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Strategies & Market Trends : The Stock Market Bubble -- Ignore unavailable to you. Want to Upgrade?

To: The Ox who wrote (3280)	6/13/2000 8:11:00 PM
From: The Ox	Respond to of 3339

((thanks go to NucTrader for the link)) pimco.com The Bottom Line The journey to the Brave New United States economy is over. Some form of landing is necessary, with the only question being just how stagflationary it will be. And the key to that is where NAIRU is relative to the prevailing 4% unemployment rate. If NAIRU is 4%, the Fed funds rate should be at 5«%; but if NAIRU is 5%, the Fed funds rate should be at 8%. The current Fed funds rate of 6«% is implicitly consistent with a NAIRU of about 4«%, in which case the Fed has already taken sufficient tightening action to stabilize inflation below 3% over the next two years. And in fact, I think that?s probably a pretty good cyclical peak forecast for the core inflation rate. Whether or not 6«% is a good cyclical peak forecast for the Fed funds rate is, of course, an entirely different matter. There are many at the Fed, led by Governor Meyer, who believe that the new NAIRU is near 5% not 4«%, and are therefore pushing for a Fed funds rate closer to 8%. Thus, it would be foolish for me to forecast that the Fed is necessarily finished tightening, even though that outcome would be consistent with my own preferences. What I can forecast with very high confidence, however, is that the economy?s performance is going to be starkly less pleasing over the next two years than in recent years. As both a citizen and an economist (once one, always one!), that doesn?t bother me. I?m more than happy to sing the praises of a Brave New United States economy of only 4«% unemployment and an inflation rate near 3%. Only five years ago, those of us who envisioned such a wonderful United States neighborhood were viewed as members of Mr. Rogers' fan club. But regardless of the beauty of the destination, the journey to it is over. And that has profound implications for asset allocation. The winning asset class in the midst of a positive productivity shock is logically always equities, because the P/E multiple should go up. But because stocks are the winners during the journey, investors become ever more enamored with stocks, even as the new, lower NAIRU destination is reached. Accordingly, I?ve long believed that the end of the journey to the Brave New United States economy would be marked by an equity market bubble. I think that moment has come. The current P/E is simply too high relative to a cyclical landing scenario that is skewed toward stagflation. Accordingly, I must admit that the investment message I delivered on my recent trip was indeed somber: A fully employed Main Street is a beautiful thing, but has ugly implications for an irrationally exuberant Wall Street. The time has come to strategically sell high P/E stocks into high quality bonds! Paul McCulley Executive Vice President June 1, 2000 mcculley@pimco.com