Recession Worries Rise as Key Stock Market Indexes Fall
Wall Street suffered another major rout Thursday, driving key stock indexes down sharply in some of the heaviest trading volume ever.
The market’s deepening losses now are raising a question whose impact goes far beyond the ranks of share owners: Are stocks foretelling a full-blown recession in the economy in 2001?
Some analysts turn that around, and ask the question this way: With a record number of Americans owning stocks, will a continuing market slide help cause the next recession by frightening many consumers into paring their spending plans?
Historically, the stock market’s predictive power when it comes to the economy has been mixed. Nonetheless, the sell-off Thursday--on a day when fresh economic data gave unmistakable signs of widespread weakness--triggered new concerns that many investors are fleeing because they fear the first recession in 10 years may be imminent.
The Nasdaq composite stock index, dominated by technology stocks, plummeted as much as 6.7% on Thursday before recovering somewhat to close off 109 points, or 4%, at 2,597.93--its lowest since August 1999.
The Dow Jones industrial average sank 214.62 points, or 2%, to 10,414.49, after falling more than 300 points early on.
Trading volume on the New York Stock Exchange set a record, and Nasdaq volume was second only to the record set on April 4.
Stocks’ slump “certainly forecasts that the economy and [corporate] earnings will not be as strong as we thought, and that there’s a good chance that we’ll have a recession. You simply can’t dismiss the very strong message that’s coming from the financial markets,” said Hugh Johnson, veteran market analyst at brokerage First Albany Corp.
The market’s weakness since late summer has been blamed on various culprits--including, in recent weeks, on the presidential election stalemate.
But the over-arching concern is about the economic outlook, most experts say.
The market’s latest tumble followed another in a long string of warnings from major technology companies about weaker-than-expected sales and earnings.
Personal computer giant Gateway Inc. warned late Wednesday that its Thanksgiving-weekend sales were drastically below expectations.
Though Wall Street’s greatest losses this year are in the tech sector--which had soared to unprecedented heights in winter--the selling in recent weeks has spread to other market sectors as well.
What’s more, a tandem plunge in yields on U.S. Treasury bonds, particularly over the last week, has added to the sense that many investors are growing fearful to own all but the safest securities going into 2001.
Typically, many investors who expect a sharp economic slowdown, or an outright recession, seek to sell stocks because they anticipate that companies’ sales and earnings will dwindle or fall.
Investors’ concerns are being stoked by what they’re hearing from Wall Street analysts. Many of the same analysts who were accused of inflating the tech-stock bubble early this year by hyping Internet and other stocks to the moon now seem to be in competition to slash their sales and profit estimates.
Third-quarter profits for Standard & Poor’s 500 companies--the biggest and generally most stable of America’s corporate elite--rose an estimated 18% over the same period in 1999, a healthy jump, said Charles L. Hill, research director at First Call/Thomson Financial, which tracks analyst recommendations.
But analysts who as recently as Oct. 1 had been predicting profit gains of more than 15% for the fourth quarter are now forecasting a gain of barely 10% for the S&P; 500 companies. And Hill said he expects the estimates to drop quite a bit more before the actual earnings reports are filed beginning in mid-January.
In certain industries, the downward revisions are far more dramatic. Take the consumer-cyclical sector, which includes retailers. At the beginning of the third quarter--July 1--the Wall Street consensus was that such firms would post profit gains of about 12%, on average, from the third quarter of 1999.
Instead, the sector posted an earnings decline of 7% from 1999--a shocking deterioration from what analysts had expected.
There’s no reason to think the outlook is getting better, Hill said. Coming into the fourth quarter, analysts were forecasting a 10% profit gain for the sector. Now they’re predicting no gain at all, and a month from now Hill expects the actual number to be sharply negative.
What about the supposed great start to the holiday-shopping season? Yes, Hill said, stores are showing gains in sales volume, but much of the increase is being stimulated by heavy discounting. After all the price-cutting, it probably will be a weak holiday season for retailers’ profits, he said.
And as consumers spend less freely overall, analysts’ estimates of earnings for the blue-chip S&P; 500 companies in 2001 also are dropping fast.
Analysts’ average estimate for 2001 profit growth has fallen to 11.6% from 14.2% as of Oct. 1, Hill said. If the economy continues to weaken, actual earnings gains for the average blue-chip company could very likely fall into low single digits, he said.
Certainly, analysts who were too optimistic about companies’ results early this year could now be too pessimistic, experts say. Still, recent economic data seem to point to a deepening slowdown.
On Thursday, the government said consumer spending in October showed the smallest gain in six months. Separate reports showed a steep drop in Midwestern manufacturing activity in November, and a surge in claims for jobless benefits.
