Stanley Fisher's Warning
Lord William Rees-Mogg
LONDON - Stanley Fisher, of the International Monetary Fund, made an interesting comment on the Asian financial collapse, from which Asia has now largely recovered. He said that he could now recognize the signs of an impending crash. These are:
a large external deficit
a deteriorating credit condition
and an overvalued stock market
Only two of these conditions applied to the U.S. stock market crash of 1929 or to the Japanese crash after 1989. In both those cases the external balance remained satisfactory. All three undoubtedly applied to the Asian markets before their crash in the late 1990s, and all three undoubtedly apply to the United States at present.
The U.S. external deficit has never been so large.
The credit spreads are widening, and the U.S. private sector is running the largest deficit ever recorded. Measured by any standard ‹ dividend yield, price to earnings ratio, price times book ‹ the U.S. stock market is at about double the peak level in 1929. I recommend Andrew Smithers¹ book, Valuing Wall Street, published by McGraw Hill, to anyone who thinks that these values are in any way normal.
Since the early 1990s, Strategic Investment has expressed anxiety about the trend line as it moved away from historic norms. It was in the early 1990s that the U.S. current deficit started its current phase of expansion, the cash surplus of the private sector started to deteriorate and stock market valuations started to rise faster than earnings.
Until 1995, these trends were still inside the past historic norms. The 1995 figures look like the normal top of a boom; if the economy and the stock market had cooled down at that point, the result would probably have been a recession rather than a crash, though the market was already at levels approximately equal to the 1929 peak.
Since then it has approximately doubled.
What were the reasons that the boom continued after 1995? Probably the most important was the psychological impact of the end of the Cold War, both on American and foreign investors. For the last 10 years, the United States has been the sole remaining superpower, the stronghold of capitalist investment. Almost equally important was the success of American technology, particularly in the development of information technology. The 1990s were the decade of Microsoft.
Other reasons include the cash flow into investment as the baby boom generation reached the middle-aged stage of saving for retirement, and the compounding effect of rising stock prices on public confidence.
The fact that the White House was occupied by one of the least Puritan of all American presidents may have contributed to the euphoria. The Federal Reserve was afraid of precipitating a stock market crash and continued to feed easy money into an already bloated credit system.
These positive factors are all still in place, though this November will see the election of a somewhat more prudent president, whichever candidate wins. The United States is not likely to see any serious foreign challenge in the next presidential term, the development of I.T. technology will continue at an explosive rate, the Fed will continue to be accommodating, the baby boomers will not yet have retired.
No one can be sure when the boom will end, though end it must.
There will come a point when the deterioration of credit conditions and of the external balance will apply a braking effect, probably forcing the Fed to raise interest rates further. Yet the momentum of the market, and of the U.S. economy, remains very strong.
The new technology is a real factor of growth. After the fall in the technology share market in the second quarter of this year, growth stocks, which can actually maintain their growth, do not even look particularly overvalued. Microsoft still faces the possibility of a court ordered breakup, though that might not happen, or might prove to release value. At a price to earnings ratio of below 40, and with its share price 40% below the year¹s high, Microsoft does not look overvalued.
It is, after all, the market leader in the most important of the advanced technologies.
The investor has a very difficult judgement to make. At some unknown future time, the present valuation in the U.S. stock market will prove unsustainable. The reasons for that can all be seen quite clearly. The U.S. cannot allow a current deficit of 4% of GDP to double again. The U.S. private sector cannot go further into debt without destroying the credit structure. At some point the public appetite for stocks will have been sated.
It will then become apparent that the downside risk to the U.S. economy, to world trade, to world stock market valuations, is a huge one. Japan and Asia have already experienced the bursting of their bubbles, but the United States had the strength to prevent a world slump as a consequence.
There is no other economy with the capacity to do for the United States what the United States did for the world in the 1990s. Not even the European, which has a similar stock market over valuation.
If Wall Street crashes, world trade is only too likely to fall.
Sooner or later, the historic trend line will reassert itself. When it does, markets may have to go a long way down. There will be a leak in the bottom of the swimming pool and not much water left to swim in. |
