Tags: economic | recovery

Cost-Cutting Will Continue to Drive Profits in Slow Recovery

Thursday, 17 September 2009 09:11 AM Current | Bio | Archive

In a continuation to yesterday’s trade news concerning the United States and China, the Chinese government has now filed a formal complaint to the World Trade Organization (WTO) on the 35 percent U.S. tariff imposed on all car and light truck tires from China in a so-called attempt to "remedy the clear disruption to the U.S. tire industry."

Under the WTO's dispute settlement system, the two countries will now have 60 days to try to resolve the dispute through consultations. If consultations fail, China can go further by requesting a WTO panel to investigate and rule on the case.

That said, San Francisco Fed Governor Janet Yellen yesterday made, at least in my view, for investors rather important statements in her speech titled, “The Outlook for Recovery in the U.S. Economy.”

Here are some excerpts: “I believe that we succeeded in avoiding the second Great Depression … I regret to say that I expect the recovery to be tepid … The financial system has improved but is not yet back to normal … the unemployment rate will remain elevated for a few more years … the slack in the economy, demonstrated by high unemployment and low utilization of industrial capacity, threatens to push inflation lower at a time when it is already below the level that best promotes the Fed’s dual mandate for full employment and price stability …”

Here are some more: “This time though rapid growth does not seem to be in store. My own forecast envisions a far less robust recovery, one that would look more like the letter U than V … more credit losses are in store even as the economy improves and overall financial conditions ease … When the array of problems facing consumers is considered, it is hard to see how we can avoid sluggish spending growth … the main impetus to growth in the second half of this year will be inventory investment … The slow recovery I expect means that it could still take several years to return to full employment. The same is true for capacity utilization in manufacturing … The fear of higher long-term inflation reflects, to a large degree, worries about Fed monetary policy …”

Still more from Yellen’s speech: “This fear is real, growing, and disruptive. That’s why it’s so important for me to say the following loud and clear: We at the Fed are and will remain fiercely independent from politics. We have the means — and we certainly have the will — to tighten policy when the time is right. In fact, by raising the interest rate that we pay on excess reserves, we can tighten monetary policy even before our balance sheet shrinks.”

Practically at the same time, Nouriel Roubini repeated his earlier prediction that the U.S. economy faces the threat of a “double-dip” recession, and at best a slow-growth U-shaped recovery.

He also stated that more than 1,000 U.S. financial institutions could fail before all is said and done, and housing prices are likely to fall another 12 percent in the next year because of price adjustment that, in his opinion, is going to continue for another year.

So, what’s in store for equity investors?

Well, as I expect to see a correction in the markets in the foreseeable future (take care, I expect dollar and markets to move in opposite directions), investors should start to look where and in what to reinvest part of their wealth in equities once that expected correction will have run its course.

Taking into account Yellen’s and Roubini’s statements, I would look for companies with the ability to cut costs. Generally speaking, I see the world remaining a place where pricing conditions will remain challenging for companies.

While I don’t expect a full-blown deflation, I also don’t expect a sufficiently above-trend growth that will allow companies to raise their prices aggressively.

We should keep in mind that, historically, profits don’t grow meaningfully unless GDP is above 1.5 percent to 2 percent.

Because of that, I believe cost-cutting will be one of the main drivers of profits in the foreseeable future. Indeed, this not-so-popular reality of itself will also create consolidation momentum.

Therefore, I believe that it is important to be conscious of companies with a low and flexible cost base. Of course, here we clearly can’t generalize about sectors because this is very much more a micro exercise where everybody will have to do his or her serious homework.

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In a continuation to yesterday’s trade news concerning the United States and China, the Chinese government has now filed a formal complaint to the World Trade Organization (WTO) on the 35 percent U.S. tariff imposed on all car and light truck tires from China in a so-called...
Thursday, 17 September 2009 09:11 AM
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