Experts Term Impact Limited Unless Stock Slide Turns Steep
By MICHAEL M. PHILLIPS
Special to THE WALL STREET JOURNAL
The summer stock-market pullback may have a few investors lying awake
at night. But as long as the market doesn't go down too much further, too
much faster and too much longer, economists won't lose too much sleep
over it.
A survey of 10 of the country's top economic forecasters reveals a wary
optimism among practitioners of the dismal science in the face of the
market's 9.8% fall since the Dow Jones Industrial Average hit a closing
record of 9337.97 on July 17. A decline of at least 10% is generally
defined as a market "correction"; several major indexes are either past or,
like the Dow industrials, are just shy of that mark.
"So far, my view of the stock-market correction is it's pretty much of a
nonevent," says John D. Walter, corporate economist for Dow Corning
Corp., Midlands, Mich. "People have been expecting it for some time,
except for the younger guys on Wall Street who didn't know it could go
down."
Mr. Walter was the winner of The Wall Street Journal's last semiannual
forecasting competition, in which 55 economists were asked to predict
economic growth, interest rates, unemployment, inflation and exchange
rates for the first half of 1998. In light of the recent turmoil in the stock
market, the Journal asked the 10 top performers from the previous survey
to reconsider their growth estimates for the second half of this year and the
first six months of 1999.
The main link between the stock market and economic growth is
consumer spending, which makes up about two-thirds of the U.S.
economy. Economists estimate that for every $100 in increased wealth --
say, capital gains from a surging stock market-households spend between
$1 and $5 each year. The richer that individuals feel, the more they're
likely to spend.
Since 1987, the year of the October market crash, the value of U.S. stock
holdings has mushroomed to $14.6 trillion from $2.8 trillion, as of the first
quarter of 1998, according to Federal Reserve data. While not all of it has
gone to households, of course, that rapid increase in wealth has helped fuel
consumer confidence and the 7 1/2 -year-old economic expansion, the
argument goes.
Raising Capital
In addition, businesses use the stock market to raise capital -- through
initial public offerings, for example -- and, increasingly, to finance mergers
and acquisitions. The strength of the stock market, therefore, is tied to
investment spending as well.
The question that the economists face, however, is whether that
market-driven consumer and business spending is reversible. In other
words, is the recent market dive sufficient to cause consumers and
businesses to choke off spending?
The consensus is that while a serious stock-market downturn, if sustained,
could crush the economic expansion, the current near-correction isn't even
severe enough to reduce earlier growth forecasts by more than a token
amount.
"This much volatility hasn't impacted people's commitment to the market,
their view about the future or their confidence," says Maureen F. Allyn,
chief economist, Scudder Kemper Investments Inc. "Nor has it made any
dent in their sense of wealth or anything that would change their behavior."
While the incredible stock-market boom of the past few years is
unprecedented in its scale, economists look at the quick recovery from the
Oct. 19, 1987, Black Monday crash as evidence that a strong economy
can sustain a certain amount of stock-market volatility. In 1987, the Dow
Jones Industrial Average tumbled 32.5% from its peak to its trough. Yet
GDP expanded at a torrid 6% annualized rate in the fourth quarter of that
year, and at a less dramatic, but still healthy, 2.4% in the first quarter of
1988.
No Change in Forecasts
"The last time we had what was in percentage terms a much more serious
crash, but you had a strong economy and it hardly took a nick out of it,"
says Maury Harris, chief economist and managing director of
PaineWebber. Mr. Harris expects the current market drop will shave at
most a couple of tenths of percentage points off GDP growth in the
months ahead, so he's not going to bother changing his forecasts.
That's not to say that the economists believe the U.S. to be immune to the
spillover effects of a long-term stock-market crash. But Mr. Walter warns
that it would take a sustained 4,000-point to 5,000-point drop in the Dow
Jones Industrial Average to cause a recession, barring other economic bad
news. Kurt E. Karl, chief economist, global services, at WEFA Inc., says
there's a 25% chance that the stock market would fall 30% to 40% from
its peak, causing a recession. He has dropped his full-year 1999 GDP
growth estimate to 2.6% from 2.7%.
Ms. Allyn puts the odds at 30% that the market will plunge far enough to
end the expansion. "I don't know where the stock market is going, but if it
does go down another 10%-15%, consumer spending is toast," she says.
"People will have to boost savings to preserve wealth for the future."
It's not just the depth of the decline that economists look at; it's also the
duration. "If it goes to 7000 and the next week is back to 9000 it's not
going to do much," says Ed Hyman, chairman of ISI Group. "If it gets to
7000 and stays there, we're going to have a recession." Mr. Hyman says
the primary effect of such a market drop would be a sharp cutback in
consumer spending, with a reduction in business investment of secondary
importance.
Philip Braverman, chief economist at DKB Securities (USA) Corp., says a
20% to 25% collapse in stock prices from their peak, if the decline lasts
more than six months, could lead to a "full-blown cyclical recession in
1999."
Many economists consider the stock market, over time, to be a reflection
of the strength of the economy, even more than stock prices themselves
are a contributor to that strength. Stocks reflect companies' profitability,
and corporate profits stem from such factors as inflation, interest rates,
price competition and labor costs, as well as company-specific issues.
Effect of Asian Woes
The U.S. economy, despite the turmoil in Asia, still boasts strong labor
productivity, controlled inflation, low interest rates, and efficient
companies. Asia's problems have eaten into exports and generated
increased competition from imports, thereby reducing overall growth. But
many forecasters already took that into account, and predicted a slowing
from the 3.7% growth rate posted last year.
"The current [stock market] drop will have no impact on GDP growth -- it
is Asia that will impact," says Comerica Inc. chief economist David L.
Littmann, responding to the survey jointly with his colleague William T.
Wilson. "Over a long period of time, stocks simply reflect the health of the
underlying economy." If those fundamental conditions remain sound, then
market gymnastics are "essentially irrelevant."
Mickey D. Levy, chief economist at NationsBanc Montgomery Securities,
argues that a stock-market decline itself has little impact on economic
growth, independent of other factors. "It's not too pleasant to go through,"
says Mr. Levy. "But from a macroeconomic point of view I'm not
particularly concerned at all, because I look at the fundamentals underlying
the domestic economy."
Ironically, he credits the Asian crisis for having strengthened the dollar,
reduced inflationary pressures and therefore helped to keep interest rates
in check. Lower rates have led to a boom in home sales, followed by a
surge in sales of home-related products such as appliances.
The bright side of the stock-market decline, say several economists, is that
it could induce the Federal Reserve to leave interest rates unchanged, or
perhaps even to reduce them by the end of the year. That might give
consumers and businesses a boost just when they need it. |
