MONUMENT DERIVATIVES: Euphoria Or Relief?
05 Mar 06:53
By Stephen Lewis
Of Monument Derivatives
LONDON (Dow Jones)--It is a long time since the words 'euphoria' and
'equities' have figured in the same sentence. But there are plenty of reports
today claiming that euphoria has overtaken the US equity market. Relief may be
a more accurate characterisation of US investors' current mood. They no longer
judge a Japan-style economic meltdown to be on the cards in the USA. Such a
depression may always have seemed improbable to some of us but it was a
scenario that gained many adherents on Wall Street last autumn. The latest US
data show that the impetus to growth persists, though they are far from giving
a convincing answer to the question how strong that growth will be. We are
inclined to side with Mr Greenspan, for once, in looking for patchy and fitful
economic progress, perhaps not fully matching the connotations of recovery.
However that may be, the point is that a significant body of market opinion has
had reason to change for the better its view on the prospects for the economy
and for corporate earnings. The consequent reweighting of portfolios by such
investors has generated upward momentum in stock prices.
No major move in the capital markets may be properly judged without reference
to the monetary background. It has not been widely appreciated that, in recent
weeks, the Federal Reserve has adopted a credit stance more accommodative even
than in the run-up to Y2K. This is evident from the free reserves data. In
November-December 1999, the average two-weekly level of free reserves did not
exceed $1.23bn but latest figures, for the two weeks to 20 February, show free
reserves at $1.408bn. They have consistently averaged above $1bn so far this
year. Another measure, total bank reserves, rose at an annualised rate of only
5.8% between October and December 1999. Most of the growth in monetary base
that occurredover that period came in the currency component; it was a
response to a rise in precautionary demand for banknotes reflecting fear of
computer glitches. Between December 2001 and February this year, by contrast,
total bank reserves rose at the much faster annualised rate of 21.4%.
Fed policy with regard to the provision of reserves to the banks has been
similar to that seen in the past at times of financial crisis. Indeed, with
Argentina and then the Enron debacle, Fed officials might well argue that the
system has been facing a crisis situation. However, when a central bank pumps
so much assistance into the banking system to ward off crisis-induced
illiquidity, the risk is that the degree of accommodation will prove excessive
as soon as the immediate threat passes. Unless the central bank is quick to
drain funds, the surplus will tend to find its way through channels into the
capital markets. This may be an important element in what has happened in the
US equity market, now that accountancy concerns have waned.
The challenge for the Fed is to work out how best to proceed from here. There
may well be members of the FOMC who are worried that the issues raised in the
Enron case could flare up again at any time, though Mr Ferguson sought to
downplay these risks in his speech a few days ago. From a broader
macro-economic viewpoint, Mr Greenspan seems anxious that the equity market
should not run too far ahead. That, at least, appeared to be his motivation in
the early days of this year when he sought to pour cold water on the Wall
Street rally then under way. His concern, presumably, is that a surge in the
equity market would take it to an unsustainable level from which a
destabilising break downwards might subsequently occur. Such gyrations could
greatly complicate the Fed's task of managing an economic recovery that must
rely on a steady improvement in business and consumer confidence. In early
January, the Fed Chairman was a little heavy-handed. Instead of moderating
investors' ardour, his words sent equities into a reverse so steep that, within
days, he felt obliged to admit that he had used inappropriate language. He will
have learnt from that experience. There is no reason to think that he has set
aside his concerns over a runaway rise in the equity market, when the economic
foundations are unsure, but he may adopt a more subtle approach to market
management this time. He has an opportunity when he appears before the Senate
Banking Committee in two days' time. As ever, the written testimony will be
unchanged from last week but the Q&A session could well be illuminating. In
particular, Mr Greenspan's response to the question asked by the chairman of
the committee should, as always, give a pointer to the direction in which his
thoughts are moving.
-By Stephen Lewis: 44 20 7338 0179: analysismonumentderivatives.com
(Stephen Lewis is chief economist at Monument Derivatives, London,
independent brokers specializing in institutional business.)
Opinions expressed are those of the author, and not of Dow Jones Newswires.
This column is published for information only, and it neither constitutes,
nor is to be construed as, an offer to buy or sell investments. The information
and opinions expressed herein are based on sources the author believes to be
reliable, but he cannot represent that they are accurate or complete. Any
information herein is given in good faith, but is subject to change without
notice. No liability is accepted whatsoever by Monument Derivatives Ltd,
employees and associated companies for any direct or consequential loss arising
from this article. Monument Derivatives Ltd is regulated by the SFA and is a
member of the London Stock Exchange, LIFFE and ISMA.
(END) DOW JONES NEWS 03-05-02
06:53 AM |
