The Dow Jones Taking a Plunge
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MARGARET WARNER: With today’s 230 point drop, the Dow Jones Industrial Average has declined nearly 16 percent from the all-time high set on January 14th.
Yet, the NASDAQ market of technology stocks is up 13 percent for the year, despite today’s small decline. To help us understand what’s going on we’re joined by David Wyss, chief economist at Standard & Poor’s, an economic research and rating firm, and Bob Walberg, chief equity analyst at Briefing.com, an online financial research firm. Welcome, gentlemen. Bob Walberg, explain why the Dow has declined so much in just six weeks.
BOB WALBERG, Briefing.com: Well, Margaret, I think a lot of it has to do with fears that interest rates are going to be moving higher. We had Alan Greenspan tell us a number of times now it is his goal to slow economic growth down, and, consequently, we’re seeing those groups that are interest rate sensitive like retail, housing, the consumers, cyclical stocks, and the industrial sector, all of those stocks have been pulling back. They’re obviously much more heavily weighted in the Dow than NASDAQ. That explains the divergence between the two indices that you talked about at the beginning of the program.
MARGARET WARNER: But, I mean, why has the NASDAQ also not suffered a similar decline?
BOB WALBERG: Well, again, the reason is the NASDAQ is a much more heavily weighted index in technology and biotechnology. Today’s individual investor is looking at those sectors of the economy – the new economy sectors – such as wireless and fiber optics, business to business commerce and they’re looking to invest in those areas that are going to grow at, you know, 30, 40 percent over the next five years, relative to the slower growth, the more traditional old-economy stocks that more heavily weighted in the Dow Jones Industrial Average and S&P500. That’s why you’re seeing the tech-heavy NASDAQ outperform the market.
MARGARET WARNER: David Wyss, is it a valid assumption to think that these technology stocks are less interest-rate sensitive?
DAVID WYSS, Standard & Poor’s: Well, they’re certainly less interest-rate sensitive. Whether they should be this strong and absolutely 0-interest rate sensitive I doubt. The fact of the matter these stocks should have some interest-rate sensitivity. It’s a shock to me we haven’t seen any reaction in the NASDAQ.
MARGARET WARNER: But don’t companies like this, whether cellular phone companies making routers or something, don’t they have to do a lot of capital investment, don’t they have to borrow money?
DAVID WYSS: They’re doing a lot of capital investment but they’re not borrowing a lot of money. Most of their money actually coming from the stock market. You use the cheapest possible money when you’re trying to finance investments. And right now, given the P/E ratios, stocks are a lot cheaper than borrowing in the bond market.
MARGARET WARNER: So, back to you, Bob Walberg, do you think this faith in the technology stocks is justified?
BOB WALBERG: I definitely think it is justified. You’re looking at individual investors that are looking to park their money now for the long term. They’ve seen tremendous rewards in technology. This is the sectors of the economy you’re going to be looking at an explosion because the Internet revolution in band width, you’re seeing an explosion in wireless communications. And people want to make sure they’re invested in those areas.
Consequently they’re looking at the leadership means such as the Qualcomms and Ciscos and those areas or they’re starting to fan out in Internet stocks looking for smaller companies that are showing extremely top line or revenue growth of anywhere from 50 to 100% a year. They’re looking at stocks like Interwoven, Commerce One or Reva, leaderships of the new economy.
I think you’re going to see continued out performance in those sectors. The small guy isn’t really paying much attention to the fact that rates might go from 6.5 to 7. It has very little bearing on this companies.
MARGARET WARNER: You have talked about the small investor. Who is doing all this selling and buying? Are these both the individual investors and large institutional investors?
BOB WALBERG: One of the reasons you’re seeing the divergence between the two indices is a lot of today’s individual inventors, smaller investors today are primarily investing in technology and biotechnology and so on — again heavily weighted in the NASDAQ. Whereas the institutional people, those money managers are investing in S&P 500 Index funds or value investors that are investing in stocks such as, you know, Procter & Gamble possibly or some of the food stocks. Those are the investors, institutional investors, that are really getting hurt.
And we’re also seeing share redemptions and a lot of mutual funds are value oriented with money shifting from that area to the faster, aggressive growth stocks, again more tech-heavy weighted, biotechnology-weighted mutual funds. That’s why you’re seeing this rotation of assets out of old economy stocks into new economy stocks. I don’t think it’s going to be an event that will slow down any time soon.
MARGARET WARNER: David Wyss, do you think that this decline in the really the blue-chip stocks, the great industrial giants from IBM, to Coke, I guess, is it a sign of underlying problems or weakness in the economy?
DAVID WYSS: I think it’s a sign mostly of interest rates going up. Let’s face it. The rates are up by a full percentage point from where they were a few months ago. Given that, a 16% decline in the Dow is pretty much line in line with expectations. I think the Fed is trying to put the brakes on the economy. Whenever that happens you have got to see the impact in the stock market. That’s the primary financial medium after all.
