Market Selloff Could Forecast Trouble Ahead
By EDWARD WYATT - New York Times - 08/30/98
NEW YORK -- The sharp selloff in stocks has led a growing number of people on Wall Street towonder whether the stock market, often a leading economic indicator, may be forecasting a recession in the United States.
The stock market is down nearly 14 percent in the last six weeks, with more than a third of those losses coming in the last week. The stock market has not experienced such a prolonged downturn since 1990 -- when the United States last slipped into a recession.
So far, few economists believe the end of the nation's seven-year economic boom is near. Like most of the investment strategists on Wall Street, they think that even if stock prices had risen too
high, jobs are plentiful and housing is booming. And there are no indications of inflation that might cause the Federal Reserve to raise interest rates, the typical precursor to an economic slump.
Even though corporate profits are slowing down because of the economic difficulties in Asia, Russia and elsewhere, there are few signs yet that this weakness is widespread enough to cause the United States' total economic output to begin to shrink.
But if the drop in stock prices continues, it could shake the confidence of the many Americans consumers who accumulated considerable paper wealth in the 1990s bull market. If these
consumers begin to cut back their spending, that might be enough to further weaken corporate profits, sending the economy into at least a stall, if not a downturn.
And beneath the surface of the booming American economy is a disparity that financial analysts say cannot last. "Americans recently have been spending faster than their incomes have been rising," Greg Smith, the chief investment strategist at Prudential Securities, said. "Could their spending be even stronger next year? I don't think so." In recognition of that fact, Smith said, the stock market is anticipating "a profits recession, if not an economic recession."
Still, many economic experts say the market's decline has not yet been severe enough to change investors' psychology. "The average investor doesn't believe he will be impacted by this" recent decline in stock prices, said John Cleland, the chief investment strategist for the Security Benefit Group, a mutual fund company in Topeka, Kan. "The enormous wealth that has been created over the last three years means that most people are playing with the house's money." For their outlook to change, investors will have to get a sense that the money they are losing is their own, he said.
Albert Wojnilower, an economist at the Clipper Group, a Wall Street investment firm, agrees. "If the stock market does not fall much from where it is now, I think all this will have zero effect on people's
spending habits," he said.
Yet some investors already appear to be pulling back from the stock market, perhaps in recognition that more of Americans' total wealth is tied up in stocks today than at any time since the end of World War II. Individuals have rushed to buy more stocks after every significant market decline since 1990. But in recent weeks, as many of their mutual fund investments have begun to show losses for the year so far, investors have been funneling more cash into the safer havens of money
market funds.
Some of that reaction can be traced to the general feeling of uncertainty about the future that has grown in recent months, as the economic troubles overseas have worsened.
"It isn't that the stock market is predicting a recession," Peter Bernstein, a New York economist and consultant, said. "What's happening is much more complicated than that. There is a sense that
people really don't understand what makes the world work, and they don't know what to do about it. Two months ago, people understood how the world worked, and in case anything happened, Alan Greenspan was there to make everything come out right."
The stock market starts the week with the Dow Jones industrial average coming off its worst week in nine years and, at 8051.68, the index is 13.8 percent below its high of July 17. The Standard & Poor's 500-stock index, a broader market indicator, has posted a similar decline. If the Dow falls into the 7,000s, the psychological effect could be great on investors accustomed to seeing a far larger
number on the nightly news.
To prevent that, many analysts on Wall Street say that what the stock market, if not the economy, needs most is for interest rates to decline further. Some analysts hoped that the Federal Reserve
might move in that direction after last week's symposium of economists in Jackson Hole, Wyo., which was sponsored by the Federal Reserve Bank of Kansas City, Mo. Until now, the Federal Reserve has leaned in the direction of raising rates to keep inflation under control.
Some of the more traditional signs of an economic downturn have begun to show up on Wall Street as well. The companies that would be hit hardest by a recession are those in cyclical industries, like manufacturers of heavy equipment and big-ticket items like cars or jet airplanes.
Companies like Harnischfeger Industries, for example, a company based in St. Francis, Wis., whose subsidiaries manufacture huge pieces of machinery used in paper-making factories and for surface and underground mining. Last week, Harnischfeger said it would lay off 20 percent of its work force, or 3,100 people, because of "ongoing weakness in all our businesses" that is expected to extend into 1999. Harnischfeger's stock price last week fell to its lowest level in four years.
Similarly, Boeing's share price has given up two years' worth of gains as slowing sales of jets to Asian buyers has started to create a glut of planes around the world. Auto stocks have fallen 15 percent in the last six weeks on concerns that American consumers might be willing to make do with their not-so-old current models.
And stocks of financial companies, particularly banks, have been hit hard as investors have absorbed the impact of losses suffered on loans made to developing countries, particularly Russia. The coming weeks are expected to bring more disclosures of losses on Russian operations similar to those made last week by Republic Bank, BancAmerica and J.P. Morgan.
Some people on Wall Street see nothing to worry about in those developments. Abby Joseph Cohen, the bullish investment strategist at Goldman Sachs & Co., for example, sees the best opportunities for investors in financial, technology and cyclical stocks.
"What we have seen among many of the financial service stocks is certainly a whole wall of worries," Ms. Cohen said. But in addition to concerns about their exposures to developing countries like Russia, bank stocks are often the stocks in investors' portfolios that have gone up the most over the last few years.
"If investors are inclined to raise a little cash, they look to sell the stocks that have gone up a lot," Ms. Cohen said. "But we think the change in fundamentals has been dramatically overstated" by the
recent decline in financial and other stocks.
Others are not so sure. Generally, banks make money by first borrowing money at low, short-term rates of interest and loaning it out at higher, long-term rates. Currently, however, some short-term interest rates are higher than long-term rates -- a situation known on Wall Street as an inverted yield curve. As with the recent sharp decline in stock prices, the last time interest rates maintained such a skewed relationship was in 1990, just as the American economy was stumbling into a recession.
"The Federal Reserve has enough room to lower interest rates should they see fit to do so," said Richard Cripps, the chief investment strategist for Legg Mason Inc., the Baltimore brokerage and
investment firm. "And the American economy still has room to grow. But companies like Gillette and Coca-Cola are going to get hurt" by their dependence on sales outside the United States to generate profits.
Those companies have been the source of some of investors' greatest gains in the recent bull market. Already, declines in the general market are eating into the profits Americans have accumulated in recent years. Through Friday, the average general equity fund had lost about 2 percent of its value since the beginning of the year, according to fund tracking companies. |
