Investors Ask: How Now, Dow?
Tuesday's slip is seen as a 'normal correction' by most analysts. Its effects on the economy remain to be seen.
Is Wall Street finally coming back to Earth?
Stock prices, after blasting into orbit over the past three years, are finally reentering the atmosphere. And, as investors know after Tuesday's 299.43 point drop in the Dow Jones Industrial Average, it's a rude ride. The consulting firm Birinyi Associates estimates that in the last two weeks, the market has lost $905 billion in value, equal to the annual gross national product of China.
If the market's descent continues, falling stock prices could have wide-ranging implications for the US economy. The stock market has been a huge engine of prosperity. With yearly double-digit gains in their stock portfolios, some investors have been living a caviar lifestyle.
If the market continues sliding, "economists will start to lower their growth expectations," says Paul Kasriel, chief US economist for Northern Trust Company in Chicago. If the sell-off continues "in a major way, it would raise the risk of recession."
So far, most market analysts attribute the decline - which has amounted to about a 9 percent fall in the Dow - to a normal market correction after a sharp climb. Such corrections often amount to about 10 percent off the market's highs. However, the broader market has been falling for a longer period, with the average Big Board stock off 26 percent from its high. (Year-to-date trends, see Page 10.)
Despite the market's recent drubbing, it's still up for the year. The Standard & Poor's average was up 10.48 percent through Tuesday, and the Dow average, a much narrower gauge, was up 7.32 percent over the same period.
Analysts warn volatility is part of the stock market and investor psychology can swing sharply.
The most recent turning point was July 22 when Federal Reserve Board chairman Alan Greenspan testified before Congress. Mr. Greenspan warned that the economic turmoil in Asia would not end anytime soon and cautioned that a sharp drop in the stock market was inevitable.
Stock-market analysts are quick to point out that volatility is part of the stock market. Investor psychology, which is intangible, can swing sharply. "This is kind of a wake-up call that the market won't go up forever," says John Markese, president of the American Association of Individual Investors in Chicago.
Because the stock market is so volatile, analysts caution against trying to gauge future direction from short-term trends. There is an old Wall Street saying that the stock market has anticipated eight of the last three recessions.
However, this particular stock market has been unusual because it has been rising for a long period. In October 1990, the Dow Average sat at 2,365. After its close yesterday, it was at 8,487.31, up 258 percent. New York-based Lipper Analytical Services estimates that an individual who invested $10,000 in 1990 in a balanced portfolio (all kinds of stocks and bonds) would have seen its value rise to $29,000 by July 31.
As the stock market has climbed, so has consumer spending. Recently, spending has been outstripping personal income because consumers have felt confidant about the future. For the first six months of the year, consumer spending rose 6 percent, a level considered unsustainable by most economists.
A market decline, says, Ian Shepherdson, chief economist at HSBC Markets in New York, "could take some of the froth off consumer spending."
Economists have been particularly surprised to see the savings rate shrink to its lowest level in decades. "It makes you aware how much spending has depended on accumulated wealth in the stock market," says Robert Brusca, chief economist at New York-based Nikko Securities International Ltd.
A lower stock market might also act as a brake on business spending, which has been booming. The high stock-market valuations have made it easier for corporations to justify building new factories and products.
However, many corporations are now starting to report disappointing earnings. Some are blaming the financial turmoil in Asia.
IN the beginning of the year, stock-market analysts were predicting the S&P's earnings would grow by 10 percent this year. However, this has now been reduced to 4.7 percent.
But few economists are predicting the economy will slide into an Asian-type recession, no matter what the stock market does. "If we were to slip into a recession, it would be short and shallow because the Fed would quickly cut interest rates and Congress and the administration would quickly cut taxes," Mr. Kasriel says.
The Fed has some room to act because the US inflation rate is running at only a 1.7 percent annual rate. And Congress has room to act because the country is running a budget surplus.
However, most economists don't think this will be necessary. General Motors, fresh from resolving its labor problems, is starting to crank up production to restore lost output. By the fourth quarter, the economy may be growing at too rapid a pace, says Lyle Gramley, a consulting economist at the Mortgage Bankers Association in Washington.
"If the falling stock market cools off consumer spending, it will do the work the Fed would normally do," says Mr. Gramley, a former governor of the Fed.
That still may mean a wild ride for investors.
"This kind of slump is certainly hard to take when you look at the paper in the morning," says Mr. Markese. But he says the best thing for investors is to be patient and wait for long-term growth.
* Monitor staff intern Neil Irwin contributed to this story.