Sometimes the Market’s Oracle Is a False Alarm
Is the fun over? The Dow Jones industrial average, which tracks large stocks, has fallen more than 400 points in the last seven weeks. The Nasdaq index, for smaller stocks, is down more than 15% since early June. That’s the equivalent of an 860-point drop in the Dow.
For some high-tech companies, the decline began earlier and just won’t quit. The price of Micron Technology, a profitable maker of semiconductors, has fallen from $90 a share in September to $19 on Monday.
The stock market is an oracle. Like the one at ancient Delphi, Greece, it tells the future, often in riddles. When the market falls, it’s saying that it doesn’t like what it sees ahead--though the reasons are left for us to divine.
Sometimes a decline can be a false alarm: The market is just cranky or depressed. Sometimes it is merely suffering a temporary hangover after a binge of buying. And sometimes its forecasts are plain wrong. On Oct. 19, 1987, for instance, the Dow dropped a record 508 points, but the economy continued to grow at a 3% clip for the next three years.
Still, the stock market is usually a reliable soothsayer--in part because its prophecies are self-fulfilling. If the market falls sharply, vast sums of wealth are eliminated from the balance sheets of America’s households, new ventures have a hard time raising money and people and businesses become pessimistic and slow down their purchases or shelve their expansion plans.
With the rise of self-directed pensions, such as 401(k) plans and IRAs, Americans will feel this stock market decline more personally than ever before--and more intensely. In 1980, for instance, the average family owned stocks and bonds equal to about twice its annual income; today, those assets equal three times income. We have much more to lose this time around.
What sort of trouble does the oracle of Wall Street see? Here are two possibilities:
* Recession. The market took a big dive July 5 on the announcement that unemployment had fallen to 5.3%, the lowest rate in six years. The pundits saw a hot economy, leading to inflation and higher interest rates. But by now, a strong economy is an old story. The worry for the future is not strength but weakness.
Economist John Mueller of the Arlington, Va.-based consulting firm of Lehrman Bell Mueller Cannon Inc. has been a lonely voice predicting a recession in the second half of 1996--a drop of 2% in the gross domestic product. He made this prediction two years ago, and he’s stuck to it.
Now, at last, he’s getting some company. “There could be a recession by the end of 1996,” said Charles Clough, chief strategist for Merrill Lynch & Co.
Mueller and Clough both worry about corporate profits, which are getting squeezed in the same business cycle that’s prevailed for decades. What goes up always comes down--a fact that investors, confusing a bull market with their own supposed genius, blissfully forget. Companies such as Motorola, Hewlett-Packard and United Healthcare are starting to report disappointing earnings, and it’s a good bet more will follow.
* Politics. The best minds on Wall Street have been saying since the start of the year that the stock market is “discounting” (that is, assuming) that Bill Clinton will be reelected and that the Republicans will hold on to majorities in both houses of Congress.
Investors may not be overjoyed with this setup, but it doesn’t alarm them. Gridlock such as we’ve seen for the last 18 months means no higher taxes, a budget deficit that stays under control and a White House that talks centrist. But the status quo may not prevail in November. Recent polls show that Democrats could indeed recapture Congress.
The pattern in the stock market during Clinton’s presidency has been clear. From the time he took office through the November 1994 elections, when Republicans captured the House and Senate, the Dow rose at an annualized rate of 9%. From that point through Clinton’s rejection of the GOP balanced budget plan, the market rose at an annualized rate of 29%. Since then, the growth rate has slipped back to a yearly 6%.
It’s hard to predict what an all-Democratic government would do, but the last time around, it raised taxes on just the sort of people who own stocks and bonds. One new Democratic idea calls for deciding (based on criteria such as health insurance for workers and relatively low salaries for CEOs) which corporations are “good” and “bad.” The good get tax breaks, the bad lose federal contracts.
It’s possible that these two scenarios could cancel each other out. A recession--or a market crash in anticipation of one--could wreck congressional Democrats’ chances in November. In that case, the market might recover quickly. But don’t count on it. Right now, the oracle is talking trouble.
