce-back in America

America's index of leading economic indicators has risen for four consecutive months, suggesting that the worst may be over. But as yet there is no sign of the V-shaped bounce-back in the economy that most economists had promised earlier this year. The 32% fall in new orders for electronic goods in the year to June signals that capital spending will plunge further as firms respond to weak profits and excess capacity. The Fed's beige book, a monthly survey of economic activity, suggests that the manufacturing slump is now spreading to the rest of the economy.

So far, the consumer has kept the American economy ticking along—partly thanks to rising house prices, which have cushioned household wealth against the drop in share prices. But retail sales were flat in both June and July, down from an annual growth rate of 10% in early 2000; and consumer credit fell in June. Many commentators argue that America can still avoid recession, so long as consumer spending does not collapse. But 1982 suggests otherwise: America then had its deepest recession since the 1930s, yet consumer spending continued to grow, offset by plunging investment and exports.

Consumer spending may soon perk up as tax-rebate cheques drop through letterboxes. But worries about jobs could lead workers to save the money instead. The jobless rate has risen by 0.6 percentage points since last October, and recently announced huge layoffs imply that it will rise further. Goldman Sachs forecasts a rate of 5.2% in 2002, up from 3.9% last year. Unemployment has never previously risen by this much without there being a recession.

Nowhere is safe

Earlier this year, when America first sneezed, the European Central Bank (along with most private-sector economists) argued that the euro area was insulated from America's slowdown and had little to worry about. This seems to have been wrong. In Germany there are fears about recession as business investment and retail sales tumble. The blame lies with weaker domestic spending rather than exports. New figures this week confirmed that Germany's GDP stagnated in the second quarter. But the Ifo survey of business confidence was better than expected in July, rising for the first time this year.

Italy's GDP fell in the second quarter, and although growth has held up better in France and Spain, most economists reckon that growth in the euro area as a whole was close to zero in the quarter. Nobody is forecasting an actual recession in the euro area this year, but it is no longer expected to provide an engine for world growth.

As for Japan, it is probably already in recession. Japan's GDP grew slightly in the first quarter, but only because consumer spending was boosted by the introduction of a new recycling law which encouraged households to bring forward purchases of fridges and televisions. Goldman Sachs reckons that figures due on September 7th could show that GDP fell at an annual rate of as much as 6% in the second quarter, and the contraction has almost certainly continued into the second half of the year.

In Japan, persistent deflation continues to weaken spending

Persistent deflation continues to weaken spending by increasing the real burden of debt and encouraging consumers to put off spending. A revised measure of Japan's consumer-price index, due to be published next week, is likely to show that deflation is worse than had been thought. The new index will include more up-to-date weights and new goods whose price has fallen sharply, such as personal computers and mobile-phone charges.

Worries about a deflationary spiral prompted the Bank of Japan to announce last week that it would pump more liquidity into the economy, increasing banks' reserves at the central bank and buying more government bonds. It was a step in the right direction, but probably not enough to drive away deflation. The government's plan to cut public spending is also likely to depress the economy. If one assumes that growth in the second quarter was close to zero in America and the euro area, and that Japan contracted sharply, the combined GDPs of the rich economies will have contracted for the first time since late 1990. But, unlike 1990, a growing number of emerging economies are also sliding into recession.

United we fall

Some of the numbers coming out of East Asia are truly scary. Singapore and Taiwan have both seen two quarters of shrinking GDP. Singapore's fell at an annual rate of 11% in the first half of the year, Taiwan's at a rate of 6%. South Korea's economy has slowed sharply, and second-quarter figures are likely to show that Malaysia and Thailand are also dangerously close to recession. J.P. Morgan estimates that emerging East Asia, excluding China, contracted in the second quarter and will do so again in the third quarter.

East Asia's problem is that the region had been over-reliant on exports of information technology(IT) equipment to the United States. America's IT investment boom allowed the Asian economies to recover much faster than expected from their financial crisis in 1997-98, but as the boom has turned to bust they are now being dragged down. Taiwan's total exports fell by 28% in the year to July. As well as a collapse in exports, Asia also faces a huge overhang of capacity and hence the risk of a sharp plunge in investment.

Although America's slump may be the main culprit, the former East Asian tigers also have themselves partly to blame. The strength of their rebound bred complacency about the need for structural reforms, such as cleaning up banks and cutting corporate debts. As a result, the growth in domestic demand has been relatively weak, making economies even more dependent on exports. South Korea's exports of goods and services jumped from 30% of GDP in 1996 to 45% last year; Thailand's from 39% to 66%. Asia is thus more exposed to a global slump than ever.

