Author’s note: Since this article written in April 2000, Wall Street was battled by technology bubbles, corporate scandals that weaken investors’ confidence. Most important of all is the soft economy that includes a mixed bag of corporate results. Consumer confidence is intact, and productivity is up. In the past, Wall Street boom depended on technology sector. And demand for technology sector remains weak. The question is what do we expect Wall Street to carry us from here? Are we still dreaming of the bustling of Wall Street in the late 90s?(12/2002)
Wall Street‘s black Friday last week reminded me a book about DOW 36,000 points. It was the euphoria that everybody had when economy was progressing without impediments.
Last week’s DOW and NASDAQ continually fell, culminating in last Friday a record fell for DOW 617.78 points and NASDAQ 355.49 points.
What precipitated the fell? It was said the likelihood of Fed to increase interest rate could not be more real than ever attributed to consumer price index rose by 0.7% and energy and transport price rose by 0.4%. Of course, the adverse changes in environmental factors affected US economic performance, there is no doubt about it. The question is was the fell out of proportion? What are the implications to the stock market as a whole and to the US economy?
The repetitive calls by Mr. Alan Greenspan for increase in interest rate sent intermittent signals to the market and the subsequent less than 50 basis point adjustments were called for. The impact of the actual increases was less significant than the haunt for fear of increase that debilitating confidence which made the market very stressful. And it is this complex behavioral factor that wanting to relieve psychologically aggravated the volatility of the stock market.
What is the impact of 100 basis point increase in interest rate to the US economy? I think it is minimal. I have great respect to Mr. Alan Greenspan. But I am interested to see evidence how interest rate increase alone will be able to slow down US economy and curb inflation.
My skepticism is based on the view that the massive restructuring in the US corporate landscape, reengineering and outsourcing vastly increase their productivity level. These supply side economic changes make their economy very flexible. I see there is every reason for the economy to withstand the interest rate hike shock. It is inconceivable that interest rate hike will totally erode the productivity gain. But why things blew out of proportion?
Those people lived in the 70s experienced how inflation affected us. I remembered the time in the 80s I was still learning current cost accounting when the threat of inflation was no longer in existence. I wonder why those American survived that level of inflation fever was unable to sustain the current benign inflation. The only explanation I can have is the narcissism of American culture.
I read an interesting book about how market traders manipulated share prices to reap profits. Could there be little conspiracy theory in play judging the share price already run up at very high level? The trading system in US for short term trading contributed to the volatility of trading, enlarging the fall when market turns bear. It was said greater volatility would make the market more attractive in terms of the upside. Of course, the herd instinct that behavioral finance frequently talking about that made the selling pressure more fervent.
One very unlikely reason is the hidden factors that US corporate earnings are unsustainable. If this suspicion was supported by the traders, why it took so long to make adjustments until it made this drastic and painful correction lately. It also brings decades long debate about market efficiency. US has the most established stock market and the most detailed corporate disclosures. These should result in greater transparency and more accuracy in stock valuation. I am expecting no more than 5% variation normally. The free fall posed a big question to the market efficiency advocate how market efficiency theory explains this phenomenon.
There are many articles talking about dot.com companies’ valuation and reports about overvaluation of these companies for their performance fall short of expectation resulting in NASDAQ corrections. Unlike in this part of the world, there are articles talking about e-commerce in some US magazines in the 80s. The revolution of technology drastically changes the way business is done and our daily life. The Japanese should be happier than others should because this development totally eliminated intermediaries, making the supply chain shorter, and the goods so much cheaper. The euphoria of the magic of new economy was oversung. No one was looking into the role of e-commerce in the supply chain process and the limitations of e-commerce.
The proliferation of dot.com companies making market concentration in this industry too intense and thin margin sees the report card was into the red. Poor performance dampened the hope of previous euphoria. The final verdict is any valuation is still cash based. It is not the end of the day for Dot.com Companies. Dot.com Companies still play a role as a result of the industry structural change. The high tech industries have many upside potential to lure consumption. Continual innovation and change will make new economy more vibrant than old economy. This is not to write off the old economy. We must see the relationship of the two in context and how they operate in the business framework.
Lastly, let see the impact of the stock fall:
It shifted the wealth from group of people, largely the investors;
The fundamental of the US economy will remain unchanged for this instance;
The scapegoats are those short term speculators
The worst case scenario will be hot money flow out of The America, and resulting depreciating of US currency. As US large current account deficit is actually buttressed by inflow of funds from over the world. The outflow of funds will certainly have substantial impact on US economy. If the US corporate performance continues to stay robust, in the medium and long term will not be a problem.
