Smart Money Is Betting on Common Sense
The economy is changing--and that’s confusing even the so-called smart money. Market experts in the past two weeks have been worried that falling prices for high-interest junk bonds would drag down all stocks and bonds, and maybe even the economy. Some lamented that junk bond financier Michael Milken, now under indictment, was no longer available to hold things together.
Now the experts are looking backward, fearing a rerun of the crash of 1987. But that isn’t going to happen--and certainly not because of junk bonds. For all the talk about it, the junk bond market--at $200 billion in total value--simply isn’t important enough to bring down markets trading twice that much every day, not to mention the economy. “The junk market is hardly enough to fill the corner of the economy’s eye,” wrote the irreverent editor James Grant in his Interest Rate Observer newsletter.
And the day is long past when a Mike Milken or anybody else can hold things together. The legendary J. P. Morgan--who is said to have lent the U.S. Treasury money to tide it over a crisis--is dead and gone and his power with him.
People Aren’t Borrowing
Which is a healthy development because in diversity there is strength. The decisions of millions, even hundreds of millions of people propel today’s massive economy and markets--and those decisions are often intelligent; panics occur, but rarely.
So, what’s really happening in the U.S. economy? It’s slowing--and yet in a way it’s also improving.
Evidence of slowdown is increasing. The nation’s factories may still be producing at a steady pace and sending stuff to the stores. But customers are not buying as they had been doing.
The fact is, people are not borrowing to buy things. Total debt creation in the April-through-June quarter grew 6.8%, notes Charles Clough, chief investment strategist for Merrill Lynch Capital Markets, and that was slower than the 7.1% growth (including inflation) of the whole economy. Banks, pushing credit cards and home equity loans, have money to lend. But a lot of people are paying down their debts and starting to save more instead.
And that spells an economy in transition. What happens in such a slowdown is that businesses cut back--Detroit’s big three auto makers plan bare bones production this fall. Prices of raw materials, supplies and labor come down.
The slower 1990 economy may see roughly 1 million more jobless workers, predicts the UCLA Business Forecasting Project, as unemployment rises to 6% of the labor force from 5.2% now.
Corporate profits will be down--indeed are already slipping--and that casts a shadow over the stock market. But bonds will benefit as interest rates decline, says Deborah Allen, president of Claremont Economics Institute. “We expect to see government bonds at 7.25% within a year, down from 8.25% today,” says Allen.
Will the slowdown become a recession? It could, but other signs in the economy say it’s not likely to be a deep recession.
Support for Strong Dollar
For one thing the value of the dollar is rising, because millions of traders the world over see the U.S. economy changing for the better. They see inflation abating, if not disappearing--consumer prices have risen only 0.4% in the past three months--and in August inflation was zero.
And they see the Federal Reserve, despite public talk to the contrary, supporting a strong dollar by keeping tight reins on the U.S. money supply. Given the right conditions, writes Ronald B. McKinnon, professor of international economics at Stanford University, a strong dollar can help U.S. trade. Those conditions include higher savings--already becoming a fact--and higher business investment, which will become a fact thanks to declining interest rates and low inflation.
The real story is that after the slowdown, the U.S. economy could strengthen as early as 1991.
And a lot of people are already looking forward to that strengthening. Fifty million Americans now own stock once again, either directly or through mutual funds. That’s the highest total since August, 1987, when the Dow Jones average topped 2700 and 53 million Americans owned stock. Then came the crash and their numbers dwindled to 33 million last November.
What brought them back to the market? Confidence in the future and in their own judgment, says Michael Hines who studies investors for Fidelity Investments. Call it a lesson of adversity.
The crash of 1987, says Hines, “was a tremendous leap up the learning curve for investors. They hadn’t known what would happen to them if the market crashed, but then it did, and they weren’t blown away.”
But more important, says Hines, “they realized that nobody had warned them, not their broker, not the experts, not the authorities. So investors have decided not to listen to experts and to make their own decisions.” Such as now, which may not be the best time to get into the market. But then people reckon that nobody is likely to tell them the best time. So they may as well look ahead, and decide for themselves. And maybe that’s the real smart money talking.
