INVESTMENT OUTLOOK : 1988 OUTLOOK : A SILVER LINING? : The Stock Crash May End Up Benefiting the Economy

Could the stock market crash actually have been good for the economy?

Oddly enough, there is a chance the debacle will turn out that way in the long run, according to some analysts. By forcing the nation’s financial problems into a glaring spotlight, the collapse triggered action by the Federal Reserve to ease interest rates. It also cooled inflationary pressures, at least for now.

And it made painfully clear the importance of economic cooperation, not only between the United States and its major trading partners but also between Congress and the White House. As Paul A. Volcker, former Federal Reserve Board chairman, said recently: “In some sense, the stock market developments in themselves may be warning people . . . and increasing our chances of wending our way forward without recession or inflation.”

But all agree that the crash’s effect is not yet understood fully, making economic projections more uncertain than ever. It is a traumatic event that has altered the economy, raising fears that consumers and businesses will hold on to their money rather than spend it. As a result, some financial strategists now counsel investors to play it conservatively and place an unusually large share of their assets in money-market accounts. At the same time, they foresee growing value in export-oriented manufacturing companies.

Many experts cautiously predict that the nation should make it through 1988 without a recession. They foresee a year of lackluster or modest growth, with little change in interest rates and inflation. And an expected retrenchment in consumer spending, the economy’s salvation in the mid-1980s, will be offset, at least in part, by new vigor in manufacturing.

The sorts of consumer industries with a questionable outlook include autos, appliances, apparel, electronics and financial services. By contrast, many of the U.S. manufacturers that endured a battering from their overseas counterparts in the early 1980s will rebound with the help of a weaker dollar that makes their products more competitive. These include makers of machinery, farm equipment, medical equipment, scientific instruments and computers.

The fortunes of many industries will hinge on the dollar, which has fallen on and off since early 1982. For many U.S. manufacturers, the dollar’s continued decline means cost advantages over the competition. Yet in the complex global economy, forces that help one sector affect others, too, and the drooping dollar is no exception. As long as foreign investors perceive that the currency has further to fall, they demand higher U.S interest rates to protect the value of their U.S. holdings. And high interest rates affect everybody who needs to borrow money, from corporate executives planning a new plant to young couples seeking a home loan.

Roger E. Brinner, chief economist at Data Resources, an economic consulting group in Lexington, Mass., predicted that the dollar would drop 8% next year and another 5% in 1989 before stabilizing. “Until the dollar adjustment takes place, there is a premium in U.S. interest rates that must be paid,” he said. “Once that adjustment takes place, interest rates could be lower.”

There is no guarantee that the dollar’s downward journey will be smooth--or that it will end at the level sought by U.S. officials. Clearly, the speed of the fall--an event influenced by speculators and investors throughout the world--matters significantly. “If it happens fast, we’ll have lower interest rates and we’ll get the trade turnaround sooner,” Brinner said. “If it’s drawn out, people (who invest in dollars) will feel the need to protect themselves, and interest rates will be high.”

Even before Black Monday, consumer spending was expected to weaken. The public has been on a binge for the last few years--loading up on appliances, electronic goodies and other products. In the process, consumers piled up so much debt and saved so little that a spending falloff seemed inevitable.

In other words, the stock plunge aggravated an already-lackluster consumer outlook. It did so by directly hurting those who own portfolios; in addition, it spread insecurity--and a reluctance to spend--among the much larger portion of the public that didn’t dabble in the market.

Yet a cutback in consumer spending wouldn’t be entirely bad, if the decline is moderate. For one thing, it could act as a brake on inflation. Indeed, analysts say that the crash alone may be responsible for trimming as much as a point from next year’s price increases. “Consumers just are not going to have the willingness to spend enough to push inflation up,” said John S. Hekman, senior economist with the Claremont Economic Institute, a private consulting firm.

Hekman projects an inflation rate of 3% next year, compared to the 4% range expected for this year. Other economists, including the 49 recently surveyed by Blue Chip Economic Indicators of Sedona, Ariz., foresee a 1988 inflation rate a bit higher than 3%, but still in the relatively benign 4% range.

Similarly, interest rates aren’t expected to go sharply up or down next year, although opinions vary on which way they will move. In the hours following the stock plunge, the Federal Reserve Board moved to ease rates in order to keep the shell-shocked economy breathing. Short-term rates, currently in the 6% to 7% range, fell sharply and have since only regained a minor portion of their lost ground. In addition, the higher long-term rates have fallen somewhat as well. Conflicting forces will dictate their future--the continued upward pressure that comes from foreign financing of U.S. debts and the downward pressure that comes from a low rate of inflation.

Indeed, nothing is a sure bet in the year following the crash. The heightened risk of recession could mean lower corporate profits and further problems for stocks. At the same time, an uncontrolled plunge of the dollar would light a fire under interest rates and damage the bond market.

In response to the uncertainties, Claremont is advising clients to hedge their portfolios: one-third in stocks, one-third in bonds and one-third in money markets, an unusually large portion in the last category. “Our biggest fear for 1988 is there will be another crisis of the dollar that will cause the bond market to panic--and if interest rates are pushed up too high, that will cause a recession,” Hekman said.

The short-term outlook for bonds is good in light of the fact that if the economy should stray from expectations, it seems more likely to get cold than to overheat, said Paul Getman, a financial economist with the WEFA Group. Such a sooner-than-expected downturn “would mean lower inflation and lower demand for credit--and you’d get quite a rally in the bond market,” Getman said. Inflation could start to re-emerge later in 1988, however, hurting bonds, he added.

Economists also said that the new strength in manufacturing and the growing doubts about consumers should be reflected in the stocks of those sectors, with some of the same old-line manufacturers once seen as moribund turning out to be the winners of 1988.

But with the historic stock plunge hanging over the economy like some gigantic question mark, 1988 is hardly shaping up as normal. Or as Getman said of the crash, “If it doesn’t cause a recession, it will surely prevent one.”

FORECASTS FOR 1988

Blue Chip Economic Data UCLA Claremont Indicators Resources Business Economic of Sedona, McGraw / WEFA Forecasting Institute Arizona Hill Group Project Real GNP +3% +1.9% +1.7% +2.2% -1.5% Inflation +3% +4.2% +4.3% +4.2% +3.6% Consumer +1%-2% --- +1.3% +1.6% -1.3% Spending Value of +10% --- -8% -7% -10.4% Dollar 30-Year 8% --- 7%-8% 9.75% --- Treasury Bonds Corporate --- 9.7% --- --- 7.8% AAA Bonds