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10 August 1998

Stock Market Jitters

The Dow Jones Industrial Average has fallen nine per cent in the last three weeks. Phil Mullan separates perceptions from real developments

After Ralph Tuesday came Abby Wednesday. The immediate cause for last week's mini-panic on Wall Street, with its echoes in London and beyond, was said to be a schism between two schools of market analysts. On Tuesday Ralph Acampora, the head of technical analysis at Prudential Securities, went on television to voice his concerns that the bull market was at an end. The market duly took a hit. The Dow Jones Industrial Average (DJIA) fell over three per cent on the day. Early the next morning, Abby Joseph Cohen, Goldman Sach's influential strategist, stepped in with a calming note to her staff and clients to contradict Ralph and argue that shares were undervalued. The market bounced back.

Ralph and Abby are different types of market gurus. Acampora represents the technical analysts, who watch for statistical trading patterns to try to divine the future. This depends a lot on number crunching but is about as scientific as looking for patterns in tea leaves. Cohen, on the other hand is a market strategist, who looks at the 'fundamentals' such as company earnings, interest rates and real economic performance as a guide to share price tendencies.

This distinction between the 'technicals' and the 'fundamentals' is not important in itself, nor is it an explanation for events last week. (In fact, by the time Acampora's bearish comments were represented in the mainstream, more 'fundamental' factors were added on to make the statistical chicanery more user friendly. The fall in the markets was attributed variously to Asian flu, worries about Russia, the downturn in US corporate earnings, and to Monica's little blue dress. But none of this was 'new' news.)

However, the story of the clash of the market gurus does point to two interesting issues from last week, one to do with perceptions, the other with real developments.

Perceptions are very nervy at the moment. When a few gloomy minutes on business TV from a relatively unknown analyst - who only the day before predicted that the bull market would take off again at least until year end - precipitates a 100 point slide in an hour, you can tell that people are already pre-disposed to assuming the worst. When you are apprehensively waiting for an accident to happen, it generally does. And because, over the short term at least, share prices are all to do with perceptions, worries about equity prices falling are almost always self-fulfilling.

Attitudes to the stock market in the US, and Britain, are symptomatic of wider social apprehensions, from the Year 2000 computer problem to the dangers of mobile telephones and an almost endless list of other concerns. It is a mood based upon extreme uncertainty about what is around the corner. With respect to the economy and stock market, it is characteristic that there is enormous uncertainty even about what the nature of the danger. Polar opposites are feared at the same time: recession and inflation, stagflation and deflation, overheating and depression. While few are sure what the problem is, they are sure there is one ahead.

Secondly, which of the gurus is closer to the truth on the America's economic prospects: the pessimism of the 'technicals' or the optimism of the 'fundamentals'? On balance, the 'fundamentals' are a bit closer, in the sense that there is no prospect of a serious economic crash to undermine the stock market (though that doesn't mean share prices can't fall for other reasons). Some of them grossly exaggerate US economic strength with their talk of an 'economic renaissance' and of new 'paradigms' and productivity revolutions. When it comes to the fundamentals of growth and profits, things will motor along pretty much as they have been with some variation downwards over the next couple of years, but with no big economic bust in the offing.

Volatility in the stock market is a different animal and can be expected to intensify. Liquidity - the availability of lots of money to buy shares - has driven the direction of the market upwards over the past five years or so, but there is no exact correlation between the flow of money into the market and the precise level of share prices. Whether you think shares are 'over valued', 'fully valued', or even slightly 'under valued', there is no doubt that prices of most company shares have risen much faster than their underlying earnings. The relationship between the price of corporate paper and the real strength of the underlying business is well stretched, containing the possibility of some realignment.

After this year's fall of around ten per cent in the DJIA from the year's high, another ten per cent fall is quite possible. However, the combination of the long sustained bull market with today's mood of uncertainty means that a continued volatility in share prices is a more likely prospect than either a sustained fall or rise.

It's good to bear in mind, when reading or listening to media commentaries of stock market turmoil, that because share prices have risen so high - by eight times in less than 20 years - that seemingly big movements do not represent that much in relative terms. For instance, Tuesday's fall in New York was the third biggest one-day fall ever in points' terms, but did not even register in the top 100 falls in percentage terms.

Returning to the 'real economy', what are the parameters in the US (with its parallels in Britain)? For a start we can be sure that most of the specific fears talked about are misconceived: inflationary take-off, over-heating (including that old favourite: skills' shortages), stagflation and a 'hard landing', or as they used to say, an economic crash. Not only are they logically inconsistent, but none of the extremes will be realised.

The period we are living through is much better characterised as a restrained depression. During the 1990s upward phase of the cycle, average growth in real output, productive employment, and business investment has been far short of record levels. It has been pretty restrained, matching the business mood of restraint. The business cycle remains, but is flatter and smoother this time round, and less likely to be marked by sharp movements, up or down. The 1990s 'boom' has been less vigorous than anything seen for a very long time. The slowdown in the next phase will also be less pronounced, and less sharp than the recessions in the 1970s, 1980s and 1990s.

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