There's Hope Yet For the Economy

Now that we officially are in a recession, the question on everybody’s lips is “For how long?” On Friday, Abby Cohen-Managing Director at Goldman Sachs and Chair of Goldman’s Investment Policy Committee-visited the HBS campus to explain why she is projecting a return to trend growth rates in real GDP and corporate profits in 2002.

Cohen is Goldman’s Chief U.S. Investment Strategist and was ranked as one of Wall Street’s top equity analysts during the 1990s, when her bullish comments were seized upon by investors and moved markets. Of late, she has fallen in the pecking order, but she continues to be one of the most influential equity analysts on the Street.

Cohen believes that the U.S. economy reached its peak in the fourth quarter of 1999, with a inflation adjusted GDP growth peaking at 8% (three times the historical trend growth rate) and S&P operating profits growing at 22% (also three times the historical rate). Since then, she argued, there has been a dramatic downward adjustment in the U.S. economy, taking the form of decreased inventories, muted capital expenditures and a quelled enthusiasm for new business ventures.
On September 24 of this year, with the S&P500 at 966, Cohen recommended that investors buy stocks. Though most investors who believe in a fundamentals-based approach to forecasting (i.e., using DCF or other analytical models) as opposed to so-called technical analyses (where investors measure quantities like the momentum of a particular stock at a given time) agreed with Cohen, not everyone bought stocks at that time. Cohen pointed to the notion of “career risk” in a subset of investment manager’s decision-making processes, which suggests that for some, the risk of being in the market at a time of uncertainty outweighed the potential for upside. One reason why we have experienced a rally in the past two weeks, according to Cohen, may be that this set of investors now see the biggest risk as being out of the market.

“It’s very hard to see what is happening in this fourth quarter,” continued Cohen. First of all, some key indicators (e.g., Consumer Confidence) are proving difficult to interpret. Secondly, Cohen believes that corporate earnings in this quarter will be obfuscated as a result of four special factors: Seasonal effects have made the fourth quarter historically the most difficult to forecast; the effects of the FASB ruling that prevents most companies from classifying charges related to September 11 as extraordinary; the SEC SAB100 ruling which forces companies to make yearly rather than quarterly estimates of restructuring costs; and the fact that companies may see this quarter as an opportunity to take write-offs on bad decisions made over the past decade.
Cohen’s view is that we are approaching the end of the downward adjustment in the economy which begun in Q4 1999, though she warned that “the last piece of the downward adjustment is labor-related and is likely to be the most painful.” Although it is impossible to forecast exactly when the downturn will reverse (indeed, it will be different for different industries), Cohen is forecasting a year-end 2002 S&P500 somewhere between 1300 and 1425, depending on the risk premiums demanded by investors. Given this muted recovery in 2002, she concluded, “It may be 2003 until we have a clearer picture of exactly where we are heading.”