It’s Up to the Fed Now, but Beware of Betting on Fast Fix
Nine individuals--the justices of the U.S. Supreme Court--may effectively decide who takes the White House for the next four years.
But their burden is arguably light compared with what now faces the 12 members of the Federal Open Market Committee, the policymaking arm of the Federal Reserve. They may well hold the fate of the global economy in their hands.
At least, that is increasingly what we’re hearing from Wall Street, where the stock market remains on a very greasy slope, the dollar is suddenly being slapped around by the euro, and more investors are stampeding into the relative safety of U.S. Treasury securities.
Depending on their Fed politics, their perception of the economy’s rate of deceleration and, perhaps, the percentage of their portfolio that is in technology stocks, major brokerage and bank investment strategists and economists now are using one of these lines in communicating with clients:
* Alan Greenspan will save us.
* Alan Greenspan must save us.
* Alan Greenspan is too late to save us.
The debate over what the Fed will/should do seems certain to dominate the financial headlines for the next two weeks, leading up to the central bank’s policy meeting on Dec. 19. That is because many investors are rapidly losing faith that anything but a Fed interest rate cut--or at least, a strong signal from the Fed that a rate cut is highly likely early in 2001--can halt the slide in the economy and in stock prices.
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The battered Nasdaq composite index lost nearly 9% last week, and at its low point on Thursday was off exactly 50% from its March 10 record high. To put Nasdaq’s ongoing collapse in perspective, major U.S. stock market indexes don’t suffer meltdowns on this kind of scale but once in a generation (if we’re lucky). The last time was 1973-74; the time before that was the 1930s.
Apart from the Intels, Gateways, Yahoos and other tech stocks, however, the U.S. market’s decline thus far remains little more than a garden-variety “correction.” Most major indexes are off between 7% and 14% from their 2000 peaks.
Even so, the losses in the broad market, too, have deepened in recent weeks. In the 30 days ended Friday, 48 of the 87 industry groups in the blue-chip Standard & Poor’s 500 lost ground, while 39 advanced, according to Bloomberg News data.
Within S&P;’s index of 600 smaller stocks, 70 of 96 industry groups have declined in the last month.
Wall Street had just barely digested the first batch of corporate warnings about fourth-quarter earnings when another wave arrived last week. Gateway’s announcement that Thanksgiving-weekend computer sales were far below expectations was the biggest bomb to hit the market, but there also were warnings from retailer Gap Inc., auto giant Ford Motor and defense contractor Raytheon Co., among others.
Raytheon’s forecast on Friday that 2001 earnings will be weaker than expected hammered defense stocks in general, a group that had been a market leader since spring.
If you believe that these warnings are further fallout from the economy’s weakening pace--as opposed to individual cases of bad corporate execution--then the argument to make to the Fed is that they’ve gone far enough in tightening credit and engineering an economic slowdown. Time to give the car more gas, in the form of easier money, before it stalls out and begins to roll backward.
Foreign stock markets also seem to be making that case. Many of them have fallen more sharply from their peaks this year than have U.S. blue-chip indexes, which at least partly reflects that investors worldwide are questioning how good local 2001 economic growth can be if the world’s dominant economy is waning.
And in a case of unwelcome deja vu, the term “international financial crisis” is back in the news: The International Monetary Fund is dealing with financial crises in Turkey and in Argentina, both of which appear certain to require multibillion-dollar bailouts.
For the Fed, these mere symptoms of deeper economic problems aren’t supposed to matter, officially. The central bank is supposed to stay focused on keeping the U.S. economy on an even keel, with low inflation. And just because the stock market thinks the economy may be slowing too sharply doesn’t mean it’s true.
So the arguments that Greenspan will or must act to lower interest rates soon could well be premature. If investors in the next two weeks make the assumption that the Fed on Dec. 19 will nod in the direction of lower rates, and stock prices rise accordingly, the market could be setting itself up for another painful stumble if the Fed fails to oblige.
But it’s also true that the weight of the economic evidence seems, more and more, to be confirming that the U.S. slowdown has become pronounced. Separate reports last week showed manufacturing activity declining for the fourth month in November, car sales tumbling and jobless claims surging.
Bond investors seem convinced that the economy is decelerating at a pace that opens the door for Fed rate cuts: A new rush of money into Treasury securities last week sent yields on Uncle Sam’s longer-term bonds to their lowest levels since mid-1999.
More important, yields on Treasury issues of all maturities, from three-month to 30-year, now are below the Fed’s target rate of 6.5% for the federal funds rate, the overnight loan rate among banks.
In other words, the bond market, as usual, is leading the Fed.
By Friday, at least one voting member of the Fed’s FOMC was publicly sounding as though the odds of a rate cut early in 2001 had improved substantially.
Fed Gov. Edward Gramlich told reporters in Washington that the Fed “had noticed the slowdown in spending and the tightened credit conditions, and there have been data that came out since [the Fed’s mid-November meeting] that make it perhaps even more noticeable.”
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So let’s say, for sake of argument, that the Fed on Dec. 19 does as expected--which is not to cut rates, just yet, but to make a statement that opens the door to a cut in 2001.
History says the stock market, or a good chunk of it, should rally if investors believe that interest rates are going down. Foreign stock markets likewise should view an easier Fed as a reason to rebound.
But how much can markets rebound, and for how long? That’s the trillion-dollar question.
If the economy is in fact slowing sharply, the issue of the Fed wanting to save us from recession will quickly morph into a debate over whether the Fed is too late. That is what has happened before at many of these economic inflection points, and it seems reasonable to believe it will happen again. And the end result may be more, rather than less, confusion and doubt in the stock market, at least in the near term.
The point being, no one should assume that Wall Street’s troubles are over for good just because the Fed turns friendly. It’s a step in the right direction, but just a step.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Hello? Mr. Greenspan?
Yields on U.S. Treasury securities of all maturities are well below the Federal Reserve’s target short-term interest rate of 6.5% (as measured by the federal funds rate, the overnight loan rate among banks). That means bond investors are convinced the Fed will begin cutting rates sooner than later.
Source: Reuters
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Global Bear Market
The U.S. stock market remains split, with the Nasdaq composite index deep in a bear market, while the blue-chip Standard & Poor’s 500 still is off far less from its peak than the 20% threshold that typically marks a bear market. But among 10 major foreign markets, eight now have joined Nasdaq in bear territory.
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52-week Friday Decline Market (index) high close from high Britain (FTSE-100) 6,950.60 6,170.40 -11.2% France (CAC-40) 6,944.77 5,928.50 -14.6 Germany (DAX) 8,136.16 6,512.91 -20.0 Hong Kong (Hang Seng) 18,397.50 14,441.43 -21.5 Canada (TSE-300) 11,423.70 8,941.17 -21.7 Japan (Nikkei-225) 20,833.20 14,835.33 -28.8 Brazil (Bovespa) 19,046.50 13,437.40 -29.4 Mexico (IPC) 8,417.33 5,652.63 -32.8 Argentina (Merval) 648.61 402.33 -38.0 S. Korea (composite) 1,066.18 514.46 -51.7 U.S. (S&P; 500) 1,527.46 1,315.17 -13.9 U.S. (Nasdaq composite) 5,048.62 2,645.29 -47.6
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Sources: Bloomberg News, Times research
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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to https://www.latimes.com/petruno.
