BIG PICTURE: Does Stock Market Gloom Doom Economy?
23 Jul 13:55
By John McAuley
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--Economists had been arguing that the stock market's
decline of the past year was disconnected from a more buoyant economic reality.
It would be up to the market, they said, to adjust upward to bring the two
variables closer into line.
But in light of the transition in the past couple of weeks from an equities
decline to a plunge, some economists are modifying their outlook to incorporate
stock market effects into their economic forecasts. These forecasters now think
the economy will also have to do its bit to get more in line with a harsher
reality suggested by the stock market.
"The problem is we're waiting for another shoe to drop," said Joe LaVorgna,
senior economist at Deutsche Bank. "While there might be a disconnect from the
economic data to the stock market, we worry that the ongoing fall will nip what
we have been believing would be a decent economic expansion."
Like many other economists, LaVorgna is reluctant to make a big change in his
forecast, yet. But there's been a big change in stock market behavior.
"Until two weeks ago, it was a very orderly selloff," he said. "If the stock
market turns around, we could be back to where we were a month ago."
Other economists, like LaVorgna, are reluctant to react too suddenly to a
market move that could turn out to be a blip.
"I think a big (negative) impact on the economy is possible, but not very
likely," said Henry Willmore, chief U.S. economist at Barclay's Capital. "The
main influence is overwhelmingly from the economy to the stock market."
Willmore's forecast is for a 5.0% rate of gross domestic product growth in
the current quarter and 3.0% in fourth quarter.
" I haven't changed my forecast, I don't think these short-term moves mean
very much. I certainly didn't when the stock market declined after Sept. 11,"
he said.
Sands AreShifting
The sanguinity that economists had been showing, however, is definitely
eroding.
"We haven't changed anything yet," said Jim O'Sullivan, senior U.S. economist
at UBS Warburg. "It's not that the stock market doesn't matter, it's just that
we don't want to be changing the forecast every week."
A key reason why O'Sullivan has held off altering his forecast is that he
still sees offsetting positives.
"There's still some offset from the low level of interest rates and there has
been fairly positive momentum in the economic numbers that hasn't been derailed
yet."
Finally, while far from a slave to econometric models based on history,
O'Sullivan does cite the Federal Reserve's macroeconomic model that shows,
based on historical behavior, that a 20% decline in the stock market, by
itself, shows up as a 0.4 percentage point decline in GDP growth in the first
year.
"I'm inclined to think that result understates the effect, but it also
doesn't take into consideration the offsetting softness in interest rates,"
concludes O'Sullivan. Lower interest rates have fueled a strong rally in home
prices, which has boosted households' wealth at the same time that the stock
declines have cut into it.
Some other economists are more worried, however, that the decline that we've
already seen is enough to chip away at the recovery.
"When the stock market plunges as much as it has, it clearly hurts confidence
and has a negative wealth effect," said Sung Won Sohn, chief economist at Wells
Fargo. "I think that there are already some real consequences."
Sohn notes that business confidence has been hurt more than consumer
confidence and that as a result the cost of capital has gone up and some
capital spending and hiring decisions have been delayed.
"Consumers have been less affected so far. The last Fed consumer study found
the average household only owned $11,500 in stocks. They have a much greater
stake in their homes," Sohn said.
Nevertheless, the changes he has made to his forecast are still relatively
cosmetic: lowering third quarter GDP growth to 2% from 3% and trimming fourth
quarter growth to 3% from 3.5%.
Transmission From Stocks To Real Estate
A more pronounced change is noticeable in the outlook of other economists,
who until recently were economic bulls and have now become more bearish.
"Up until last week I wasn't worried by the second quarter stock market
decline, but the drop in July is beginning to worry me," said Ram Bhagavatula,
chief economist at the Royal Bank of Scotland in New York.
The reason Bhagavatula is worried is that he believes credit tightening is
beginning to take place. "The commercial paper market has dried up unless
you're rated Triple-A and banks have already taken hits on Enron and WorldCom.
It's like 1992-93 when credit tightness caused the `head winds' that (Fed
Chairman) Greenspan referred to."
Moreover, he's worried that the decline in one asset market - the stock
market - could transmit to the another asset market - that of residential real
estate.
"Unless the S&P 500 can climb back over 900, fourth quarter GDP growth is at
great risk, possibly of only 1.5%" concludes Bhagavatula.
Another economist who was until recently been an optimist but who is now
hedging his bets is Jim Glassman, senior economist at JPMorgan Securities.
"I think the Fed is keeping interest rates lower than they otherwise would
for a longer period," Glassman said. "I feel like the window of danger is the
fall. If the economy keeps cruising along, however, people will begin to talk
about the interest rate effects being greater than the wealth effects."
"The test that the worst will be over will come when we start talking about
the interest rates are in the wrong zipcode and need to be pushed higher," said
Glassman.
-By John McAuley, Dow Jones Newswire, 201-938-4425; john.mcauley@dowjones.com
(END) DOW JONES NEWS 07-23-02
01:55 PM |
