Jewish World Review March 20, 2001 / 25 Adar, 5761
http://www.jewishworldreview.com -- THE stock market bears are back, and they have routed the bulls. The question now is what can be done to tame the bear and what damage the bear hug will do to the real economy. There has been an astonishing destruction of values–the Nasdaq down more than 60 percent from its peak a year ago, wiping out $4 trillion. That is a sum equal to 40 percent of our gross domestic product, compared with the 20 percent lost in the 1987 crash. Stock market collapses hurt economies more than they used to because business and consumer confidence is more vulnerable now that over half of all Americans own shares–and half of them bought stocks only in the 1990s and have only seen markets rise.
How did the market get so high?
Just a year ago Wall Street was more overvalued than at any time in 150 years. The price-earnings ratio for the S&P composite index was one third higher than the P/E ratio in September 1929 just before the Great Crash. In 1999 alone, the Nasdaq went up an astonishing 74 percent, with many high-tech stocks trading at over 100 times earnings–meaning that to provide a reasonable return they would have had to increase profits at the impossible rate of 40 percent a year for a decade.
What we had was "momentum investing," where people were buying stocks because they were going up. (Now people are selling because stocks are going down.) The media's obsession with the "new economy," with endless gee-whiz stories about the Internet and overnight billionaires, helped puff up the bubble. Stock analysts became pitchmen on cable TV outlets such as CNBC, whose audience doubled. Armchair investors and day traders played the market as if they were betting on horses–except that horseplayers often spend more time poring over the data in the Daily Racing Form. Investors began looking to mutual funds for quick profits, punishing funds where managers took a longer view. Twenty-five years ago investors stayed in mutual funds an average of 12.5 years; now that figure is just over two years.
Room to fall. Adding to investor jitters is the fact that the high-tech sector, despite its sharp decline, may still be overvalued. Many tech stocks are still not cheap because earnings are falling even faster than stock prices, in effect raising and not lowering P/E multiples. The P/E ratio of the S&P is still 24, compared with just 12 at the end of the 1987 bear market, and the Nasdaq ratios are even higher relative to their earlier averages. This means there is plenty of room for further declines in stocks, especially now that market sentiment has turned upside down. Risk aversion has taken the place of risk tolerance, fear and caution the place of greed and euphoria.
The news from the real economy is no tonic. The deceleration of the investment-led expansion is sharper than ever before. Capital spending shows little sign of recovering in the face of shrinking profits and nervous lenders looking for safe havens for their money. Add to this the residual effects on consumer spending caused by higher interest rates imposed by the Federal Reserve last year, higher energy prices, and consumers maxed out on durables and personal credit, and you have the prospect of a double whammy that might extend the decline in sales and earnings throughout the year.
What can restore confidence, slow and reverse the contractionary forces that have emerged at such unprecedented speed? Only the Federal Reserve can provide a parachute. The risk of a longer and deeper slump than previously anticipated requires a bigger, and swifter, cut in interest rates. Speed is critical. If business and consumer confidence break, scared consumers will focus on saving more, and business on reducing costs and excess capacity–and growth will not be resumed. The recent Japanese experience is a vivid example of how even minimal rates don't restore momentum once confidence is shattered. Forget the Bush tax cut. It will be too small and too late to really boost the economy; 89 percent of the cut is backloaded into the second half of the decade.
The stock market has already discounted a reduction of one half of 1
percentage point in anticipation of the March 20 meeting of the Fed.
More will be needed if we are to avoid an environment of fear in which
anything can happen, most of it bad. The Fed has had a good spell for a
number of years, but rates are still too high. We are falling fast, and it is
time to pull the rip