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.
Join a discussion on this commentary