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Global Economy — Enronitis and "An Array of Factors"

By Scott B. MacDonald

The G-7 summit in early February proclaimed that the global economy is on track for recovery. According to the G-7 communique the U.S. is showing the first signs of recovery, Europe is soon to follow (indeed the UK is expected to sidestep a recession altogether), and Japan’s problems were treated with measured concern. On Wall Street there are still a handful of bulls, looking for a V-shaped recovery. Yes, a growing number of North American companies are talking about better returns in the second half of the year. Yes, it looks as though the U.S., the critical engine for the global economy, is in the trough and ready to start an upward move in the business cycle. Yes, geo-political concerns have swung in favor of the good guys.

Nevertheless, we maintain our view that the global economy is on a slow boat to recovery and that U.S. stock markets will remain on a roller coaster ride due to ongoing uncertainty about corporate performance, accounting issues and the state of the economy. This sober assessment of the US economy was caught by Fed Chairman Alan Greenspan who stated on February 27, 2002: "the U.S. economy is close to a turning point and should begin growing at a slower pace than in previous recessions." The Fed chairman also added: "An array of influences unique to this business cycle, however, seems likely to moderate the speed of the anticipated recovery."

Part of that array of influences is "Enronitis", a nasty illness that hit U.S. securities markets in December and which refuses to entirely go away. It afflicts investors and makes them very suspicious of all companies that are not easy to understand or have any questionable issues regarding accounting, trading practices and partnerships. Part of the problem is that many of the accounting practices now under question were regarded as legitimate for much of the last decade. To put it mildly, the witch-hunt for companies with Enronitis has hit energy (Calpine), finance (Household International), telecom (Qwest and Worldcom) and tech companies hard. It has also made the corporate bond market volatile during the beginning of this year.

Despite the current negative feel to markets, we want to make four points. First and foremost, the witch-hunt for companies with Enronitis will eventually end. Not every company has the illness and even those tagged with it, like Tyco International, are showing that many of the concerns stirred by the press are not accurate. But it will take time to regain investor confidence.

Secondly, Enronitis is actually going to have a positive dimension — much better transparency and disclosure from companies and quick action once a questionable practice surfaces. Consider Nortel’s rapid action in firing their CFO in early February 2002 over certain trades he made in his personal account. Conference calls to support new bond issues are filled with assurances of standard accounting practices, the lack of partnership agreements, and a desire to hire solid accountants -- who are not also providing the same company with consulting services. In addition, a number of the companies hit by Enronitis are now conducting conference calls with equity and debt investors to address any issues that arise. Indeed, in one case the new transparency and disclosure went so far as to include the actual costs to print documents related to earlier acquisitions. There is a new atmosphere of transparency - it may be something that not everyone wants, but it’s now all there, hanging in the wind for all and sundry to see.

Thirdly, Enronitis is spreading. It is now in Europe. So far we have seen Elan, an Irish pharmaceutical company, and Cable & Wireless, a UK telecom company, catch Enronitis and their bonds and stock prices have suffered. We suspect that German companies will also come under pressure, especially after evidence of financial difficulties at the large Kirch media empire. Additionally, Enronitis is heading for Asia, where it will probably test new claims of improved transparency and disclosure.

Our fourth point is that Enronitis is hiding U.S. economic data that shows a gradual improvement and a possible end to the recession. Lost in all the headlines about Enron, Elan and Global Crossing (bankruptcy), is that US unemployment is probably nearing its peak, inventories are being cut, capital expenditures are way down, and a growing number of North American companies are talking about an upturn in demand, as well as in revenues and profits, for the second half of the year. While it is hardly news worth breaking open a bottle of champagne for, it does show evidence there will be a recovery in 2002, which is likely to gain in strength in 2003.

However, Enronitis is not over. It will remain one of the factors that will overshadow global economic recovery and provide an additional element to stock market volatility. It does underscore that the business cycle has not gone away. It is symptomatic that the cleansing process is now well advanced in the United States and Canada. It is heading toward Europe and eventually will reach Asian shores. Once Enronitis begins to diminish, it will signal the move back toward a more healthy global economy.