Greenspan's testimony on state of US economy unable to calm markets

WITH US equity markets having crashed to below their September lows and, in so doing, managing to breach support levels that date back to the 1987 crash, this week's address by Alan Greenspan to public representatives on the state of the economy was highly significant.

The uncertainty which continues to surround the outlook for corporate profitability and indeed the validity of the accounting techniques on which these estimates are based, has severely dampened investor confidence. With many investors interpreting the weakness in stock markets as a signal of overall weakness in the economy, any comments from Greenspan on the state of the economy and the current interest rate policy stance were extremely relevant to the market tone.

On the medium-term prospects for the US economy, the tone of Greenspan’s statement was relatively upbeat. He declared that the fundamental underpinnings of the US economy remain strong and that the Fed expects a return to sustained healthy growth in the coming quarters. As the labour market continues to show signs of stabilisation and the data clearly showing that productivity growth remains strong, there is ample reason to believe that the pick-up in economic activity since the beginning of the year will be maintained. Moreover, with inflation at its lowest rate since the late 1950s, there is little pressure on the Fed to raise interest rates in the near term. However, the respectable 3.5%-3.75% GDP growth outturn envisaged by the Fed for this year is not without risks, some of which are particularly significant at the present time. Further weakness in equity markets is one such risk and Greenspan dedicated a good portion of his statement to this issue. Although household spending continues to be supported by a stabilising of the labour market and low borrowing costs, falling share prices are a drag on personal wealth. While the Fed remains confident that final demand will increase this year, the pace of any such increase is unclear given the weakness in equity markets and the lack of pent up demand in the economy. The Fed also notes that stable prices make it extremely difficult for companies to grow revenues in the absence of a surge in demand conditions. Greenspan drew a neat comparison with the 1950s, the last time that prices were stable, but noted that population and employment growth were much higher which made life easier for companies at that time. In contrast, today’s companies have to rely more on cost-cutting as a means of preserving margins.

On the issue of dishonest reporting of earnings, Greenspan notes that widening of share ownership among senior managers in large companies has increased the incentive to talk up stock prices. In Greenspan’s own words: “the avenues to express greed have grown so enormously.”

Ultimately, the CEO must bear the responsibility to accurately report the condition of the company to shareholders and potential investors. As the current equity weakness implies that profitable opportunities for dishonesty are diminished, we hope to see far fewer questionable accounting practices in the future.

Don Walshe is Senior Economist at Goodbody Stockbrokers