Stock Market Seen to Signal It’s Losing Faith in Recovery : Economy: Sharp declines indicate that investors are worried about corporate profits, long-term interest rates.
When the stock market takes a sudden, violent tumble--as it did Tuesday and last Friday--it is saying something important about the economy.
Analysts and economists were relieved Tuesday when stock prices--after cascading severely at points during the day--rallied to close with a decline of only 41.15 points, or 1.4%, on the Dow Jones industrial average. Still, the drop fueled concern because it erased Monday’s rebound and seemed to confirm the selloff that took the Dow down 120.31 points last Friday.
Granted, these recent declines were nowhere near the October, 1987, crash of more than 500 points, when the market declared that the era of easy credit was finished. Nor were they as severe as the 190-point, one-day downdraft of 1989 that said debt-financed takeovers were passe.
Still, most traders and analysts believe that today’s market is making a statement about critical pressure points in the U.S. economy.
It’s saying that recovery in corporate profits will be anemic, and it worries that Washington doesn’t understand the economy and may stumble in coming to its aid. And the market, representing the decisions of millions of investors, sees an ominous sign in long-term interest rates, which remain relatively high.
Although the market foresees a cold winter and an uncertain spring, in no sense is it forecasting a blizzard or other catastrophe. In fact, the economy could even surprise everybody with a quick upturn, say some Wall Streeters, who note that the market’s judgments are notoriously fickle and never gospel.
A year ago, stocks were in the doldrums, anticipating recession. But, in January, with instant success in the Gulf War, they began a nine-month rise.
Now, confidence in the recovery is fading, analysts say, and companies throughout the economy--despite massive cost cutting--promise to show disappointing earnings. Before their current fall, stock prices reflected investor confidence that companies would enjoy a 25% to 30% recovery in profits next year. But, as evidence of economic weakness mounted, investors found such confidence unrealistic.
So they have sold stocks, and prices are declining. The widely held shares of General Motors Corp. and American Telephone & Telegraph Co. have dropped about 9% each in recent days; IBM and Merck, the giant pharmaceutical company, are down about 5%.
Those big companies will not encounter real distress next year, but smaller companies whose stocks are declining may be less fortunate.
“Lack of profitability could force them to borrow, increasing demand for money,” said Rao Chalasani, chief investment strategist for Kemper Securities Group, a Chicago brokerage house. And that could send interest rates back up again, further hobbling the economy.
Meanwhile, the Federal Reserve’s many reductions in interest rates this year have not yet spurred the economy, and now investors wait with some trepidation as the White House and Congress discuss tax cuts. “They’ll discuss tax cuts for six months and come out with a lot of crazy statements,” one Wall Street economist said. “The net result will be to scare investors even more.”
Many Wall Streeters blame the current stock selloff in part on comments by President Bush and hasty action by the U.S. Senate aimed at bringing down credit card interest rates.
The action could only have helped poor credit risks, but it wouldn’t have spurred the economy, some financial experts contend. They argue that the credit card business is in trouble because banks handed out cards without regard to credit-worthiness and now are incurring high rates of default. Meanwhile, banks are losing credit-worthy customers, who are paying off debt rather than suffer high interest rates.
Both the Senate’s hasty action and the market’s intemperate reaction worry Philip Roberts, senior vice president and chief investment officer of Mellon Bank. “We’re concerned about the financial health of the country,” Roberts said. “These abrupt moves reflect stresses on the economy.”
Foreign investors are worried about America’s economic struggles, too, analysts say. That is why long-term interest rates, on bonds that mature in 10 years or longer, are still between 7.5% and 8%--relatively high at a time when inflation is less than 3%.
Economist David Resler of Nomura Securities’ New York office said that, these days, long-term interest rates are governed by global markets, not by the Federal Reserve, and that “the high rates reflect foreigners’ fears that America won’t manage its economic troubles without increasing inflation.”
So, when the world lends money to America, it demands a premium for fecklessness.
Resler believes the world is wrong in such judgments because, in fact, “the political commitment to lowering inflation is very strong in this country.”
If so, that could make U.S. stocks and bonds a bargain. But no one really knows.
In 1929, the stock market’s fabled crash led to the decade of the Great Depression. Almost no one in business worries about such a catastrophe’s recurring because of market reforms and government’s willingness to aid the economy.
At the same time, the market can be capricious. “Sometimes, the market declines simply because it tires of good news,” noted Richard McCabe, who analyzes market movements for Merrill Lynch.
In 1962, stock prices fell about 20% for no apparent reason, other than a fading of the euphoria over “Camelot” that had accompanied the new Kennedy Administration in 1961--similar in a sense to euphoria for the New World Order that followed the Gulf War. Still, the economy kept growing in the early ‘60s, and the stock market recovered and kept marching higher.
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