The Economist: "Year of the Bear"
March 2nd 2001
From The Economist Global Agenda
Stockmarkets around the world have had another turbulent week. Since last March, American markets have fallen more than they did in the crash of October 1987. How much further will they go?
IT DOES not matter whether you are in America, Europe or Japan: share values have been dropping across the industrial world this week, and last week—and, come to think of it, the week before that. Although the markets have been unusually volatile, with sharp rises as well as falls, the underlying trend is clearly down, and has been for months (years in the case of Japan). Each time investors breathe a sigh of relief, thinking that the worst is over, another sell-off begins.
Is this widespread nervousness yet another sign of globalisation? To some extent, it is. Doubts about the prospects for high-tech companies in America are bound to be mirrored in Britain, France and Germany, and European markets have indeed reacted to sharp falls across the Atlantic. But globalisation is not the whole story. The ripples of panic which seem to sweep regularly these days across various stockmarkets can disguise important differences in the world’s biggest economies.
Consider Japan. The Nikkei index peaked in 1989, and has been sliding ever since. The slide has accelerated sharply over the past few days as it became clear both that the country is now teetering on the brink of recession once more (industrial production shrank by 3.9% in January) and the government and the central bank seem unable to get to grips with Japan’s fundamental economic problems. By March 2nd, the Nikkei had fallen to levels not seen since 1985. Pessimists fear that Japan is already in recession with little hope of an early recovery. Weaker export sales to the slowing American economy will not, of course, help.
Indeed, that R-word is pre-occupying American investors too at present. A seemingly endless series of disappointing company results has severely weakened confidence in both new and old-economy stocks. One of the brightest high-tech performers, Oracle, warned on March 1st that the economic slowdown in America would mean disappointing profit figures: this is just the latest in a long line of companies in the technology sector which have admitted that they will not be able to meet shareholders’ expectations, either because of the generally weakening economic environment, or because they had been over optimistic in the past. This sort of negative news has seen the high-tech Nasdaq index lose more than half its value since March last year.
Many people thought the spectacular rise in the Nasdaq up to March 2000 bore all the signs of a bubble that needed bursting. Certainly, the price/earnings ratios of Nasdaq stocks suggested a substantial overvaluation of shares—and an inevitable downward correction. The inevitable has now happened, and it has been painful for everyone, not just high-tech firms. Over the same period, the slide in broader indices of share values, such as the S&P 500 and the Wilshire 5000, has been less pronounced: but it has been significant, as more and more old-economy companies feel the effects of the slowdown as well.
Talk of a stockmarket crash seems to have faded though—and no wonder. The Nasdaq has already lost more of its value in the past year than the Dow did in October 1987, and the recent stockmarket falls represent a larger share of American GDP than did the 1987 crash. In other words, the crash has already happened. The negative “wealth effect” of falling share-values on the economy as a whole cannot be ignored: as investors feel poorer because of the shrinking value of their stockmarket holdings, it seems almost certain that they will cut their own spending. But the extent to which this is causing America’s economic slowdown, or just aggravating one which is underway for other reasons, is far from clear.
Though difficult to determine, the extent of the negative “wealth effect” could be crucial, especially in Europe, where stockmarkets have also dropped, but where hopes remain high that economic growth can be sustained. As America struggles to avoid recession, Europe is—so far—congratulating itself on keeping its economy humming. The European Central Bank expects the euro area, the 12 countries in the single European currency, to be above its trend level in 2001, and The Economist’s own poll of private forecasters shows that the consensus view is that Europe’s economy is already growing faster than America’s. But Europeans should not be complacent. Inflationary pressures in Europe remain worrying, the euro is still relatively weak and stockmarket confidence is now faltering.
An increasing number of European companies have substantial interests in America and through them a direct stake in what happens to the American economy. Many others export high-tech products to the US. Therefore investors are right to be concerned about the impact of an American downturn on European firms. If concern turns to panic, European stockmarkets will suffer as much as any in America. Fewer European households than own shares than those in America, so the wealth effect of sliding share values is likely to be less, but it will not be absent altogether.
Of course it would be a brave—and foolhardy—person who predicted when the current bear market will end, and how much further shares will fall before it does. Markets frequently overshoot, in both directions, so now that they are heading downward they could well keep going in that direction for some time. In addition, many market watchers believe American stocks, in particular, remain overvalued when compared with historical trends. If they're right, stocks could have further to fall before any long-term recovery is sighted.
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