MARGARET WARNER: And do you think that this decline in the Dow will have an effect on the economy, will have an effect on consumers’ buying patterns?
DAVID WYSS: Consumer spending recently has been dominated by wealth. People feel rich. They are rich. People have never had so much money relative to income or in absolute terms and when you’re rich, you spend. Now they’re a little bit less rich, the risk is they’re going to spend a little bit less – that they’re going to decide maybe they’ll save a little bit more since the 401(k) doesn’t have as much money in it as it did a few months ago.
MARGARET WARNER: But, as economist, do you — we’ve always talked about the wealthy effect, people felt they were richer than they really were — it was all on paper in their retirement funds. Is 16% enough of a bump down to make them feel less wealthy? And, if not, where is that point.
DAVID WYSS: Well, I think 16% probably isn’t enough to do it unless it stays there and unless it continues to go down a lot farther. We’ve had 20% corrections in each of the last two years. And the consumer has pretty much ignored them. Even if you take 20% off the stock market, we are still at a record ratio of wealth-to-income in this country.
MARGARET WARNER: Is that a new phenomenon, Bob Walberg, that… First of all do you agree that this won’t have a huge effect on consumers and is that a new phenomenon?
BOB WALBERG: I don’t really think it will… At least the nominal increase we’ve seen so far in rates, I don’t think it will have a huge impact on consumers. The fact that 401(k) money is invested in S&P 500 Index Funds or even Dow 30 funds are down a little bit year to date, that’s not going to have a big impact.
That’s primarily retirement money. People aren’t say I’m going to buy new refrigerator because I have more money in my 401(k) plan. So I don’t think you’ll see a significant impact on consumer spending as long as rates don’t get above 7% in the long end. Right now despite this correction we’ve seen over the last several weeks, we’ve seen long-term interest rates come down to 6.3% from 7%. We’re seeing it start to come down.
That’s going to be the area where it has the biggest impact on the housing market and so on. If those long-term rates continue to stay in the 6.3% range, I don’t think it will be a long-term phenomenon. I would expect the Dow to be right back up near its highs within a few months.
MARGARET WARNER: So, how should the normal U.S. investor, the person who is not day-trading or even actively trading but is simply in their 401(k), how should they look at today’s news?
BOB WALBERG: There is a great buying opportunity particularly in the traditional stocks. If you look in the retail sectors, these stocks are down 50, 60 percent from their highs based on a very modest increase in interest rates. The same thing could be said for a lot of the food stocks and a number of the airline stocks due to the rise in oil prices.
There are a lot of sectors of our economy right now trading at very low price to earnings ratios. The financial sector is another area right now offering very good long-term opportunities. So I see this as a very good long-term buying opportunity in some of the more traditional areas of the old economy.
MARGARET WARNER: David Wyss, how should the ordinary investor regard this, as serious news?
DAVID WYSS: No. this is a correction in the market; this is a typical correction in the market. I think it’s going to be as short lived as the last few. I think that we do have a lot of value stocks out there which are undervalued.
There are simply good buys out there in areas like housing and banking which have been hit too hard by interest rates, especially the housing sector and in areas like oil companies which haven’t responded at all to the surge in oil prices, another big shock.
MARGARET WARNER: And I assume that you are a close Greenspan watcher and Fed watcher, as we all are. Do you think from what he said in the past that this kind of correction or a decline is enough of a cooling off as what he’s looking for?
DAVID WYSS: I don’t think he cares about the stock market. He cares about what it does to the economy. And if he starts to see some impact that the consumer is beginning to react to the stock market, then obviously if the stock market is putting on the brakes, the Fed doesn’t have to jerk rates up quite as far or quite as fast as otherwise.
MARGARET WARNER: Do you agree with that, Bob Walberg, this alone isn’t enough to forestall future interest rate hikes?
BOB WALBERG: Oh, definitely not. You’re looking at least at two more interest hikes over the next few months by the Fed. That’s preordained. We’re looking at an economy growing over 6% from last quarter almost 7%. I think you’re going to be looking at two more rate hikes. Then again you have to remember that the first 75 basis points that we’ve seen raised over the last year, a lot of that was just taking back the cuts….
MARGARET WARNER: From the first three.
BOB WALBERG: We had only one 25-point basis point cut on top of what we took back from last year. Again this has not been an aggressive Fed yet. Greenspan tends to take gradual approaches to raising rates. I think you’ll continue to see that. Basically we’re trying to keep the economy from getting too far ahead of itself. Right now I think you’re going to see simply two more rate hikes. From there we’ll see what happens.
MARGARET WARNER: Bob Walberg, David Wyss, thank you so much.