Bloodbath
Gee. Why doesn't someone make stock prices go up?
Stockmarkets around the world have been in freefall, with traders and investors in America, Japan and Europe scrambling to offload shares as concern grows about global economic prospects. Does the reaction to the latest American interes-rate cut mean Alan Greenspan has lost his touch?
JOHN MAYNARD KEYNES used to blame big stockmarket swings on what he called the 'animal spirits' of investors. Certainly, the herd-like behaviour of the markets has been on display this week, as shares plunged in one country after another. The rout started with the negative reaction in American markets to the Fed's announcement on March 20th that it was cutting interest rates by another half-percentage point. The high-tech Nasdaq, the Dow Jones Industrial Average and the wider S&P 500 all fell sharply, reflecting traders' disappointment that the interest-rate cut was not bigger. European markets followed suit on Wednesday March 21st, recording very large falls. And then on March 22nd, markets in Europe and America plunged further. Even Japan's Nikkei index, initially cheered by signs that the authorities were starting to get a grip on the country's problems, started to slide again on Thursday. Despite a better day on Friday, markets ended a nerve-wracking week in a jittery state.
If the Fed's chairman, Alan Greenspan had been hoping to soothe stockmarket nerves by cutting rates, he has, at least for the moment, failed. There is a risk that the Fed will now be pushed into making further cuts in a way which will look as if the markets are dictating policy.
The latest reduction in American interest rates was the third in less than three months and was billed as part of the Fed's strategy of aggressive response to the downturn in the American economy. Mr Greenspan has noted several times in recent weeks that companies are now able to respond much more quickly to changes in the business environment, and that the economic impact of these shortened response times means the authorities have to act more quickly too. That's why the Fed took everyone by surprise on January 3rd when it first cut rates because of new data (the National Association of Purchasing Managers' Index) showing the slowdown was more severe than previously realised. But in spite of temporary pick-ups, the underlying trend in American stockmarkets has been relentlessly downward since before the turn of the year.
Of course, Mr Greenspan would be the first to admit that it is not the job of the Fed to prop up the markets. Indeed, there is much speculation about whether what is happening is still part of a correction to the spectacular rises in many share prices—especially those in the high-tech sector—and that the markets have further to fall before they reach levels more closely linked to appropriate valuations taking proper account of company earnings and other factors. One econometric model that tried to calculate these valuations, put together by the Centre for Business and Economics Research (CEBR) in London, comes up with some interesting figures. The model suggests that the Dow is, if anything, slightly below its appropriate level of 9,550, and that the FTSE 100 is now well below what it should be, 6,200; but that the high-tech Nasdaq still has some way to go, to about 1,500.
Of course, many analysts take a significantly different view, and such calculations can in any case only be approximate. Markets invariably overshoot both on the way up and on the way down. But the CEBR analysis implies that the Nasdaq might fall by another 15% or so, based on a more sober assesssment of the earnings prospects of high-tech companies than investors were making only a year ago.
Just over four years ago, Mr Greenspan himself spoke of the "irrational exuberance" of the markets. In the intervening years, they became even more exuberant, so the Fed chairman was presumably not averse to some sort of correction. But he now faces two, closely-related problems. One is simply the way in which the decline has been gathering speed. It may not be his job to offer a bail-out to investors by cutting rates whenever the market drops; but he might want to slow the speed of decline to prevent markets going into freefall and causing a financial crisis. Managing that, without appearing to be cutting interest rates in a panic, has become more difficult in the wake of the reaction to the latest cut.
Mr Greenspan's second worry, which is a concern for President George Bush as well, is the direct impact the stockmarket falls are having on the real economy. The economic outlook has rapidly become much gloomier in the past few months. Industrial production fell in February for the fifth successive month, hitting a level not seen since 1992 (when the economy was just emerging from recession). Inventories are up, showing that firms are still producing more than they are selling and making further cuts in production likely. Unemployment is now creeping up, albeit slowly. The Economist's own poll of private forecasters shows that they have been busily—and speedily—revising their forecasts of American growth in 2001 downwards: from 3.5% in October to 1.6% at the beginning of March. With nearly half of American adults owning shares, the "negative wealth effect" of falling stockmarkets encourages people to start saving again and cut back on spending. This in turn could worsen the downturn and delay recovery—something both Mr Greenspan and Mr Bush are anxious to avoid.
As if this gloomy scenario did not pose enough of a problem, there was further bad news for Mr Greenspan on March 21st, with figures showing that inflation was proving stubbornly high for an economy now slowing down sharply. This could limit the scope for further rate cuts, even as the pressure for them intensifies. Lower interest rates now might be the only way to halt the current stockmarket hysteria. But they will make the task of curbing inflation when the economy does start to recover even more difficult.
The Economist, March 23, 2001
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