Wall Street Grapples With a New Set of Fears
The stock market is supposed to be a “discounting mechanism”--that is, it’s supposed to be a place where well-informed, rational people weigh future prospects against current events and value stocks accordingly.
Theoretically, then, the sum of all fears at any given moment should be reflected in share prices.
But that assumes that investors know what they’re supposed to be afraid of and can fairly judge the likelihood of the worst-case scenario (say, for the economy), the best-case scenario and the points in between.
As key stock indexes have stumbled this year after the fourth quarter’s surge, analysts frequently have cited the generic fear factor. Investors are “uncomfortable, uneasy, nervous,” a market strategist said in describing one day’s action last week. That’s classic Wall Street--explain everything by explaining nothing in particular.
Yet there is more to that quote than meets the eye. A core reason for the market’s struggle this year is that many investors are trying to weigh, and to appropriately discount, very different fears from what they faced in the 1990s.
The things that frightened the stock market in the last decade amounted to the usual suspects, in some cases left over from the 1970s and 1980s. Would inflation revive? Would the Federal Reserve raise interest rates? Would Japan’s economy collapse and take the rest of the world with it? Would U.S. consumer debt levels become so burdensome that spending would fizzle?
The events of Sept. 11, of course, have made the 1990s’ worries seem almost pedestrian. When the stock market reopened after the attacks, prices plummeted, reflecting the sum of all new fears at that moment. But within one week the market was rebounding, which proved to be a correct bet that the war in Afghanistan would largely succeed and that the U.S. economy wouldn’t plunge into depression.
Terrorist Acts Are
New-Style Uncertainty
Even as shares recovered in the fourth quarter, it was generally accepted that terrorists would strike on U.S. soil again. The stock market appeared to be intelligently discounting that probability--that is, investors accepted it, but believed that new attacks would lack the total surprise factor of Sept. 11 and that the market therefore quickly would overcome the shock of any new strikes.
That still may turn out to be true. Yet in the absence of new attacks since Sept. 11, many people (including those with money to invest) may feel as much apprehensiveness as relief. Nobody wishes for another strike, but the terrorists’ inaction makes for greater uncertainty: We’re still guessing what they’re capable of doing, and when.
One of Wall Street’s favorite say-nothing explanations is that “the market hates uncertainty.” It’s a silly line because, after all, there is always plenty of uncertainty. But it’s meant to be a relative term--that certain kinds of uncertainty are worse than others when investors are trying to discount the future and judge risk versus potential return.
Whether the Fed is going to raise interest rates two times or three times by year’s end is old-style uncertainty for the stock market. Whether terrorists might be capable of electronically invading and sabotaging the U.S. banking system is new-style uncertainty that presents a far bigger challenge for the market as a discounting mechanism.
In the last two weeks, a new fear element has been introduced into the discounting equation: the threat of nuclear war between India and Pakistan.
How is Wall Street supposed to discount that possibility? It doesn’t appear to know, but the idea clearly can’t be of any comfort to a stock market that has plenty of other worries.
On Friday, share prices rallied early on surprisingly bullish economic news, including a surge in manufactured-goods orders in April and a report basically affirming previous data showing that worker productivity rocketed in the first quarter.
The Dow Jones industrial average was up as much as 130 points by midday. But an afternoon sell-off took back nearly all of that gain. Many traders blamed the reversal on concerns that an India-Pakistan conflict might erupt this weekend.
At the close the Dow was up 13.56 points at 9,925.25. For the week the index was down 1.8%, putting it back in the red (by 1%) year to date. The Nasdaq composite index dropped 2.8% last week to end at 1,615.73. Nasdaq has fallen in 10 of the last 12 weeks, and is down 17.2% year to date.
Some investors may argue that fear of nuclear war was a much bigger issue for Americans, and financial markets, in the 1950s and early 1960s--yet stocks posted dramatic gains in that period.
But the nuclear threat during the Cold War was so massive as to be almost surreal. A war between the United States and the Soviet Union seemed likely to quickly escalate into mutually assured destruction. Whether the New York Stock Exchange would be left standing was the least of anyone’s worries.
A “limited” nuclear war is a new concept. Despite the obvious horror at the thought of any nuclear device going off anywhere on the planet, and the millions of lives that a limited nuclear conflict in South Asia could take, the cold reality is that the world probably would survive such a war.
Likewise, a single nuclear bomb attack on the United States--the plot line of the current film “The Sum of All Fears”--wouldn’t end civilization.
Investors Are Being
Particularly Careful
But it could change the way many people live their lives and their assessment of the future. In that context, it could change people’s view of money and how they save and invest it, or perhaps whether they should save it at all.
For many investors, little or none of this disaster-discounting is methodical. Much of it doesn’t even occur on the conscious level. It’s too unpleasant.
Rather, such discounting occurs in the gut: For many, it’s a general feeling that things just aren’t quite right, that it’s too risky to make significant new commitments to financial assets such as stocks. Better to wait than chance a loss, especially given the red ink most portfolios have suffered over the last two years, investors may figure.
At a minimum, the new fears that have confronted investors since Sept. 11 leave many with the sense that they must be particularly careful not to overpay for stocks. That would explain a lot about the market’s trends this year--for example, the ongoing aversion to the technology sector, and the continuing hunger for “value” stocks.
But the discounting mechanism still is adjusting for this new era. The market may not yet know how to calculate the sum of its new fears.
*
Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to: wwww.latimes.com/petruno.
