Financial Market Forecast for 2001.

• Author: Simkowitz, Michael
• Position: Brief Article

It is time for us to take out the crystal ball once again. 2000 being a presidential election year we must repeat one salient truth: the 2001 forecast is not dependent upon who is in the White House.

There are three major factors in forecasting the financial markets: interest rates, earnings and the risk premiums. First, interest rates are lying on a yield curve that declines by 60 basis points in the first 15 months and is then essentially flat. This appears to indicate that the markets are looking for a slight decline in interest rates. But beneath this there is a major struggle between the forces of light and darkness.

The forces of light believe that the Fed is done tightening and the next move in interest rates, if any in the next few months, will be downward. While the forces of darkness see rising interest rates necessary to combat inflationary pressures due to the rise in the price of oil. By the way, there are two schools of thought regarding oil prices and interest rates. One is that the rising costs of crude diverts dollars out of the domestic economy and, although some may come back via the financial system, that this may actually reduce inflationary pressures in the general economy. The counter argument is the classic cost-push argument that high crude prices raise costs and business will pass these costs through the system causing inflation. Being essentially a monetarist, I lean toward the former in that higher crude prices reduces the domestic real supply of money if we assume a constant Fed policy.

Second, earnings have been very robust for the past few years and although next year's growth may not match the recent record, corporate earning may still grow by nearly 10 percent. Corporate earnings growth will be hampered by the strong dollar and a consumer sector that is already spending at the "max". On the upside is a rate of productivity growth that does not show any signs of slowing. But the net is that earnings will grow but at a slower rate than in the recent past.

Third, will this...