World stock markets have been experiencing Irrational Exuberance II. That's the downward leg that inevitably follows the irrationally exuberant overvaluing of businesses, markets, and funds.
The downward leg always risks being just as irrational as the upward one. To judge when enough down-valuing is enough, ask a few questions:
*** Is XYZtec Corp. really worth 10 percent less than it was yesterday?
*** Is the Chinese economy going to stop growing at a healthy clip?
*** Will Thai banks, Japanese insurers, and Hong Kong property dealers fail to correct excesses? (As their American counterparts corrected similar misjudgments in the past decade - all with government help, of course.)
*** Will Alan Greenspan and other central bankers raise interest rates, pinching profits and costing jobs, if their nations' economies begin to reflect the doubts (and, in some instances, panics) that have savaged stock markets?
Likely answers: no, no, no, and no.
Pension savings to the rescue
Then there is perhaps the most important question:
*** Where will all those multibillions of dollars worth of systematic retirement savings that come off the top of paychecks every month go, if not eventually back into stock markets?
True, the percentage of pension money that goes into high-grade corporate bonds and government securities will probably rise for quite a while. But where will the bulk go? Not into real estate, gold, Beatles memorabilia, or mattresses. The portion earmarked for index funds and growth or value stocks can't stay in cash for very long.
So, as we said in this space last week, it's a time to be very cautious about investment for retirement, house-purchase, education, or emergency use. But not a time to abandon careful programs for those purposes.
The real period of caution about markets is more likely to arrive next century as the postwar baby boomers of North America, Europe, and Japan approach retirement and begin to think of drawing down retirement savings after building them up for a decade or two.
Yes, you might say at this point, all very logical. But does the rational trump the irrational when the latter appears to be in full cry?
Perhaps not overnight. But mental contagion cannot long sway sensible men and women. The problem in markets is that sensible people will retreat too far (or advance too far in the next runup) simply because they think the great mass of "other investors" is going to do so.