Morgan Stanley's Roach: "I Don't Think the Bubble Has
Necessarily Burst"
The firm's chief economist talks about valuations, volatility, and the Old and New Economies
By Margaret Popper, Business Week Online Street Wise
NEW YORK, Apr. 05 (Business Week Online) - These are mad times. After a day of trading in
which the Nasdaq reversed a 575-point -- 13% -- freefall to end down a mere 74.79 points, while
the Dow surged 100, lost 500, and wound up closing down 57.09, it's hard to know what to make
of market movements anymore. Is it Armageddon, or just an adolescent tantrum as the New
Economy attempts to define its role vis a vis the Old Economy?
At the close of Tuesday's market, Business Week Online's Margaret Popper spoke with Stephen
Roach, chief economist and director of global economic analysis at Morgan Stanley Dean Witter to
see what this highly respected Wall Street veteran makes of days like this.
Roach's opinions have long been broadly sought. During the market's major correction in
third-quarter 1998, he had the widest global audience of any Wall Street analyst, according to
Thomson Financial Services' research firm First Call Corp. And last May, Roach testified in front of
the U.S. House Committee on Banking & Financial Services about the world financial architecture.
Here are edited excerpts of their conversation:
Q: Are stocks more volatile now, and if so, why?
A: We've just gone through an absolutely extraordinary period where the Nasdaq virtually doubled
from mid-October to mid-March. We've never seen anything like that in the modern-day experience
of this well-developed stock market of ours. And at the end of that surge, there was a virtual
implosion of the Old Economy industrials. We saw some extraordinary disconnects on valuation --
overvalued technology, undervalued industrials. I think the market is trying to find a more
reasonable equilibrium. Volatility is one of the ways in which it goes about its sometimes very
painful task.
Q: Is this volatility going to be routine?
A: My best guess is we will not have exact replicas of what we saw today. But in the early
afternoon, there was certainly something that bordered on a massive selling climax. That seems to
be behind us. But that doesn't mean the worst is over. It simply means that this particular volatility
surge may have run its course for the time being.
Q: A lot of people have been saying that Nasdaq stocks are overvalued and the technology
bubble had to burst. Is that what's going on here?
A: Nasdaq stocks are vastly overvalued. I don't think the bubble has necessarily burst. There's a
big hole in the bubble. But this was a market that on Oct. 19 was at 2688, the last time I checked,
we're still at 4100. We're well above the lows of mid-October.
Q: Is there too much dependence on two or three stocks holding up the market?
A: Narrow markets are inherently volatile and fragile. This has been a very, very narrow market for
a while. For those of us who've been around for a relatively long time, experience teaches us that
narrow markets always end badly.
The classic example was in 1973-74, when the "Nifty Fifty" was driving the market to new highs.
The leadership got narrower and narrower, the rest of the market cratered. The Nifty Fifty itself
hung on and then ultimately gave way. We went into one of the worst bear markets of modern
times.
Q: Which stocks were in the Nifty Fifty?
A: Old-line blue chips, glamour stocks. Xerox, Polaroid, IBM?
Q: What's the relationship today between the Dow and Nasdaq? Is the Dow the Old Economy
index, while the Nasdaq represents the New Economy?
A: I think we have gone too far in making this wonderfully alluring contrast between the Old
Economy and the New Economy -- the old stock market and the new stock market. We're all part
of the same economy. It's absurd to think that we have created a dynamic sector that is insulated
from any of the traditional forces that affect either macroeconomic activity or financial markets.
I think over time there'll be growth spurts in one area or another, whether it's technology or
something else. But they'll be driven by the same powerful macro forces that shape the overall
economy. The New Economy of today is no different than the New Economy of yesterday.
Q: What do you mean?
A: Economic growth is the American way. With the exception of infrequent recessions that
interrupt the growth, we've been on a powerful growth curve for over 50 years. With growth the
norm, something new is always evident in the structure of our economy. Whether it was the
aftermath of post-WW II in the '50s, whether it was the productivity renaissance of the '60s,
whether it was the increased globalization of the late '70s and '80s, whether it's this
technology-led environment in the '90s and whatever you want to call this decade, "new" is
intrinsic to the process of economic growth.
Q: Do our old measures really represent what's going on at the heart of the economy and the
stock market? Is the Dow Jones industrial average outdated as a meaningful indicator of
anything?
A: I think that's a fair rap. The Dow is not indicative of the broader market. The GDP, which is very
much driven by an old manufacturing-based economy, is not indicative of the service-based,
knowledge economy. There's a lot to be said for the fact that we're lacking in metrics as we
transform from the goods-producing into the information-producing era.
Q: But when you see the volatility of the Nasdaq, it doesn't seem fair to say that just looking at
the tech sector explains the economy.
A: I think that's absolutely correct. At the end of the day, technological innovation is powerful, but
like all innovation it becomes commoditized. The real benefits from technology are the way in
which these tools will affect existing companies. So to me, the real challenge for us as analysts is
to figure out how the Old Economy is going to be impacted by the new tools of the so-called New
Economy.
Q: Will the Old and the New Economy start to converge?
A: Absolutely. B2B e-commerce is all about making old companies more efficient with new tools.
The real test as to how this New Economy works will come about through the performance of the
Old Economy dressed up in new clothes.
Q: What should we expect over the coming months?
A: In terms of impact on the overall economy, the big issue for us is whether or not the broad
market goes down and whether or not it stays down. The so-called "wealth effect" works only if
there is a sustained move in the stock market. Volatility where the market goes down a lot, as it
did for a few hours today, and then the dip buyers come back and buy -- that doesn't really have
any appreciable impact on the economy.
These are spikes that mean a lot for people trading the market, but they don't mean a lot for
individual investors who smooth the appreciation or depreciation of their portfolios over a fairly
long period of time.
Q: What other economic factors can influence the market?
A: The link between what the Fed is up to and what the market is doing. It's probably not a
coincidence that the Nasdaq has come under a fair amount of pressure as Alan Greenspan has
indicated his desire to slow down the economy and do that by taking the wealth effect out of play
as a factor in driving the overall economic growth in the U.S.
Q: How does he do that?
A: That's the sixty-four dollar question. Thus far, he has done it by jawboning and by taking
interest rates up a little bit. But interest rates are still so low in the U.S. they're really not having
that much of an impact. My guess is that he will become increasingly frustrated by using a blunt
instrument like the overnight rate -- the Fed funds rate -- to target both the economy and the stock
market. Right now, that approach seems to have worked reasonably well. But I suspect the
market is going to come back, and Greenspan will find himself frustrated.
Q: Should Greenspan be slowing the economy?
A: Yes. The growth rate is far too fast. We grew at 7% in the fourth quarter of last year and
probably in excess of 5% this quarter. We're on a tear. It's not safe in terms of keeping the
balance in our economy under control. |
