Zaks Investment Advisory Service

Current Events and a Bit on India

On Friday, March 7, the Labor Department issued its February employment data. It turned out that our economy lost 63,000 jobs. This is pretty disappointing news. It testifies that our economy is either approaching a recession, or has already slipped into one. The private sector lost 100,000 jobs while government payrolls rose slightly, which, of course, is not terribly comforting news. The data for January was also revised down. The market absorbed all this information and fell, compounding the losses that came on the eve of the report. Treasury prices, meanwhile, gained as numerous investors sold stocks and bought Treasury bonds, which are less risky financial instruments. In financial lingo, this process is called a “flight to quality.” For the week, the S&P 500 index lost 2.8 percent and currently trades at its lowest level in the past one-and-a-half years. Last time, we talked about risk and how its perception affects market prices. Risk premium grew over the past week. We have posted an expanded and updated series of data in the Market Notes section of our site. In addition to the risk premium on high-yield corporate bonds, we also published a chart on the risk associated with subprime mortgages, where the current problems began. Despite all the efforts to resolve this crisis undertaken by Congress, the Administration, banks, and mortgage companies, the market still perceives subprime mortgages as ever more risky instruments. This negatively affects both the financial markets and the economy as a whole.

I would like to remind you that despite the deluge of negative information coming at us from the press, the situation is actually far from catastrophic. The current unemployment level stands at 4.8 percent. Historically, this is a very low figure. Of course, if the economy falls into a deep recession, unemployment would grow. But let’s take a look at the data. Five years ago, in 2003, the unemployment level was above six percent. During the recession of 1992, it rose to eight percent. In 1982-1983, it went up to nearly 11 percent. Our Labor Department has assembled unemployment data going back to 1948. This information is accessible to all. A quick calculation shows that the average unemployment rate for the past 60 years stands at 5.6 percent. In other words, at the moment, unemployment is significantly below average. One should keep this in mind while listening to the hysterical programs devoted to financial issues.

It is worth noting that not all of last week’s news was bad: February retail sales, for example, rose by 1.9 percent. This exceeded analyst forecasts. However, the market currently has absolutely no intention of responding to positive news. It has focused solely on the negative. As I have already said, the Federal Reserve should be trying to dispel this mood. The market is waiting for interest rates to be cut by another 100 basis points – of course, not all at once. The rates will probably be lowered at the next Open Market Committee meeting by 50 basis points (some even expect a 75 point reduction, although this is unlikely). And this will not be the last time rates are lowered. In the meantime, the Federal Reserve has raised the amount of money that banks may lend directly through the so-called “term auction facility” to $100 billion. In other words, the Federal Reserve is not sitting idly by. We should hope that the interest rate cut, along with the money the Administration and Congress decided to return to taxpayers (these checks will be arriving in the mail in May), will have a positive effect on the financial markets and the economy.

And now, let us return to this program’s main subject. In our previous programs devoted to the so-called emerging markets, we analyzed three of the four countries making up the BRIC group: China, Russia and Brazil. Only one remains: India. India’s stock exchanges, just as those of the other BRIC nations, have been growingly tremendously quickly over the past five years: for example, the Mumbai exchange index has shot up some 450 percent in this span. But this type of growth is a novelty for India. Just recently, the country’s economy wallowed in dire straits. Over the course of many years that followed its independence, the Indian economy grew painfully slowly while its financial markets, for all intents and purposes, failed to function at all. There was one simple explanation for this: India’s economy was built on socialist principles. Jawaharlal Nehru, independent India’s first prime minister and a great admirer of Stalin’s economic policies, began introducing five-year plans – just as they were being done in the Soviet Union. Wrapping itself in nationalist slogans and formally out to defend the economy, the government passed a series of protectionist measures, banning the import of many goods and slapping huge import tariffs on others. The practical result of these measures was an uncompetitive, backward economy and a lack of foreign investments. The bureaucratic red tape was so thick that it became gruelingly difficult to set up new businesses. The government’s official economic goal was to root out poverty. But in practice, hundreds of millions of people continued to starve even as late as the 1960s. Between 1951 and 1979, the average annual economic growth rate stood at 3.1 percent, while in per capita terms – at one percent. Intriguingly, while India’s political system remained one of the most openly democratic throughout the Third World for all these years, its economic system pretty much copied the Soviet one. In 1990, India found itself on the verge of bankruptcy.

In 1991, India elected Narasimha Rao as its prime minister. He implemented a series of economic reforms that reshaped India and gave it a chance to grow. Everything we witness today – from the fast-paced economic growth to the developing financial markets and rising stock exchange prices – is a tribute to the reforms undertaken by Rao and his finance minister (and current prime minister) Manmohan Singh.

What Rao and Singh actually did, how this affected the country’s economy, and what brought on the stock exchange boom – this will all be the subject of our next program. But with this, we will draw today’s program to a close. This was Sergey Zaks. Thank you for your attention and until next time.