Jewish World Review Dec. 13, 2002 / 8 Teves, 5763

David R. Kotok

David R. Kotok
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Consumer Reports

Frequently Asked (financial) Questions | Listed below are some of the questions we received during recent speeches and meetings with clients and consultants.

Where is the stock market headed next year?

Higher. We think that the Dow will cross 10,000 as the economy continues to recover and that recovery becomes more robust. Earnings comparisons are going to improve; that trend will become more apparent and durable as next year progresses.

Isn't the risk of deflation serious? Will it happen?

Yes, it is serious. No, it won't happen. The Fed and the other arms of the U.S. government are committed to stimulus in order to prevent a general deflation. They have put into place five types of stimulus to avoid deflation. Those five pieces will work because they impact the nominal aspects of the economy; that insures their success. For a list of these five see :Five easing pieces.

What about Iraq? Terrorism? What will happen if there is another Al Qaeda attack?

My assumption is that we win. Iraq will get resolved. President Bush has staked his Administration's reputation on this. He must succeed. Remember, Iraq has the means to pay off its war debts. A post Saddam Iraq will pump and sell oil and open it borders to trade and improvement for its presently oppressed people. History shows that this is a logical outcome of a conflict like this one.

As for terrorism, we expect more. It is clear that there are forces in the world which are determined to kill Americans. That is their goal. We think that the U.S. is still too complacent. We Americans have not fully realized that terrorism is more than the mega variety of 9/11. We have exposure on trains, in cargo ships, on bridges, in malls, etc. Our society has changed its way of handling aviation. We will change other forms as well. Regrettably, that will probably come in response to another attack and not in advance of it.

But isn't the impact of terrorism a negative for the economy and financial markets?

Only in the beginning and we are way past the beginning. 9/11 was a shock. It is an inflection point in history. There are aftershocks from 9/11 just like there are from earthquakes. But we have already changed. One needs only to go through an airport security line and compare it with pre-9/11 to see that change.

This change meant immediate obsolescence for much of our airport system. It also means replacement. Rapid obsolescence with a sunk cost is the initial and negative part of the shock. Adaptation and the new system are the pieces which cause economic growth and present business opportunity. That is how our system works.

Where will interest rates be next year?

Short rates will stay low all year. The Fed is not about to raise rates until the manufacturing sector is clearly out of the woods. That is not yet apparent. Long rates are in a tug of war between those who cannot stand the yields on cash equivalents and those who believe that higher rates are coming in the future. We are in the higher rates camp because we believe that the five pieces of stimulus will lead to somewhat higher inflation in the future. Bond interest rates will adjust upward as this transpires.

Should I refinanced my mortgage now?

Absolutely yes, if you have not already done so.

What about the employment situation?

It is not good and will not improve for a while. This is typical of the economy when it transitions out of a recession and starts to recover. Employment is a lagging indicator. It may be fodder for politicians but economists know that looking at the employment statistics is observing the results of the past policies. We expect the Unemployment Rate to peak in mid-2003 and then start a gradual decline.

What about these great productivity numbers?

In the beginning of an economic turnaround, firms raise their output but do not hire new people. The increase in volume from the same number of workers causes the productivity number to look good. As the recovery takes hold, these same firms start to add labor. That is when the productivity numbers fall. We will see this transition to lower productivity commence sometime in 2003.

What about inflation?

We expect inflation to stay low for the next few months and then start a gradual and persistent rising trend. We look at all measures of inflation. For financial markets the Headline Consumer Price Index is the most important measure. It is the benchmark for adjustment of payments like social security and labor contracts and rents, etc. To gauge the impact of policy on inflation we look at several specific measures and particularly follow those computed at the Cleveland Federal Reserve Bank. That bank's work attempts to capture how much inflation is resulting from monetary policy and how much is coming from the normal ebb and flow of the economy. Those measures are suggesting that policy-induced inflation in the United States is headed toward the 2 to 3% range.

What about the dollar?

We are in the the camp that believes the currency will weaken, especially against the euro. We initially projected a 1-to-1 dollar/euro ratio when the euro was about 85 cents. The euro is 1.01 today. Our latest work suggests that the euro will reach the 1.10 to 1.15 range by the end of 2003. The reason is that the European Central Bank follows a mandated more conservative policy than our Federal Reserve.

How confident are you about these forecasts?

Risk is higher now than it has been in a very long time. These are our best guesses but they come with a higher probability of being wrong than usual. That is why we are constantly adjusting our outlook. All these items could change rapidly in response to new information or to events.

Barring something that requires immediate commentary this will be our final market strategy discussion in 2002. Travel and client related activity are intense for us at this time of year.

We wish our readers all and only the best for a happy holiday season and for a fruitful and prosperous new year. We pray for peace for all in this troubled world. Let us not forget the lot of those who are less fortunate than we are as we enjoy the fruits of our freedom and the benefits of the world's greatest economic system.

All the best.

JWR contributor David R. Kotok is President and Chief Investment Officer of Cumberland Advisors, Inc. His articles and financial market comments have appeared in The New York Times, The Wall Street Journal, Barron's, The Bond Buyer and numerous other publications. He can be seen on CNN, CNNfn and CNBC. Comment by clicking here.


12/11/02: The Fed, The New Bush Folks, The Policy
12/05/02: Five easing pieces
11/26/02: Lessons Learned at The Philadelphia Fed and an update to our strategic outlook
11/22/02: What happens when you mix politics and municipal bonds
11/20/02: Secular vs. Cyclical Bull and Bear Markets
11/14/02: Please stop bashing the ECB!
11/08/02: Fed may have taken themselves out of debate but they've added to uncertainty by surprising the markets
11/07/02: The election and the Fed: Both validate stimulus
10/31/02: Welcome to the world of an enlarged and open Europe

© 2002, David R. Kotok