Collective Wisdom, or Is It Delusion?

Times Staff Writer

The stock market isn't a happy place these days, but given the sensory overload of bad news in the real world, there's a case to be made that Wall Street is showing remarkable resilience.

Either that or remarkable naivete.

The Dow Jones industrial average, at 7,891.08 on Friday, is down 5.4% this year. The average domestic stock mutual fund is off 3.7%, Morningstar Inc. says.

"But you could ask why we aren't trading at 5,000 on the Dow," said Art Hogan, chief market analyst at brokerage Jefferies & Co. in Boston. "You could argue that we should be doing a lot worse than this."

Other markets are practically agitating for a collapse in U.S. share prices.

Driven by U.S.-Iraq war fears, crude oil futures in New York nearly reached $40 a barrel Thursday, the highest since 1990. Though the price eased back to $36.60 at Friday's close, it's still up 36% just since Dec. 1.

As if soaring oil costs weren't enough of a problem for businesses and consumers, the price of natural gas also skyrocketed last week amid dwindling supplies. Natural gas futures prices are up 69% year to date.

Although U.S. stock market indexes are holding comfortably above their five-year lows reached in October, a key index of European blue-chip stocks fell to a fresh six-year low last week and has lost 9.8% this year, nearly double the Dow's decline.

In Japan, home of the never-ending bear market, the Nikkei 225 index dipped to a new 20-year low in trading Thursday.

As a measure of the fear level among investors, Treasury bond yields also provide a good barometer. Renewed heavy buying of Treasuries last week by safety-seeking investors drove the yield on the 10-year T-note to 3.69% by Friday, the lowest since the week of Oct. 7, when the yield fell to a generational low of 3.57% amid a mini-panic on Wall Street.

On top of their other woes, markets last week suffered a bout of deja vu with regard to corporate scandals. Dutch/American supermarket giant Royal Ahold Inc. fired its chief executive after saying that the firm had overstated earnings by at least $500 million over the last two years. And the Justice Department indicted former executives of telecom company Qwest Communications International and retailer Kmart Corp.

The stock market certainly wasn't oblivious to the bad news. The Dow lost 1.6% for the week and the Nasdaq composite index eased 0.9%. The New York-traded shares of Ahold plummeted 65%.

Still, investors clearly aren't falling over themselves to dump U.S. stocks. Trading volume on the New York Stock Exchange and on Nasdaq has remained fairly anemic recently. Last week, even as major indexes lost ground, the number of NYSE stocks that rose slightly outnumbered falling issues. The market is depressed, but it isn't morose.

Advocates of free markets are fond of pointing to the discounting mechanism therein: More often than not, it is said, the collective wisdom of investors will keep prices in accord with a reasonable view of the future.

In other words, free markets are supposed to have a good handle on what's coming down the pike, before it arrives.

But what about a time like this -- when different markets appear to have very different assessments of the future? The short answer is, somebody's going to be wrong. Painfully wrong, perhaps.

The U.S. stock market doesn't believe energy prices will stay near current levels for long. If Wall Street chose to build these prices into its economic models for the entire year, the expected effect on consumer and business spending would be dire.

Investment and research firm Bridgewater Associates in Wilton, Conn., which has long had a worried view of the economy, calculates that Americans could spend $177 billion more on energy this year than last year if prices don't abate significantly. "In other words, 1.5% of gross domestic product will have to be diverted from other goods to be spent on energy," the firm said in a report last week.

Most U.S. stock investors, however, appear to be sticking with the oft-repeated view that if war with Iraq is inevitable, it will be over quickly and it will end favorably for the United States -- and for oil prices.

"Should the Iraq campaign go smoothly, oil prices likely would come down sharply and provide at least the moderate-economic-growth scenario a major boost," said Tobias Levkovich, market strategist at brokerage Salomon Smith Barney in New York.

European stock investors must not attach the same high probability to that outcome. Likewise, anyone buying long-term Treasury bonds today with the thought of holding them to maturity must be extremely worried about the future. You can't feel very good about the economy if you think the stock market won't beat a 3.69% annualized Treasury yield over the next 10 years.

Could Wall Street simply have it all wrong, and be grossly underestimating the potential for a disastrous war outcome and/or related fallout?

No market discounting mechanism is infallible. In Japan, the Nikkei stock index still was at 23,000 by late 1991. Investors didn't understand the magnitude of the decline facing that economy in the 1990s. (The Nikkei closed Friday at 8,363.04.)

After Enron Corp. filed for bankruptcy protection in early December 2001, the U.S. equity market overall didn't immediately see the event as signaling a wave of corporate accounting debacles. Major stock indexes continued to rally that December. But by spring the market was in a broad retreat as the scandal count mushroomed.

Levkovich concedes that "for the last few years, we've had one extreme event after another" slamming financial markets. If the next "extreme event" is a war or the aftermath of a war that doesn't go according to plan, the risk to stock prices could be very high, he allows.

"Should the conflict go very badly, double-dip recession becomes a distinct possibility in the face of higher energy costs and lower consumer as well as corporate confidence," he said.

Energy prices, Treasury bond yields and European stock prices now advise a high fear level. The U.S. stock market says, "No, it's probably going to be OK."

Somebody's going to be wrong.

Tom Petruno can be reached at For recent columns on the Web, go to

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