Column: Greenspan Discovers Investors Rule
By Pierre Belec
Saturday, January 27
NEW YORK (Reuters) - It's high noon, and the world's toughest inflation-fighter is facing a villain he's never come up against. Is he going to stand his ground, or cut and run?
Just the other day Alan Greenspan rotated his sheriff's badge 180 degrees and talked about tax cuts. Now with the stock market fading deeper into the twilight zone and the economy sliding fast, the Fed chairman has his back to the wall, namely Wall Street, and he has to bring down interest rates.
Why? The people who put their money in the market have become the economy.
Greenspan's rapid-fire increases in interest rates from the summer of 1999 to the spring of 2000, drove a stake through the bull market's heart. And, screaming headlines of ``Market Meltdown'' and talk of recession have sapped consumer confidence.
The Fed head discovered something else. With half of U.S. households holding a stake in stocks, the market created so much wealth over the years that investors are NOW the economy.
The proof: Spending by consumers on big ticket items and consumer confidence took a dive after stock prices collapsed.
The wealth effect from the boom in stocks from 1995 to 1999 doubled the ranks of millionaires in this country and generated $10 trillion worth of prosperity. It also fired up consumer and business spending and boosted the nation's gross domestic product by a whopping 1-1/2 percent.
But Greenspan in his zeal to head off inflation and unofficially, skim off some of the exuberance from the stock market, went on a rate-raising spree that spiked up the cost of borrowing money by 175 basis points. The move knocked the wind out of the economy but it also burst the market bubble, apparently more than the Fed chief had expected.
Since March 2000, some $3 trillion in market wealth has gone up in smoke as stocks imploded. That mother lode of cash equates to 30 percent of GDP, according to numbers sharpies.
People feeling less rich from the reverse wealth effect, were quick to cut back on their spending, but this turned out to be disastrous for an economy where consumer spending fuels two-thirds of growth.
INVESTORS AS JITTERY AS IN 1998 GLOBAL CRISIS
Investors' jitters over the economy is now as widespread as in the 1998 global economic crisis when the Fed rushed to slash interest rates to build a firewall around the U.S. economy.
The Street is being flooded with downward earnings revisions and there's a real risk that analysts who believe in fairy-tale corporate stories, may have to keep lowering their expectations through 2001.
In fact, the earnings revisions in the fourth quarter of 2000 for the 500 companies in the Standard & Poor's index were the highest in 20 years. The worry is that the fourth-quarter results, which are so far running nearly 2 percent below what the market had expected, may be a prelude of nasty things to come in 2001.
In congressional testimony this week, Greenspan gave some support to cutting taxes to reinvigorate the economy -- an idea also being pushed by President George W. Bush. But he did not address the rate cutting issue.
The Fed may throw a lifeline to the market when it meets Jan. 30 and 31 -- just weeks after it surprised financial markets with a better-be-safe-than-sorry rate reduction of 50 basis points on Jan. 3.
The experts say Greenspan will have to convince Wall Street that he is serious about promoting an economic recovery.
The betting is that the central bank will go for a cut of either 25 or 50 basis points in short-term interest rates. Few people expect the Fed to sit on its hands and do nothing.
There is no doubt that the Fed's rate hikes put the economy on a slippery slope and the damage will have to be repaired quickly.
BABY STEPS IN INTEREST RATE CUTS A NO-NO
Most economists say the worst thing Greenspan could do is take baby steps in lowering rates. In other words, Greenspan must avoid giving the stock market the water torture treatment by sticking to his trademark gradualism money policy.
Consumer sentiment in January, according to the University of Michigan, was the lowest since 1998 when Russia defaulted on international loans and Asian economies crashed, which sent shock waves through the global economy.
Also, the Conference Board's Index of Leading Economic Indicators took its biggest dive in five years in December. It was the third drop in a row for the LEI following retreats in November and October. Also, Corporate America's confidence in the economy plummeted in the fourth quarter to the lowest since the second quarter of 1980.
The market is re-pricing stocks as the economy shifts from booming growth of 6 percent to something in between 2 and 4 percent. A hard landing would bring an expansion of just 2 percent or less while a soft landing would mean a respectable level of growth of 4 percent. The worst-case scenario: a recession with a decline in growth.
``The first quarter will be the weakest one of the year in terms of economic growth,'' says Paul Kasriel, chief economist for Northern Trust Co.
``Inventories will be a drag on growth, especially with motor vehicle producers cutting production in order to get stocks better aligned with sales,'' he says.
Kasriel's bet: The Fed will cut rates by another 50 basis points by March, and in the end, a total lowering of 100 basis points ought to generate enough monetary stimulus in the second half of this year.
Right now, consumers are waiting to see if stocks will be able to rally or whether the market's slump is something more permanent.
The market's battering, which knocked the technology-heavy Nasdaq composite index down as much as 54 percent from last March's record high, may have lowered the risk of an even bloodier hit.
LITTLE MARKET RISK LEFT AFTER DEEP DROP?
The reasoning is that since the market has come down so much, there may be little risk left of a bigger setback.
But the concern is that the market could be a big illusion, and current sector rotation might be a new version of the old momentum-driven speculative risk game.
Alan Newman, editor of H.D. Brous & Co.'s CrossCurrents financial letter, says that despite months of tremendous volatility, the Dow Jones industrial average and the Standard & Poor's 500 indexes have moved sideways.
The blue-chip Dow has been in a trading range for the last 18 months and hovers at 10,700 after closing 2000 at 10,786. The S&P clings to 1,350 or about flat with 1,320 at the end of last year.
``The Nasdaq has actually collapsed,'' Newman says. ``Yet, with all the increased activity, nothing positive is occurring. The market is simply churning the same old dollars and posting, in total, the same old prices. As in all games where the net result is a zero return, the players will eventually leave the game to play elsewhere.''
Newman noted that there was a huge inflow of $450 billion into stock mutual funds in the past 1-1/2 years, yet the market has gone nowhere.
``That $450 billion is equal to about 5 percent of our entire GDP, but it has had no lasting impact on the stock market,'' he says. ``It proves that stock prices are unsupportable when you can have such an inflow and prices don't move higher.''
A long-time bear, Newman says people are being fooled by this magic trick, where money is being taken from one stock sector and shifted to another sector.
Investors have gotten hooked on the idea that they have to stay in stocks and it's wise to run with the herd, whether they believe strongly in the sector that is the mover 'du jour.'
IN BEAR MARKETS, OVERSOLD CAN GET A LOT OVERSOLD
``What has occurred is an illusion as one sector after another has benefited from a short-term rotation of allocated funds,'' says Newman. ``In this manner, a significant portion of the market is always rising in price, presenting the media with a hot story and presenting the public with another 'opportunity.''' |
