by Tom Slee
Third quarter results provide reason for hope.
It's too soon to celebrate but so far the third quarter results are encouraging. Most of the major companies reporting have met expectations and a few, including giants Microsoft and 3M Company, did better than anticipated. General Electric, a proxy for the entire U.S. economy, posted a 25% year-over-year improvement in profits. For once most of the surprises have been pleasant and CEOs are starting to make some cautiously optimistic forecasts. There is a better tone and the sigh of relief you hear is mine, because a great deal is riding on these results. This is the true test of whether the recovery is underway. A good third quarter would finally put a floor under this market. It can't come a moment too soon.
This is not say that we have turned the corner. Rather, my hope is that we have stopped the rot and can now start building a base for the next general advance. I certainly hope thats the case because this global economic downturn is extremely serious and still deepening, something brought home forcibly to me during a recent visit to France and Italy. The Europeans are in bad shape, which is putting it kindly. Here we argue about how fast the GDP is growing. There the talk is about the survival of the European Community in its present form and serous problems in the banking system. There have been almost 23,000 major and medium-seized business failures in France alone during the first half of 2002. It's not a happy scene.
Perhaps the thing that most surprised and concerned me during my visit was how Germany, once the economic powerhouse, has become the sick man of Europe. The DAX, Germany's major stock index, has plunged almost 40% this year, the worst performance of the world's stock markets. Unemployment is stuck at 18% in the eastern regions, the public sector is demanding massive pay increases, a 3% budget deficit looms this year, and the country is lapsing into deeper recession. Tax cuts and spending increases are called for but, because of the EU rules (rules incidentally that Germany helped forge), the government is actually raising taxes and cutting spending. That's a recipe for disaster.
As a matter of fact, the entire EU structure, designed by people who thought the good times would last forever, appears to be coming apart at the seams. Because of the treaties, Germany, France, and Italy, which together comprise three-quarters of the total EU economy, have no room to borrow, cut taxes, or increase spending. To make matters worse, these countries have lost their central banks so they cannot devalue their currencies or cut interest rates. No wonder all eyes are on Washington and Wall Street for some relief. The Europeans need a lifeline.
I hope that we can throw them one in time. Already, the governments' inability to deal with the situation is being reflected in the business sector. There are serous concerns about some of the major German financial institutions. Comerzbank and Dresdner, two of the country's three major banks, have been badly hurt by corporate bankruptcies and stock market losses. Gerling of Cologne, the world's sixth largest reinsurer, is believed to be technically insolvent as a result of a US$500 million loss at the World Trade Center, coupled to massive write-downs in its equity portfolios. ING, the Netherlands biggest financial institution, is suffering from large stock losses. And so it goes. Our bear market is taking its toll, and there could be a dangerous ripple effect if a large European institution goes under.
So you can see why I returned from Europe feeling very concerned. My last memories of Italy are morning talk show hosts worrying about how the Dow would open. Each day the DAX and London's FTSE seemed to mark time until New York provided a lead. It's not a healthy situation. As you know, not too long ago there were three economic growth centres stimulating world markets: Japan, the EU and North America. Now we are reduced to one, the U.S. Japan is a shadow of its former self and the EU seems to be handicapping, not stimulating, its members.
All of this means, as I mentioned, that the third quarter results are crucial. Even a moderate overall improvement would bring institutional investors back into the market and sustain the recent rally. That, in turn, would ease the stress on the European banks and provide everybody with some breathing room.
Tom Slee is a contributing editor to the Internet Wealth Builder, where this article originally appeared. The IWB is a weekly e-mail newsletter that provides timely financial advice from some of Canada's top money experts. For more information about becoming an Internet Wealth Builder member, Click Here