Can the Fed Find the Middle in a Market of Extremes?
By GRETCHEN MORGENSON
NEW YORK -- Even with the major market indexes up splendidly this year, the stock market remains a place where the have-nots vastly outnumber the haves. Stocks dipping to new lows dominate those reaching new highs.
And while the NASDAQ composite closed on Friday at a record high, up 71.16 percent in 1999, 84.8 percent of NASDAQ stocks are down 10 percent or more from their highs of the year, according to Salomon Smith Barney.
For months, the bifurcated market has frustrated investors unlucky enough to own shares in companies that are doing fine but that are not market darlings. Now the market's extreme segmentation is posing genuine problems for the Federal Reserve, whose policy makers meet Tuesday.
Aiming to keep the economy from overheating, the Fed has raised interest rates three-quarters of a percentage point since June. Rate increases usually put a damper on stock indexes, but not this year. That is because the technology and Internet stocks that are propelling the indexes to record highs are impervious to rising interest-rate pain. Their capital needs are satisfied at low cost by venture capitalists and stock market investors, who have money to burn and pay no attention to rates.
But the recent rate increases have hurt interest-rate sensitive companies like financial institutions and old-fashioned industrial concerns by increasing their costs of capital. Companies whose shares are in the doldrums cannot turn to the stock market for cheap capital. They must go to banks or the bond market -- and rates have risen in both. Yields on 30-year government bonds jumped from 6.16 percent to 6.38 percent.
And so the Fed finds itself in a corner. On one hand, inflation does not seem to be in evidence across the country. But the economy is considerably stronger than the Fed would like it to be, largely because of consumer spending. And what is driving the consumer into the stores? None other than the rising stock market.
According to International Strategy and Investment, an investment advisory group, retail sales closely parallel the stock market's gains, especially around Christmas. In the fourth quarter of 1997, for example, retail sales inched up 1 percent; the Standard & Poor's 500 index rose 3 percent. In the fourth quarter last year, retail sales climbed 11 percent and the S&P jumped 17 percent.
As rising stock indexes stoke the hot economy, they are also minimizing the effects of the Fed's recent rate increases. But because these indexes do not reflect the fortunes of all stocks, the Fed's next moves are made much trickier.
If the Fed wanted to rein in runaway stock prices by raising rates, it would have to go well beyond the one-quarter-point moves it is accustomed to making. That could be dangerous. One trader likened the situation to a lawn with a clump of weeds far outgrowing the grass.
"If you administer too many chemicals to kill the weeds, you could kill the entire lawn," he said. "To stop this mania, it's going to take several doses of harsh medicine."
Christine A. Callies, chief United States market strategist at Credit Suisse First Boston, said: "The Fed is concerned about an equity bubble that blunts the influence of Fed policy. But I think it's politically unrealistic for them to conduct monetary policy with the goal of cooling off the stock market." So the party goes on. And the stakes rise ever higher. |
