WASHINGTON, April 9 (UPI) -- Two weeks ago, "Bottom Line" reviewed the internal crises of democracy around the world and found plentiful reason for short-term optimism on global stock markets. ("Democracy Agonistes," March 25, UPI). So far, so good: The countries we especially liked -- Taiwan, the Philippines, Indonesia, Egypt, Israel, and Malaysia -- have enjoyed rallies of 10-20 percent in equity prices. Only a short position on South Korea moved against us.
Now, however, it's probably the right time to take profits and reduce positions in those countries that have enjoyed a recent rally. In many of these (Taiwan, the Philippines) political uncertainty has been somewhat ameliorated, but by no means eliminated. We're also short a number of overbought developed-country markets that will suffer disproportionately from internal weakness and global violence in the coming weeks. That pain and those attacks are likely to be felt especially by that mother of all democracies, the first emerging market itself, the United States.
Where to go long? Although we still have large positions in such countries as India and Russia, the funds Emerging Markets Group manages and advises have generally responded to recent events simply by pulling back, selling, and generating cash. As far as new, aggressive long positions -- other than gold, U.S. Treasuries, and other traditional hedges that tend to accompany bearishness on stock prices, we're fairly short of ideas. Here's why.
ECONOMICS, WAR, and POLITICS: "There's the economy and economic policy, war, and politics," as world-class investor William Clayton put it in the late 1930s. "Every company or commodity you might look at today in investing today is overshadowed by those three great forces." That's a statement that applies to most periods in history to some degree, but has particular relevance today.
Of the three, the brightest picture, all of a sudden, is on the global economic front. The U.S., China, and India, engine of the dollar zone that is leading world economic recovery, are surging. America, it turns out, created not 200,000 jobs or so in the last six months, but thanks to strong March figures and February revisions, about 600,000. Profits, the true-long term driver of the U.S. stock market that drives the world's, are expected to have grown 17 percent in the first quarter, results for which will be released in the coming weeks.
The trouble is, some high level of profit growth was anticipated by U.S. stock prices in 2003, and in recent weeks, capping a one-year rally in the Dow and S&P of more than 25 percent, and in the Nasdaq, of more than 50. The price-earnings ratio of U.S. equities is at more than 22-1, meaning even a 20 percent profit gain, with no rise in stock prices, would leave a somewhat high 18-1 level. Fast-rising producer prices, such as oil, are already biting into people's expectations not for first-quarter profit growth, but for corporate earnings in the second, third, and fourth quarters.
The jobs news, meanwhile, still averages out to a gain of 100,000, perhaps 120,000 new jobs a month. This is solid, but hardly strong for an economic recovery, especially after the rather deep jobs loss, considering how thin the recession was in output terms, of 2001-2003. It improves the prospects for regime non-change, i.e. a Bush re-election that markets tend to like over the dismal levels of a few weeks ago.
At best, the economy is a push for the coming weeks. As for changes in policy that would have truly global impact for the positive, there are few in prospect. Torpid governments in France and Germany may start to get back to restructuring entitlements and employment law to improve incentives, especially after their recent election embarrassments, but this will take time. Europe's Central Bank cannot reach a consensus on lowering interest rates that need to be lowered, and Alan Greenspan is unlikely to begin a needed U.S. raising of rates until August.
The problem with the war on terror, likewise, isn't a lack of possible gains over a horizon of many weeks to several months. Osama Bin Laden and his top aides are surrounded in Afghanistan and Pakistan, and may well be nabbed by summer. But in the near term, violence in Iraq, and the effort of terrorists globally to punish U.S. allies, is taking a toll.
As far as markets are concerned in the coming days, the worst thing about the attacks in Iraq isn't the sad loss of life. It's the fact that the U.S. now is fighting al-Qaida forces along with a large number of Suni and Shia militants.
The U.S. will no doubt achieve a tactical victory in killing a number of these forces in the coming days. It's hard, though, to see how this amounts to a strategic victory. Killing Moslems is not the way to spread harmony and friendship in Iraq. By large majorities, Iraqis like U.S. democracy, and want it for themselves. By an equally large majority, they want the U.S. to leave, sooner rather than later.
The same observation holds regarding the Korean, Japanese, and in the future, probably other hostages. There's a chance they will be killed horribly, and displayed triumphantly for the Western press. There's a chance they'll agree to a release -- but even if they do, it will be a demonstration of America's need to "negotiate with terrorists." An Entebbe-style raid that actually frees them is possible, but highly unlikely.
All of which feeds into domestic U.S. politics -- and will in turn weaken a number of U.S. allies around the world, from Japan to the Philippines to Australia, many of which face elections in the coming year.
The Bush campaign has now been engaged against its opponent, Senator John Kerry, for nearly two months. It's run some effective attacks on Kerry as a serial tax hiker, and engaged in some far-less-effective attacks on him for ambivalence about Iraq. It's also been engaged in a stupid effort to discredit Richard Clarke and other critics, rather than answering their criticism.
In any case, it can no longer be said that the Bush machine hasn't started humming. It has. After that start, the incumbent president has moved up -- not down -- into a statistical dead heat with his opponent, albeit a slight lead in enough polls to believe the president was ever-so-marginally ahead as of early April.
The combination of events in the Middle East, and the mis-handling of the instant Rice testimony before the 9-11 commission, will not help Bush in the coming weeks.
Worst of all, the combination of news all seems to reinforce some of the Bush Administration's central flaws. One is a perceived obsession with Iraq, and a growing one that this effort has produced marginal gains, or arguably a loss by distraction, in the war on terror. Another is the seeming arrogance of the administration, a combination of secrecy and self-righteousness to meet all criticism that now takes on an unattractive face in light of the Clinton-Nixon style manner of dealing with opponents by impugning their motives rather than debating them.
One of the president's better moments in the campaign so far was his telephone call to Mr. Kerry promising a spirited but by implication substantive debate. This and some similar efforts, such as the fair-minded television interviews given by Secretary of State Colin Powell, suggested a return to the less partisan, "compassionate conservative" pre-9/11 rhetoric Bush used to win the presidency in 2000.
The White House in recent days has undone most of the hope investors might have had for a meaningful 2004 discussion of things like Social Security restructuring, further tax cuts, and establishing democracy in the Middle East. Bush is not only in danger of falling behind -- again -- but of getting into the kind of race that will do him and the country, and thus global confidence, much less good.
THE BOTTOM LINE: For both economic and geopolitical reasons, we're short the U.S., and short the Western European markets (especially France and Germany) where weak governments are still struggling with even the most modest measures to establish economic growth amidst unemployment rates in the high single digits and higher. In the meantime, we've taken profits in most of our global portfolio, hoping to ride through the turbulence before buying back at lower prices when events warrant.
You want to be buying something? Eastern European equities, as a future "Bottom Line," will explain, should continue to out-perform others, along with gold stocks and U.S. and Japanese Treasuries. Sometimes, meanwhile, to paraphrase Warren Buffet, cash is a good short-term investment.
Gregory Fossedal manages international investments for Emerging Markets Group in Washington, DC. His clients may (and usually do) hold long and short positions in many of the investment securities and opportunities mentioned in his reports. "The bottom line" is compiled from sources we believe to be reliable, but no representation is made that they are necessarily accurate or complete. Investors should perform their own due diligence and consult their own investment professional before buying or selling any securities. Mr. Fossedal's opinions are entirely his own, and are not necessarily those of UPI or EMG. Email: [email protected].
