Did Eagles’ Soaring Set the Bear Roaring? : Market: Explanations for the jolt in stock prices range from the gridiron to speculators’ comeuppance. Perhaps it really signals that traders mistrust their own defiant optimism.
Let me explain the stock market’s flutters. Most New York money managers--the guys controlling huge pension and mutual funds--are avid fans of football’s Giants. The Giants started the season 4-0. All was well in the world. The market raced to new highs. A week ago Sunday, the Giants lost to the Eagles. Money managers became depressed. The market went into reverse. By Friday, a gathering sense of despair caused a 190-point sell-off. Then the Giants beat the Redskins. Life again seemed worth living. On Monday, the market rebounded 88 points.
Got it?
OK, I confess: the market baffles me. It inspires two opposite convictions that I hold with equal enthusiasm. First, the market is not just a random game played for fun and profit. Over any long period--say five years--it reflects basic economic trends: that is, a strong market reflects a strong economy and vice versa. Second, the market is a random game played for fun and profit. Its short-term fluctuations are driven by moods, rumors, fads and those enduring emotions of fear and greed.
So what have we got this time?
Conventional wisdom now holds that the market’s plunge last Friday stemmed mainly from the speculative excesses of takeovers. United Airlines’ management couldn’t persuade a group of banks to lend the money necessary for a “leveraged buyout” (LBO) of the airline at $300 a share. (In an LBO, a group of investors buys all of a company’s stock, mostly with money borrowed from banks or raised by issuing “junk” bonds.) The message: investors who had speculated that United and many other companies would be taken over would be disappointed. Adequate financing wouldn’t be available. Either the takeovers wouldn’t occur or the buyout prices would be lower than expected.
As a result, the theory goes, speculators dumped the stocks of takeover candidates. The panic affected other stocks, too, because the speculators were trying to offset losses on takeover stocks with profits on their other shares. This theory appeared to be bolstered by the market’s rebound Monday. Most of the stocks that rose are the bluest of the blue chips. AT&T; rose 3 1/4 to 43; General Electric was up 2 1/8 to 56 1/2. Meanwhile, potential takeover candidates--led by the airlines--were clobbered. UAL Corp., parent of United, was down 56 7/8 to 222 7/8.
By this theory, Friday’s market drop was constructive. It punished (and presumably discourages) dangerous speculation. There’s little chance of a setback for jobs, production and economic growth. After all, this decline has been far milder than the 1987 crash, with its one-day drop of 508 points. And everyone “knows” that the 1987 crash didn’t affect consumer spending or business investment. The new popular wisdom is that the market and the real economy are increasingly disconnected.
All of this seems plausible, even convincing. It could also be wrong. Although some takeovers may not happen, I doubt that the takeover game is over. For example, some buyouts may occur at lower stock prices. A few economists also believe that the 1987 crash did modestly depress consumer spending. But because the main effect was to quell a boom that was becoming inflationary, the impact was welcome and overlooked. Would the effect of a big market drop be so benign now?
I have other misgivings. One involves history. It’s doubtful that this market can continue on its merry way indefinitely. Since 1926, the average “real” return (after deducting inflation) on stocks has been 9%, says economist Patric Hendershott of Ohio State University. This combines both the increase in stock prices and dividend payments. Between 1983 and 1988, the real return on stocks was 13%, Hendershott calculates. So far this year (even after the recent declines), it’s been even higher.
Some of the higher returns in the 1980s represent a recovery from the stock market’s poor performance in the 1970s. But did companies become nearly 50% more profitable than in the previous six decades? This seems unlikely.
A second misgiving is more subjective. Among other things, I read economic and stock market forecasts. These days, they are defiantly optimistic. They exude a stubborn confidence that whatever dangers lurk, none will materialize. Consider one top Wall Street firm’s outlook. It expects a 12% to 15% return on stocks in the next year (or 7.5% to 10.5% after inflation). It assumes a “soft landing” for the economy. There will be no recession. Profits and dividends will rise. But growth will be slow enough so that inflation and interest rates will fall. Foreigners will invest heavily in American stocks.
Could some of these cheery assumptions go awry? Why, yes, admits the Wall Street firm--and then explains why they won’t.
“Never prophesy, especially about the future,” Sam Goldwyn once said. Nothing I say, therefore, should be taken as a prophecy, especially about the future. For the record, though, please note that forecasts have gone wrong in the past. There have been recessions, which raise unemployment and depress profits and production. There have been bear (declining) markets. In the postwar era, the average stock-price drop in a bear market has been between 20% and 25%.
Perhaps the Giants will win the Super Bowl. Perhaps recessions are a thing of the past and inflation will painlessly subside. But intuitively, I’m uneasy with extreme forecasts that see nothing but blue sky or, alternatively, gloom and doom. It may be that Friday’s plunge was a big non-event. But maybe not. Could it have been the market’s way of saying that it mistrusts its own optimism--and will react wildly to any hint of bad news?
