BW Online 1April 26, 20011 Greenspan's Preoccupation with Profits

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Greenspan's Preoccupation with ProfitsThe Fed is wagering that it can ignore inflation while using rate cuts to

OOL\JMNlS help boost earnings and avoid a recession. But there are risksFORUtliS _!

KEWS'L~RS I For the past five years, Federal Reserve officials have been ...-Printer-Fr:i?ndly Versionr"""---''''"--~=---=''"'. regularly contacting Thomson Financial equity strategist Joseph

'i1ERS!l)IIAI(. flllANlCE /" E-M_a_ilTh_is__St_o_r"_~ c.- -cc.. S, Kalinowski for consensus earning forecasts by Wall Street s.[ ;SEA.R~ & ,!JR9W~_E analysts, But the contacts have become much more frequent of

SP.ECIAL Rep.ORTS late. With earnings, and earnings expectations, plunging, they're • Find More Stories Like This

T;Q0LS lit S1::0PlEOO.lIiI!:GS checking with him at least once a week to get the latest news on'l!'lIllEOVIE!N~ the profits front. Of particular concern to the Fed officials, according to Kalinowski: the steep drop

in high-tech companies' profits. "They, like everyone else, have been amazed at how far thoseearnings have come down," the strategist says.

APRIL 26, 2001

NEWS ANALYSISBy Rich Miller

It's no mystery why Greenspan & Co. is so worried: Pinched profit margins are a threat to theeconomy as far as the eye can see, In the near term, the Fed is concerned that the profit squeezewill prompt companies to cut investment and pare payrolls even further, tipping an already weakeconomy into recession.

PERILS AND PITFALLS. The Fed is also worried that the earnings slump will sock the stockmarket and sap consumer spending via the so-called wealth effect. In the longer run, the Fed fretsthat reduced business investment in computers and other efficiency-enhancing equipment willundermine the strong productivity growth that has been the hallmark of the New Economy. In thelatest bit of bad news on the investment front, the Commerce Dept. said on ApI. 25 that corecapital-goods orders fell in March, the fifth time in six months,

But the Fed's focus on plumping up profits carries some risks. If companies try to rebuild earningsby raising prices, the Fed won't only have an economic slowdown to worry about -- it will be facedwith an inflation problem as well. "It's not hard to construct stagflation scenarios in which pricepressures continue to rise in the face of weak business conditions," says Louis Crandall, chiefeconomist at consultants R.H, Wrightson & Associates.

By aggressively cutting rates, Greenspan is betting that the New Economy is alive and kicking andcan insulate the U.S. against any inflation outbreak. As far as the Fed chief is concerned,Corporate America hasn't even begun to exhaust the many productivity-enhancing and profit-making opportunities the New Economy affords.

LONG ON OPTIMISM. Take corporate purchasing managers at the nation's manufacturingcompanies: A December survey by the National Association of Purchasing Management foundthat 95% of the managers contacted felt they could reap further big gains in efficiency from theapplication of technology, As long as companies don't overreact to the current earnings squeezeand indiscriminately slash investment, Greenspan believes the long-term outlook for the growth ofproductivity and profits is bright.

Stock market analysts seem to agree. Yes, they've drastically cut their short-term earningsforecasts as the economy has slowed sharply. But they remain surprisingly sanguine about thelonger-term outlook, According to Kalinowski, Wall Street analysts expect operating profits ofcompanies in the Standard & Poor's 500 to rise on average by about 16% per year over the nextthree to five years. That's down only slightly from a high forecast of 18.7% growth in August of2000 and compares favorably with this year's expected 2.3% drop.

http://www.businessweek.comlbwdaily/dnflash/apr2001lnf20010426_005.htm

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BW Online 1April 26, 20011 Greenspan's Preoccupation with Profits

Foreign investors appear to be on board as well. The continued strength of the dollar -- despite theeconomic slowdown, it's trading near a IS-year high against other major currencies -- is a vote ofconfidence by foreigners in America's long-run economic potential.

But one group is feeling twitchy: Domestic bond investors, who have been dumping Treasuries.The investors are worried the Fed has become so obsessed with boosting corporate profits that it'signoring a host of inflation warning signs, from sagging productivity growth to a renewed rise ingasoline prices. Greenspan is scheduled to speak to the Bond Market Assn.s annual meeting onApr. 27 and could use that opportunity to try to allay investor concerns.

ACCEPTABLE RISK. One of Greenspan's colleagues, Dallas Fed President Robert Mc'Teer, hasall but admitted that bond investors are right to feel a bit slighted. In a speech on Apr. 20, McTeeracknowledged that inflation could end up being a problem for the central bank, but he argued that,for now, it has to take a rear seat in the drive to get the economy moving again. "Under the currentcircumstances, I personally think we need to put concerns about inflation on the back burner forawhile and save the economy from the R'word," he said.

With the U.S. poised on the treacherous ground between recession and recovery, that'sundoubtedly the right position for the Fed to take. But once the economy starts firing on allcylinders again, the central bank will quickly need to turn its attention back to its main mission offighting inflation. Not to do so would risk a replay of the boomlbust cycle that it's now strugglingso hard to avoid.

Miller covers the Fed for BusinessWeek from WashingtonEdited by Beth Belton

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