Share this story
Close X
Switch to Desktop Site

A Rendezvous With Recession?

Stock market's sudden turn presages that economic growth may be slowing. Some analysts urge Fed to drop interest rates.

For the past eight years, the US economy has enjoyed a period of prosperity and stability

almost unparalleled this century. Virtually anyone who needed a job could find one. Inflation was low, and a rising stock market helped pay for vacations in Antigua or a new sport utility vehicle.

About these ads

Now the question is suddenly being asked: Are the good times finally over?

The query is taking on increased urgency now that the stock market is executing hairpin turns, such as the 512 point decline in the Dow Jones Industrial Average on Aug. 31. Some economists are counseling that the Federal Reserve will have to act quickly to head off a general downturn. They argue the US economy, which has seemed immune to problems in Asia and Russia, is starting to falter.

"The market is sending a message to the Fed that you guys better wake up and spell some relief here," says Scott Grannis of Pasadena, Calif.-based Western Asset, which manages $47 billion in investments.

For many investors relief would be welcome. In a few short weeks, they have watched the stock market erode the value of their 401(k)s and other retirement plans. In one day - Fire-Sale Monday, as some now call Aug. 31 - the Dow dropped 6.37 percent, bringing it down near the 7500 level where it began the year. For most investors, the losses were already much greater, with many stocks down more than 35 percent from yearly highs. By midday Sept. 1, the market was gyrating between 100-point losses and 220-point gains.

Ostensibly, the market's slide began after the Russian economy started to self-destruct. But some stock-market gurus believe Wall Street is signaling a fundamental shift in the economy.

"The US economy is rapidly deteriorating," says Mr. Grannis. "The odds of a recession are now very high, perhaps by the end of the year." There are already some signs that important pillars are weakening. Consumer confidence has fallen for the past two months. The housing sector, which has been buoyant, is starting to sink. Corporate profits are falling.

SOME analysts are especially concerned over the sharp fall of commodity prices. They believe it represents the threat of deflation, or falling prices in general. While this may be good for consumers, it could cause a global slowdown. "The Fed will have to act forcefully to arrest the deflationary forces," says Robert LaMorte, chairman of Behavioral Economics, a consulting firm in San Diego.

About these ads

But others counter that the central bank doesn't need to intervene. They argue the Fed should wait to see real data before acting. "The fundamentals are better than the stock market reflects," says Peter Kretzmer, an economist at NationsBanc Montgomery Securities.

Indeed, President Clinton tried to do his part to calm the markets during his trip to Moscow, citing the strong job market and balanced budget. "We believe our fundamental economic policy is sound," he said. His comments echoed statements by Treasury Secretary Robert Rubin in Washington.

Some numbers do continue to reflect a strong economy. On Sept. 1, the Conference Board released its index of leading indicators. The index rose 0.4 percent, prompting the business organization to predict that the nation's output should increase at a moderate pace for the rest of 1998. The group sees little risk of recession in the near term.

But what has changed is the global economy. Japan and the rest of Asia are in recession. The woes are spreading to Latin America.

"I'm now convinced we are going to have a global economic recession," says Sung Won Sohn, chief economist at Norwest Corp., a Minneapolis-based bank. But, he adds, it's not certain the US will slide into a period of negative growth. He rates the risk of recession at only 10 to 15 percent. "We will be responding to the world economic situation rather than leading it," he says.

Still, Fed watchers don't think the central bank will act to try to save the world. "It's inconceivable the Fed could make much difference in Asia, Russia, or Latin America," says Lyle Gramley, a former Fed governor.

After the last stock market crash, in 1987, the Federal Reserve acted quickly to provide liquidity to the markets and to lower interest rates. But the economy is in better shape this time. The banking sector is stronger and the financial markets have been able to respond to the enormous trading volume. "It is not the Fed's job to manage the stock market," says Mr. Kretzmer.

But the Fed will keep a close watch on Wall Street. If the market were to shave another 1,500 points off the Dow by the end of September, "then the Fed would think about lowering interest rates," says Mr. Gramley. In his view, the Fed's main concern will be the impact of a sliding market on consumer confidence. Since 40 percent of the nation has investments in the stock market, any prolonged slide might make individuals feel less wealthy.

They would cut back on vacations and "splurge" purchases. He expects the central bank to watch the next consumer confidence surveys and housing statistics closely.

Follow Stories Like This
Get the Monitor stories you care about delivered to your inbox.