In Latin America, Argentina and Mexico are already in recession and Brazil looks likely to follow after its GDP fell at an annual rate of 4% in the second quarter. Argentina's problems stem from the peso's rigid link to the dollar, which has eroded competitiveness and forced up interest rates on its massive debts. Brazil has been hurt by financial contagion from its neighbour; Mexico's headache is that its exports to America amount to 25% of its GDP. Mexico's GDP has now fallen for three quarters in a row.

There are some exceptions around the world of economies that seem relatively untouched by the global downturn. For example, although China's growth slowed to an annualised 5% in the second quarter, it is still tipped to grow by almost 8% for the year as a whole, and India by 5%. But with output flat or falling in the second quarter in economies that among them account for two-thirds of world output, the world may already be in recession.

The most striking aspect of the current slowdown is that it is more widespread than in previous world slumps in 1975, 1982 or 1991. Those three years were all officially designated as world recessions, yet global GDP growth ranged between 1.2% and 1.9%, as recession in some parts of the world was offset by growth elsewhere. (This is why growth of 2% or less is generally considered to be a world recession.) In 1975, even as the jump in oil prices pushed rich economies into recession, Latin America and Asia remained relatively strong. In 1990-91 America went into recession, but Japan, Germany and most emerging economies continued to boom.

The world economy grew by 4.8% in 2000, its fastest since 1984, and most economists had expected 2001 to be another bumper year. Even those who predicted a hard landing for America's economy did not expect the whole world to slump with it. The downward revisions to 2001 growth forecasts have been unusually abrupt (see chart 2)—and they are probably still too rosy. What went wrong?

At least four negative forces have driven the global slowdown:

• First, and most important, the global IT boom has turned to bust. It was obvious last year that America's IT bubble was bursting as the Nasdaq collapsed and dotcoms went bust, but it was not widely appreciated that this was much more than just a narrow bubble in Internet stocks. Instead, new economy hype had distorted the global tech sector and unbalanced the entire American economy. Over-exuberance about future profits and cheap capital had encouraged a lot of overinvestment, especially in IT. The consequent collapse in capital spending this year has hammered IT manufacturers at home and abroad. In the second quarter, business investment fell by an annualised 15% in America and by an estimated 18% in Japan, according to Morgan Stanley.

• A second and related dampener on growth has been the collapse in stockmarkets everywhere, which has eroded households' wealth and hence their desire to continue spending at the pace of last year. The 28% average fall in share prices since early 2000 has wiped $10 trillion off global wealth. Stockmarkets have fallen by even more in Europe and Asia than in America. Households in Europe hold fewer shares than their American counterparts, so the wealth effect on consumers is smaller. However, the plunge in share prices has seriously dented business confidence and investment plans.

A recent study by the IMF found that, whereas changes in the value of non-tech shares have little impact on consumer spending or investment in Europe, each dollar increase or fall in the value of tech shares has as big an impact on investment and spending as in America. This may explain why the bursting of America's tech bubble has dented Europe's growth by more than expected.

• The jump in energy prices last year reduced real incomes in oil-consuming economies and squeezed firms' profits. The economic impact of higher oil prices has been smaller than in the 1970s, because rich economies today use only half as much oil per dollar of GDP as they did. Nevertheless, higher oil prices have clearly reduced global growth.

• Last, but by no means least, the spillover from America's downturn to the rest of the world has been more powerful than in the past. As the world economy has become more integrated, a downturn in one economy spreads faster to another. During the past few years the world was hugely dependent on America as an engine of growth. Stephen Roach, at Morgan Stanley, reckons that the United States accounted for two-fifths of world GDP growth over the past five years, either directly or indirectly by sucking in imports from other countries. That dependence left the world more vulnerable to an American slump.

Economies have become more closely connected to America through trade, global supply chains and multinationals. Over the past decade world trade has grown 2.3 times as fast as world GDP, compared with only 1.4 times in the previous two decades. American imports now amount to 6% of the GDP of the rest of the world, twice as large as in 1990. But in the first half of this year, American imports fell at an annual rate of 13%; imports of IT equipment fell at a rate of almost 50%.Industrial supply chains have become increasingly globalised as firms in rich economies outsource production to cheaper places, such as East Asia. Two-fifths of the growth of non-Japan Asia in 2000 was due to an increase in IT exports to America. But conventional trade statistics understate the increase in business linkages, because multinationals are playing a growing role.