Of course, an economic slowdown is what the nation’s central bank, the Federal Reserve, wanted to engineer with its six interest-rate increases between mid-1999 and May. But some analysts say the action in markets now is raising the question of whether the Fed must quickly begin to cut rates to keep the economy from falling into recession.
The stock market’s trend could be both cause and effect of the next economic turn, experts say.
Concern is growing on Wall Street that a worsening market drop could have a dire impact on the economy if consumers suddenly reduce their spending to offset stock losses, just as many boosted their buying when stocks shot up in recent years.
Indeed, it is widely acknowledged that the late-1990s economy was aided by a “wealth effect” in which consumers spent more freely because the swelling values of their stock portfolios made them feel richer.
Fed Chairman Alan Greenspan has said that the wealth effect was responsible for 1 percentage point of the 4% annualized growth in gross domestic product since 1996.
Economists say that for every $1 increase in personal wealth, Americans spend 3 to 5 cents extra--which adds up to billions of dollars in spending nationwide.
Stephen Roach, chief economist at Morgan Stanley Dean Witter in New York, estimates that real consumption growth has risen an average of 4.4% a year from 1996 through this year. But real disposable personal income has risen only 3.3% a year in that period.
The difference came from people dipping into their market gains--or borrowing more, thanks in part to those gains--to buy cars, big-screen televisions and a host of other consumer goods, he said.
Brian Swanson, a computer programmer from San Clemente, was part of that wealth-effect spending.
After he bought a car for his son last year, the boy asked for a more expensive model that a friend had recently purchased. Though he wouldn’t have assented in the past, Swanson bought the second car with some of his stock-market gains.
“I had plenty of money lying around that wasn’t mine,” he said. “I thought, ‘I better take [advantage of] it while I can.’ ”
Roach and other economists fret that the opposite scenario could occur if stock prices keep falling.
That could create a vicious cycle in which a slowing economy hurts stock prices, and, in turn, a weak stock market exacerbates the economic downturn because it discourages spending.
“What the stock market giveth, it can taketh,” Roach said. “This wealth effect could be sharper on the downside than on the upside.”
A falling market may have a greater impact on the economy because of what Roach terms Americans’ rising “wealth dependency.” More Americans than ever before--an estimated one of every two people--have money in the stock market and are therefore more sensitive than ever to a falling market, he said.
Also, the population is getting older and closer to retirement--and depending more than ever on their stock holdings to finance their lifestyles, he said.
Still, economists say it normally takes six to 12 months for Americans to adjust their spending habits to a rising or falling market. And the urge to downshift spending is muted somewhat by the fact that people who have been in the market for many years still have sizable gains despite this year’s sell-off.
Even Roach concedes that broad market indexes would have to fall by an additional 15%--and stay down for an extended period--for Americans to dramatically slash their spending. So far, the blue-chip S&P; 500 index is down 13.9% from its March peak, far less than Nasdaq’s drop.
Some economists, in fact, dispute that the reverse wealth effect would be that powerful. They say Americans have far more of their wealth tied up in their homes than in the stock market, and that home prices remain strong. What’s more, unemployment is low and wages are rising--two forces that determine Americans’ outlook far more than the stock market.
“As long as real wage growth is strong, home prices are rising and inflation appears to be under control, then you tend to get temporary drops in [consumer] confidence [from a falling market] but not sustained drops in confidence,” said Jason Benderly, head of Benderly Economics in Vail, Colo.
Indeed, many investors say their spending has remained constant despite the market’s drop.
But analysts also say the consumer is only part of the story. Many U.S. companies, loaded with debt from a borrowing binge in recent years and now worried about their future earnings, could be more inclined to curb their own spending--or to cut staff to save money.
Corporate credit-rating firm Moody’s Investors Service said in a new report Thursday that credit quality is in one of its most pronounced declines since the 1990-91 recession, and that the slump will likely continue.
Just how worried the Federal Reserve may be about the economic outlook--if at all--may become clear at the central bank’s Dec. 19 meeting.
William Poole, president of the Federal Reserve Bank of St. Louis, said Thursday he would favor the Fed taking action to cut rates if a stock market slide threatened to hurt the real economy.
But it is far from certain that the majority of Fed board members believe the economy has slowed enough to justify rate cuts.
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Times staff writer Tom Petruno contributed to this story.
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Nasdaq’s Deepening Losses
The Nasdaq composite stock index, dominated by technology stocks, now has plunged more than 48% from its peak reached in March. That is the worst decline since 1973-74.
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Monthly closes and latest for the Nasdaq composite
Thursday: 2,597.93, down 109.00
Source: Bloomberg News
* SEARCHING FOR BOTTOM
Analysts see little chance for turnaround any time soon. C1
* BRIGHT SPOTS
Many larger funds have held up fairly well this year. C1
