Bearing Up as Stocks Dip
Technology stocks put on a peacock-type display Wednesday. The Nasdaq Composite Index rose a record 7.94 percent.
The Dow Jones Industrial Average, with its blue-chip companies, did pretty well too.
Is it time to jump back into the stock market? Predicting stock prices isn't our game. But we will stick out our necks a bit and suggest investors be cautious.
Our prime reason is that the Federal Reserve is trying to slow the economy in a preemptive move against inflation. A wise old adage on Wall Street holds: "Don't fight the Fed."
A joke illustrates this precept. A customer asks: "How can I make a million in stocks?" The broker replies: "Invest $2 million when the Fed is squeezing the economy. You will soon have $1 million left."
Most Fed-watchers don't believe the Fed wants a stock market crash at this time. They also suspect, though, that the Fed would welcome continuation of the recent modest reversal of the "irrational exuberance" in stocks that Fed Chairman Alan Greenspan asked about years ago now.
The danger is that a huge crash could kick off a recession - not just an economic slowdown.
David Wyss, chief economist at Standard & Poor's DRI, calculates that it would take a 40 percent slump in stock prices to start actually shrinking the economy. Since he has further reckoned that stock market prices are about 25 percent overvalued, a drop of that size in stocks overall - though not for some inflated New Economy stocks - seems unlikely.
A 40 percent plunge would take 15 percent off the wealth of households. It would hit most the older investors that own the bulk of stock. Such a huge crash could raise ordinary personal savings, now almost nonexistent, by enough to turn sales negative.
Some see stocks as having strayed even further from reasonable valuations than does Mr. Wyss. That case is put forward in Yale Professor Robert Shiller's attention-getting new book, "Irrational Exuberance."
If the market does severely tank, a big question is whether the Fed will again come to its rescue, as it did in the 1987 crash, by dropping interest rates. Many investors are counting on that happening again. The Fed isn't offering any such assurance, however.
Most economists expect the economy to grow at a modest 3.5 to 4 percent rate for the rest of the year. There are already signs of a slowdown from the torrid pace of the last half year.
Stock prices are even less predictable than the economy. It's not a time to risk the ranch.
(c) Copyright 2000. The Christian Science Publishing Society