|
PureBytes Links
Trading Reference Links
|
Good stuff!
-----Original Message-----
A little food for thought.
Mike
January 10, 2000
Other Voices
The Fed Should Act Now
It has let market speculation get out of hand
BY DAVID ROCKER
The health and vitality of the U.S. economy have become dependent on a
robust stock market. In an important speech at Jackson Hole, Wyoming,
several months ago, Alan Greenspan indicated that the Fed is now sensitive
to
the potential for the stock market itself to cause an inflationary
overheating of
the economy. Based on the Fed's own model -- even after last week's
selloff --
the market has never been as expensive as it is now. Not in 1929, not in
1987,
never.
Much of the market's inexorable rise stems from the democratization of
investing. CNBC, Bloomberg and CNN, among others, pour out a steady
stream of stock-market information to homes, airports, bars and even the
sides
of buildings. The American people have gotten the message. Never before have
so many invested so heavily, confident that the market cannot go down for
any
sustained period.
Investors have become increasingly complacent because there have been so
few meaningful declines over the past two decades and markets have snapped
back
quickly from those setbacks. The assumption that past trends will persist,
the essential analytical basis for the Dow 36,000 theorists, is a dangerous
one.
Long-Term Capital Management regularly earned nearly 40% a year. On that
basis, one might have extrapolated a similar growth rate in 1998 with little
volatility. They lost 90% of their capital in a month.
In the current feverish environment, it may be helpful to reflect on some
traditional verities.
First, price matters in making an investment decision. While the Mercedes is
a
good car, it is probably not a sensible purchase at $500,000. While earnings
of
U.S. stocks have grown over the past decade, that growth rate has been
unexceptional and P/Es have never been this high, even during periods of
lower
inflation and faster earnings growth.
Second, reported earnings are of sufficiently low quality that the
Securities and
Exchange Commission has become more vocal on this issue. Chief financial
officers seem to have had at least as much to do with reported profit gains
in
recent years as chief operating officers. Corporations have been telling
their
shareholders a story far more optimistic than the one they're telling the
tax
collector. Federal corporate tax receipts were actually lower in 1999 than
in
1998 and the Congressional Budget Office expects another decline this year.
Investors have been piling into technology stocks to the exclusion of others
because of their supposedly brighter earnings prospects, yet Dell, Intel,
IBM,
Hewlett-Packard, Lexmark and Xerox, among others, have recently had
disappointing quarters.
Third, interest rates matter and they have been rising significantly around
the
world. Stocks have soared even though yields on long U.S. Treasury bonds
have risen nearly 30% over the past year. Internet and other high-P/E
stocks,
which logically should have been the most adversely affected by rising rates
because their multiples are high and their payouts more distant, have risen
the
fastest in this twilight zone of a stock market.
Fourth, as Long-Term Capital Management showed, leverage increases
volatility. Investors have dramatically increased their leverage to maximize
returns. Margin loans have risen vertically in the past several years to
record
levels. While it is not easily measured, it is also clear that large sums
have been
borrowed against homes and credit cards for stock purchases. Similarly,
percentage cash reserves at mutual funds have been drawn down almost to
all-time lows. Everyone owns the same small group of large-capitalization
technology stocks. Investors are behaving like sheep on margin. The American
public has committed the greatest percentage of its assets to the most
expensive
stock market in history at a time when the Federal Reserve is overtly
tightening,
our external deficit is swelling and cash reserves are low. This
insensitivity to
risk is dangerous.
The Federal Reserve and other government agencies have been significantly
responsible for this euphoria because of the asymmetry of their policies.
The
Fed argues that markets should be free of government intervention, but it
seems
that such views are espoused only so long as markets are rising. When the
market crashed in 1987, the Fed intervened. When banks and savings and
loans were bankrolling wildly risky deals, the government looked on and did
nothing. When this recklessness produced vast losses, the government stepped
in to bail out the speculators -- at enormous public expense. When LTCM
overleveraged itself, regulators sat idly by. When its collapse in 1998 led
to a
market decline, the Fed stepped in again to coordinate the bailout, cut
interest
rates and pump in money. Once again, the government stopped natural
corrective forces from punishing speculators, as always cloaking its actions
in
the mantle of the national interest. The message to the investing public has
been
clear: "The government will protect you from the downside but will not
restrain
your upside." Why not speculate?
As the "buy the dip" mentality is now so fully ingrained as to prevent all
but a
sudden steep decline, the risk has risen that this market will end
violently,
threatening our prosperity. The economy would clearly suffer after a sharp
selloff because so many consumers are now so heavily invested. Real-estate
values would fall. With U.S. equities out of favor, the demand for dollars
would
shrink, forcing the U.S. to pay higher interest rates to attract foreign
capital to
cover our rising trade deficit. The combination of a weaker economy and
rising
interest rates would further depress the stock market. In essence, the whole
positive cycle we have enjoyed in the past decade would be thrown into
reverse. Of course, the Federal Reserve would then be expected to again
intervene.
Fed officials have periodically expressed concern about market valuations
and
speculation, but then the governors reverse themselves with "new paradigm"
speeches and commitments not to raise margin requirements. Each reversal has
brought forth a new burst of unbridled investor enthusiasm. The 100 largest
Nasdaq stocks rose 102% last year and are selling at over 130 times
earnings.
The IPO market has been on steroids. In a testament to these times, one
magazine implicitly criticized Warren Buffett, who has made nothing but
money,
while another lionized Jeff Bezos of Amazon.com, which has lost
ever-increasing amounts of money.
If the Fed is serious, it should send an unambiguous message to investors
that
excessive speculation is unwelcome. It should raise margin requirements and
interest rates immediately with a clear warning that more increases will
come in
the future if this speculation persists. It is better to accept moderate
pain now
and reintroduce a sense of risk to the marketplace than to wait until a
massive
blowoff and subsequent collapse occur that could severely damage this nation
for years.
DAVID ROCKER is general partner of Rocker Partners.
URL for this Article:
http://interactive.wsj.com/archive/retrieve.cgi?id=SB947302122920797966.djm
Copyright © 2000 Dow Jones & Company, Inc. All Rights Reserved.
|