In 1998 the local sales of American affiliates of German firms were nearly four times their exports to America. So the slump in America has squeezed parent companies' profits. American multinationals have also responded to the slump at home by trimming output and jobs in Europe and Asia, transferring the blight from one region to another. Similarly, Fujitsu, a troubled
Japanese electronics firm, has just announced that it will slash 16,400 jobs, 10% of its global workforce. Most of the cuts will be outside Japan.

During the good times, the increased interconnections of economies allowed other countries to share in America's boom. Now, however, America is exporting some of its recession abroad by importing less. In turn, economies hurt by America's downturn buy less from the United States and the rest of the world, which depresses demand further. In the first half of this year, Asia's exports and imports both fell by around 20% at an annual rate (see chart 3). Indeed, global trade is screeching to a halt. The Economist Intelligence Unit, a sister company of The Economist, forecasts that growth in the volume of world trade will drop to only 3% this year,from 13% in 2000. That would be the sharpest slowdown since 1975.

The long and the short of it

How long will the world economic downturn last? Most economists still expect both the American economy and the world economy to bounce back by the end of this year. Goldman Sachs, for instance,reckons that global economic activity will reach a trough in the present quarter. However, it expects a sluggish recovery.

There are two reasons for optimism. First, largely thanks to the cut in American short-term interest rates from 6.5% to 3.5%, the money supply in rich economies has accelerated sharply. If monetary policy worked with the same lags as in the past, the world could look forward to a strong rebound next year. Second, oil prices have fallen, pulling down inflation and pushing up real incomes and profits.

This downturn is part of an investment boom-bust cycle, different from other economic cycles since the second world war

But unfortunately, the balance of risks lies on the downside. Top of the list is the risk that America may go into recession as rising unemployment curbs consumer spending. Were the dollar to go into freefall, as opposed to a measured decline, that too could cause a collapse in economic confidence. America's economic downturn is also likely to last a lot longer than had once been expected. It is different from other economic cycles since the second world war. Typically, recessions have been caused by high interest rates imposed to fight excess demand and inflation. Instead, this has been an investment boom-bust cycle, more like recessions before the war. In investment-led cycles, interest-rate cuts tend to be less effective in spurring demand until excess capacity and debts have been reduced.

Then there is the risk that Argentina might yet default on its debt. This week the IMF agreed to a new $8 billion loan for Argentina. But it is only a stopgap. The fiscal austerity required to meet the IMF‘s conditions are likely to prolong Argentina's recession. The good news is that the risk of widespread contagion from Argentina to other emerging economies may be smaller than a few years ago. Most emerging economies have larger foreign-exchange reserves, less short-term debt and floating exchange rates. Investors also seem to discriminate more among borrowers.

However, if Argentina does eventually default, other emerging economies would surely suffer.Perhaps the biggest downside risk is that American share prices still look overvalued. Indeed, the recent downward revisions to both productivity growth and total profits as measured in the national accounts has increased the likely extent of that overvaluation. One of the success
stories of the new economy was supposedly the surge in productivity and profits in the late 1990s. But official number crunchers have recently rewritten history. It turns out that productivity growth was a bit less miraculous than first thought, while the profits boom of the late 1990s was mostly an illusion.

The new figures, which take account of the true cost of stock options, show that profits have been falling as a share of national income since 1997. The reductions in productivity growth make analysts' forecasts of long-term profits growth—and hence share prices—look even more ridiculous. They also suggest that America's sustainable rate of GDP growth is well below what it has enjoyed in recent years.

The risks of a deeper global slump remain high. But even if America avoids a recession this year, it is unlikely to return soon to the go-go days of recent years. Many American investors and consumers have yet to wake up to this fact.

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Trading As A Performance Sport
Brett N. Steenbarger, Ph.D.

For the past 15 years, I have served as a therapist, counselor, mentor, and advisor to the medical students and physicians at an academic health center. Most of the people I work with are bright, motivated, educated individuals who are free from debilitating psychological problems. Their goal in counseling is to bring their performance to a higher level. They know that if they are going to be competitive in a field such as orthopedic surgery or emergency medicine, they need to be firing on all cylinders.

Interestingly, their interests and needs are not unlike those of Olympic athletes, active traders, bodybuilders, concert musicians and others engaged in performance-oriented pursuits. They realize that, if they spend years honing their skills, they can ill-afford to have their state of mind interfere with their peak performance.

