Even When Were Out of the Woods, We May Not Know It

No matter how the stock market behaves, or whether the economy rebounds with all guns blazing, we're going to be at a loss to know anything with certainty until the year 2003.

No matter how the stock market behaves, or whether the economy rebounds with all guns blazing, were going to be at a loss to know anything with certainty until the year 2003.

The reason is that economics is best viewed through a rearview mirror, preferably from a fast-moving vehicle. Market behavior, as well as the health of individual companies, can only be measured in comparison to past performance. Companies can gain momentum and investor interest just on narrowing losses if they cant turn a profit. Others can lose share based upon a sustained downward slide in margins even if they continue posting a profit.

In short, everything in economics is measured in comparison to what was. We measure the current downturn against the recession of 1991, the crash of 1987 and the great crash of 1929. We learned in 1929, for example, that you dont raise interest rates immediately following a market crash and that you dont clamp down on imports even though people are out of work. We discovered in 1987 that a market crash doesnt necessarily mean a downturn will be sustained, and that stocks can continue to climb even in a downturn. And we found out in 1991 that if you wait too long to raise interest rates, a hiccup in the economy will be greatly magnified.

The hard part is making short-term decisions and trying to extrapolate what the effect will be over the long term. Given the fact that earnings were unrealistically high in 2000—and theyll be unusually low for the first six months of this year, if not longer—no one will be able to make accurate comparisons for at least two years. That means any policy decisions handed down over the next 18 months will be guesses based upon history, not scientific calculations.

Consider this: Next year will be, assuming all goes well, the first time when we will have a stable baseline year on which to base earnings. That means 2003 will be the first time we can actually gauge how well companies are doing in comparison to that baseline. And those companies that continue their unprofitable run may not be there at all to continue making measurements.

But thats also a best-case scenario, and it assumes no other factors change, as well. A sustained rise in unemployment turns the economy into a buyers market, in which good help can be had for substantially less than companies were willing to pay in boom times. Inflation, meanwhile, means that Alan Greenspan & Co. will have to again raise rates to achieve equilibrium, thereby depressing stock prices.

That, in turn, will put renewed pressure on public companies, which are finding for the first time in decades that theres a downside to their relationship with investors. While the lure of riches from options and the ability to grow using other peoples money works great during a sustained expansion, you might as well be doing business with loan sharks in down times.

Just to make matters worse, the risk of bad decisions rises with limited information. If theres no way to make accurate measurements until 2003, theres also no way to make accurate decisions about how to invest, how to best spend those investment dollars, when to expand, and which companies to buy, sell or partner with.

Even when were out of the woods, we may not know it.