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Portfolio > Mutual Funds > Bond Funds

Slower Growth, Higher Rates--But Stocks May Still

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As chief economist at Bank One Investment Advisors in Columbus, Ohio, Anthony Chan is responsible for crafting strategy affecting $145 billion in assets under management. Chan, a former Federal Reserve Bank of New York economist, remains an avid watcher of Fed policy. Investment Advisor Editorial Director William Glasgall caught up with Chan recently during a visit to New York, where he held forth on the outlook for the U.S. economy and interest rates. Chan also released a research paper arguing that an expected increase in the Federal funds rate–the charge on overnight loans among banks–spells trouble for the U.S. Treasury bond market. The paper is available by clicking here:

What are your feelings about on Donald Kohn and Ben Bernanke, President Bush’s two nominees for vacancies on the Fed’s Board of Governors? Kohn [a Fed economist and Chairman Alan Greenspan's closest advisor] certainly has proximity and access to Greenspan. And in Washington, proximity is everything. He’ll have one of the shortest learning curves we’ve ever seen. As for Bernanke, he more than makes up for the intellectual vacuum left by Laurence Meyers’s departure from the board. He has the intellectual firepower of several intellectuals combined. He prefers a closer targeting of inflation than Greenspan might like, and he will fall somewhere into the hawkish camp. He will focus on inflation like a laser beam.

So should we worry about inflation now? No. Not really. Productivity figures are lending support to the idea that inflation isn’t a concern for the immediate future.

Will strong productivity numbers result in improving corporate profits? There’s no question. In a world where corporations have no pricing power, the only way they can improve profits is by productivity growth. This goes right to the bottom line. We are continuing a productivity boom that began in the 1990s.

What’s your forecast for GDP growth? Three and a half to 3 3/4 percent, fourth quarter [of 2002] over fourth quarter [of 2001]. Average growth of 2 1/2 percent to 2 3/4 percent for the year.

How will consumers fare? The lion’s share of growth we’ve been seeing is in consumer spending. But the debt service burden of consumers is very high, compared to where it has been at the beginning of previous expansions. And a lot of this debt was taken on at floating rates. As rates go up, the debt will become more burdensome. Already, credit card debt that is more than 30 days overdue is at a five-year high. We really need to see the other force–capital spending–kick in. But that won’t be until 2003.

How much will the Fed push up short-term interest rates? Five months ago, I said no more than 75 basis points this year. I’m sticking to that forecast. I think it starts in the second half, probably in August. There’s a 40% probability of that right now.

When will budget surpluses return? Not anytime soon. The President says this is a long war, and that means more spending. A return to the old days cannot be seen.

Are stocks overpriced at current levels? The equity market is much higher than its historical price-earnings ratio. But this was the worst recession for corporate profits ion 50 years. This is not normal. When you adjust for a more normalized path of profitability, this [current average p-e ratio] doesn’t look so bad. But corporations have no pricing power and are likely to face slow economic growth going forward. That’s a hurdle for a rebound in profits.

What’s your feeling about bonds? I went back to the 1950s to see what happens when the Fed raises rates. In the nine cases since the 1950s, when the Fed raised rates more than 50 basis points, long-term rates always went up. And yes, every time Greenspan raised rates, the 10-year [Treasury] bond rate went down that day or the next. But six months later, in not one instance did [10-year] rates go down. So what I would do is to move away from overweighting bonds and start getting excited about equities.


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