The hypothesis I'd like to share with you is straightforward: There is a core set of characteristics that distinguish the greatest participants in any field of endeavor-including mastering the markets. If you read Jack Schwager's interviews with such accomplished traders as Mark Cook, Linda Bradford Raschke, and Mark Ritchie, you'll notice a recurring theme: success in trading is as much a function of the qualities of the trader as the system being traded.

In his text entitled "Greatness", Professor Dean Keith Simonton points out that mastery of any domain requires approximately 50,000 "chunks" of information. This applies across different domains, from chess and sports to scientific research. To acquire such a wealth of experience and data, the great individual needs to be able to sustain focused attention on work for considerable periods. The psychologist Mihalyi Czikszentmihalyi has found that this is possible because the creative person enters a pleasurable emotional state-a state of flow-when immersed in effortful activity. This intrinsic pleasure enables achievers to weather periods of uncertainty and discouragement on the way to success.

The implications of this line of research for trading are profound. Most texts on trading psychology emphasize such techniques as positive thinking and visualizations. These can be helpful, to be sure. But to transform oneself as a trader, it is necessary to transform one's state of consciousness. Traders lose when their mind states interfere with their natural processing of market data. To become a lean, mean, trading machine, it is necessary to cultivate the capacity to enter and sustain the flow state. Notice that Schwager found that most "Wizard" traders engage in extensive research and preparation before their trades. This is not simply a tool for scoping out the markets: it is mind-training, developing the trader's capacity to stay immersed in their craft.

Simonton also examined the specific works of some of the most eminent creative individuals in different fields and came to a startling conclusion. The odds of generating a work of lasting merit did not increase over the creator's lifetime. That is, the greatest writers, artists, and thinkers produced the same ratio of clunkers to works of genius throughout their careers. They were successful, Simonton notes, because they simply produced more. Whether a given work becomes famous or not is a matter of natural selection. Creative talents who are more productive increase their odds of generating a memorable work.

Once again, the implications for trading are clear. Even master traders are likely to produce a fair number of clunker trades. Like power hitters such as Mark McGuire, they will often strike out on their way to slugging a number of home runs. To become a master trader, traders need to trade, and need to continually hone their skills. Persistence, especially in the face of adversity, is a quality shared by most of the Wizard traders.

Indeed, in his excellent text "The Road to Excellence", K. Anders Ericsson concludes that future expert performers engage in intensive training activities over a period of ten or more years in the cultivation of superior performance. Success, he finds, is a function of intensive, deliberative practice conducted while in a state of heightened attention and concentration.

Ericsson likens the mind's development under such training to the physical benefits of athletic training. Former Mr. Universe and bodybuilding coach Mike Mentzer has written extensively on the benefits of high intensity strength training. It is the intensity of the workout-not its duration-that contributes to physical development; only under brief, intense demands will the body devote the resources to its muscles that become manifest as physique. Ericsson points out that superior performers conduct similar "natural experiments" with their growth, achieving unusual cognitive mastery through repeated, intense skill rehearsal.

From this research, we can infer two reasons why traders fail. First, they become emotionally involved in their trades-eager for profits, despairing of losses-and thus exit the flow state needed for immersion in the learning experience. One cannot be immersed in an experience and also preoccupied with its outcome.

The second reason traders fail is less appreciated. They lack the sustained concentration and focus needed to benefit from intensive practice. Imagine going to the gym and lifting a 20 pound barbell a few times. Surely we would not develop our strength or physique under such conditions. The capacity for trading success remains similarly dormant when traders attempt to beat the market with part-time preparation, impulsive hunches, and untested strategies. When asked to identify a loser on the trading floor, Wizard Tom Baldwin told Jack Schwager, "Losers don't work hard enough…They don't concentrate…You can see it in their eyes; it is almost as if there is a wall in front of their face."

To these worthy observations, I would add the following. If market opportunities are born of inefficiencies inherent in human information processing, as behavioral finance researchers suggest, then the ability to profit from these opportunities requires the capacity to stand apart from such biases and patterns. One cannot simultaneously fall prey to human nature and profit from it. This requires a considerable measure of self-development, the kind that can only occur as the result of immersive experience and practice. Those who aspire to trading greatness must find some measure of greatness within. Such is the challenge and nobility of the path we've chosen.

Brett N. Steenbarger, Ph.D. is a licensed clinical psychologist and Associate Professor of Psychiatry and Behavioral Sciences at the SUNY Upstate Medical University in Syracuse, NY. He is currently collaborating with Linda Bradford Raschke on a project to assess the ways in which personality and coping styles influence the methods utilized by traders and their trading results. He welcomes comments and questions at

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