MARKET SAVVY : IMF Gives New Alert on U.S. Market
Wall Street may be growing tired of being told it has created a monster with the great 1990s stock bull market, but that didn’t stop the International Monetary Fund from issuing a fresh “bubble” warning Wednesday.
The IMF said in a new report that the “remarkably high” level of U.S. stock prices poses a risk to global financial markets, because a sharp drop in share prices could affect markets worldwide and cause problems for highly leveraged institutions such as hedge funds.
The IMF said the three major factors that have supported the U.S. stock market in recent years--low interest rates, strong capital inflows and soaring corporate profits--have begun to reverse.
“The weakening of these supporting factors implies an increased vulnerability of U.S. equity prices to shocks, including a sharper-than-expected tightening of monetary policy, weaker-than-expected growth in earnings and a worsening of investor sentiment,” the report said.
Such a pullback could hurt not only the spending power of U.S. consumers, leading to a significant slowdown in the U.S. economy, but could also create a contagion effect internationally due to the unknown extent of leverage in international markets, it said.
Leverage generally refers to investment bets made with borrowed funds. If those bets go wrong, the losses for the investors involved can be magnified many times over.
“If there is substantial leverage in the system, then a correction in the U.S. equity market could give rise to corrections in financial markets outside the United States, which could then feed back to U.S. markets,” the IMF said.
The agency wasn’t telling investors anything most didn’t already know, or suspect--hence stocks showed no reaction to the report.
Indeed, Federal Reserve Chairman Alan Greenspan has on many occasions raised questions about stocks’ high levels and the potential fallout if prices were to dive.
The “wealth effect”--that is, how much rising stock prices have fueled U.S. consumer spending in recent years and how much such spending could be hurt by a decline in stock prices--has been a key issue of debate among economists.
Whereas the IMF’s points about interest rates rising and capital inflows to U.S. markets weakening have worried many Wall Street strategists in recent months, corporate profits have been resurging in recent quarters, at least for major U.S. companies.
The blue-chip Standard & Poor’s 500 companies are expected to post average earnings growth of 17% this year, up from 3.7% in 1998, according to earnings tracker First Call.
However, U.S. data on corporate earnings overall showed only a small increase in the second quarter, suggesting problems at many smaller and mid-sized companies.
