Greenspan, Rear-View Mirror Driver??
Feb 10 8:20am ET By Pierre Belec
NEW YORK (Reuters) - Federal Reserve Chairman Alan Greenspan looks at the economy in the rear-view mirror, which is really not the smartest way to pilot the world's biggest economy.
The reason is that Wall Street cares more about what's ahead than what just went by, such as those monthly economic reports, which are simply lagging indicators.
"That is the way Federal Reserve Chairman Alan Greenspan drives his monetary policy," says Don Hays, president of Hays Advisory Group, an investment consulting firm. "Over the years, he veers wildly from the ditch on one side of the road to the ditch on the other side of the road."
Let's look at the video tape. Stocks collapsed on Jan. 2, the first trading day of 2001, as investors threw in the towel after the market showed no willingness to shake off the bearishness that rocked stocks in the closing quarter of 2000, The next day, Greenspan popped into the news like a Jack In The Box, with a surprise 50-basis-point cut in interest rates.
More recently, the Conference Board, a New York-based research firm, said its confidence index fell for a fourth straight month in January to the lowest since December 1996. Greenspan reacted with another cut of 50 basis points in interest rates.
The slump in consumer confidence, Hays says, was not predicting a recession, but simply telling the Street what had actually happened.
JANUARY RUSH
Greenspan's rush to lower interest rates in January was a dramatic policy reversal after the Fed chief orchestrated a campaign to drive interest rates to a nine-year high between June 1999 and May 2000. The goal was to squash what has since turned out to be an illusionary threat of inflation.
The economy has been stunned by the Fed's tight money policy. With growth seen at zero after a gain of 6 percent in recent quarters, consumer confidence has taken a plunge as Greenspan has affected the wealth and spending decisions of every American.
The manufacturing sector is in the worst shape since 1991. The bad news hit just as the United States was about to toast the economic expansion's 10th birthday.
Greenspan, in his zeal to head off the inflation threat and to unofficially suck some of the air from the stock market bubble, went on a rate-raising spree that spiked up the cost of borrowing money by 175 basis points in six gouges. The rate hikes, which were excessive, choked the economy and sent stocks on a downward spiral, with the Nasdaq Composite Index crashing 39.3 percent last year.
The economy's growth nearly stalled in the fourth quarter. The gross domestic product posted its smallest rise in 5-1/2 years as the measure of the value of all goods and services inched up just 1.4 percent. Now there's a lot of talk the economy could hit the wall of recession.
"Did the Fed overshoot its mark?" asks Kent Engelke, capital markets strategist for Anderson & Strudwick Inc. "It is evident they did as today's probable recession is a policy mistake -- keeping interest rates high as the bond market was clearly stating that the economy has slowed."
The Fed chairman is rushing to fix the damage by rebuilding people's confidence in the economy, and of course, in the stock market, which has gotten so big that it has become the economy.
PANIC AT THE FED?
All signs say the Fed panicked by slashing interest rates by an unusual 100 basis points in a four-week period in January. During the last recession in 1990-91, the Fed took as much as six months to lower rates by 100 basis points.
Hays believes people should be worried that Greenspan has become a slave to the expectations of the loud herd on Wall Street. The chairman has painted the Fed into a corner and the central banker now has to manage the market's expectations.
Because there is a lot of anxiety about how much and how often the Fed will need to lower interest rates, the trick will be for Greenspan to avoid disappointing the stock market. In other words, if the market is tuned in for a 50-basis-point cut, then the Fed will have to come up with that kind of trimming or risk rattling the Street's already frayed nerves.
Right now, the market is betting that another 50-basis- point rate chop will come out of the Fed's next policy-setting meeting on March 20.
Despite the recession-like mood in the stock market, some of Greenspan's cheerleaders still view him as the "most powerful man in the world," says Hays. "If he is, it really scares me, and I am fastening my seatbelts with him in the driver's seat and trying my best to clear the fog off the front windshield."
SILENCE OF THE FED, PLEASE
The experts say the best environment for the market would be one where the rules of the economic game stay the same and the money policy is stable.
What's been happening for the past few years is that the Fed has added to the market's volatility with its stated bias either toward tightening or loosening the nation's money string.
The central bank's threat to rein in inflation two years ago by boosting interest rates was just as disruptive to the stock market as its current effort to administer smelling salts to the wheezy economy by chopping away at interest rates.
Typically, the economy's growth slows when the Fed raises rates and it picks up steam when it lowers them. But the truth is that this manipulation of the economy created unwanted waves in the business cycles.
It's not just a coincidence that during the past 10 years of economic expansion, the Fed was the most inactive and well behaved in nearly a half century, with the exception of 1994. The 'Greatest Economic Expansion' in history came to a halt only after the Fed raised rates six times. The economy has now nearly stalled and growth, to quote Greenspan, is "probably very close to zero."
The Street's main preoccupation is in figuring out how many interest-rate cuts will come from the Fed and how long they will take to reinvigorate the economy. It won't be an easy thing to do.
For the first time since the last recession in the early 90s, investors are facing an earnings recession with the profits of the Standard & Poor's 500 companies expected to drop for two consecutive quarters.
Chuck Hill, director of research at First Call/Thomson Financial, says first-quarter 2001 earnings are expected to be down 0.9 percent and second-quarter earnings off 0.1 percent.
"The market has already written off the first and second quarters of this year," he says. "The real issue is whether the second quarter will turn out to be the bottom for the economy and for earnings, and the third quarter will be the turning point."
THIRD QUARTER AND GOAL TO GO?
"So the key is the first half of the year, and since the market looks out a couple of quarters forward, it would make sense for stocks to be moving up at this time," Hill says. "But if the recovery comes after the third quarter, then stocks will have to move lower before rallying on a sustained basis."
First Call is calling for a gain of 6.8 percent in third- quarter earnings. The great news is that analysts see a rocket ride of a recovery of 16.7 percent in fourth-quarter earnings.
The third quarter is a big unknown because of the uncertain environment that was created by Greenspan. Under normal conditions, analysts would be able to estimate the third quarter's results at this time of year, but the worry is that there's a risk the current contagion of disappointing corporate profits may mean the third quarter will also be a spoiler.
The good news: The fourth quarter this year will look better because of the easier comparisons against the nasty final quarter of 2000. |
