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ELIZABETH FARNSWORTH: Today’s unemployment figures and market surge capped a week of stock volatility. Both the Dow Jones Industrial Average and the NASDAQ market fell earlier this week from the lofty peaks reached last year. The Dow rose 25% in 1999, reaching a high of 11,497. This week brought large swings, down, and then up again today to a new record. The NASDAQ Index rise last year was even more dramatic, skyrocketing 86% to an all-time high of 4,069. This week NASDAQ saw its largest one-day decrease ever and today the largest increase; for the week it ended down 186 points. To explain what’s going on, we’re joined by Gail Fosler, chief economist at the Conference Board, a business research organization; and Michael Englund, chief market economist at Standard and Poor’s in San Francisco, a bond market information and consulting company. What’s going on here, Mr. Englund?
MICHAEL ENGLUND: Well, the economy through the end of 1999 and into the year 2000 has been very strong. Generally that’s good news for the stock market. However late in the business cycle it isn’t necessarily. And right now the markets are very jittery about what’s going to happen with inflation and interest rates as we go through the year 2000.
ELIZABETH FARNSWORTH: So this has a lot to do with it just being early in the year?
MICHAEL ENGLUND: It could be related to being early in the year. We also have a Y2K effect early in the year. People were concerned that we were going to see some sort of economic ramifications, technical disruptions related to Y2K. As we know there were virtually none. That was somewhat of a surprise to the market. We aren’t seeing an economic effect. The economy was very strong late in 1999 partly due to inventory building, preemptive consumption by households, people buying canned goods and the like, prepare for Y2K. You don’t need much of a change in people’s behavior to boost the economy. It’s probably a factor for the economic data. But the markets have been relieved going into the new year to see there are no technical disruptions. It’s focused the attention on how strong our economy really is.
ELIZABETH FARNSWORTH: Okay. Let’s go over some of this in more detail. Gail Fosler, what happened earlier this week. Why did the NASDAQ fall so steeply?
GAIL FOSLER: The technology stocks have really been sort of a dominant benefactors of this run-up in the stock market. They’ve been quite extended both in the S&P and in the NASDAQ. So to pick up on on something that Mike said, the Fed left us with two messages when it last met. One was it wasn’t going to raise interest rates before the end of the year. The other was it was going to raise interest rates after the end of the year. So when we came into the beginning of this year, we had a shift in tension toward this interest-rate increase with significant gains for these tech stocks. And I think people wanted to just move to the side lines and get some information.
ELIZABETH FARNSWORTH: Do you agree with that?
GAIL FOSLER: Yes, I do. I think the markets right now are very focused on what the Federal Reserve is going to do. The signals in December were that the Fed would tighten once it put Y2K behind it. Right now the market is concerned that we’re not necessarily going to see one tightening of policy but we may see a series of tightenings. That’s what the market is really focused on right now.
ELIZABETH FARNSWORTH: Okay. So earlier this week, the steep dips were partly because of that. Why back up today and how does it relate to the unemployment figures today, Gail Fosler?
GAIL FOSLER: Well, I think that the unemployment numbers today, there was a great deal of fear that the economy– I mean, Mike has mentioned the economy was strong. I think these numbers today confirm they were strong. But there were, in some sense, they weren’t as alarmist as people had feared. When one sort of looked at the key inflation number, which is essentially the rate at which wages are rising, that number was a little bit of a tad more than people had expected. But basically when you looked into it, there were some special factors and I think people felt confident that a lot of the same forces that had been driving the market in 1999 would continue to drive the market this year.
ELIZABETH FARNSWORTH: In other words, the figures weren’t showing tremendous pressures towards inflation.
GAIL FOSLER: Well, in fact, you know, if you look at the number, the average hourly earnings number which is a key wage index, was up .4. The expectation had been .3. But when one looks on a year-over-year basis it shows you that wages are rising about 3.8%, relatively modest. It’s slightly up from about 3.5% at the end of last year. Manufacturing wages are extremely steady at about 3.5%. And most of that strength was actually in the trade sector so I think people felt with the Christmas season that maybe it was understandable to see some wage pressure in that sector and that it didn’t really represent a sort of economy-wide phenomenon that would really cause the Fed to put on the brakes.
ELIZABETH FARNSWORTH: Mr. Englund, how do you see the unemployment figures in relation to what happened in the market today?
MICHAEL ENGLUND: Well, I think in general the market is walking on egg shells right now. The fear is that all it takes is one or two economic releases that pop to the up side to trigger the Federal Reserve to either tighten by a larger amount than was previously expected, or –
ELIZABETH FARNSWORTH: Ex-excuse me. What do you mean "pop to the up side?"
MICHAEL ENGLUND: Well, for instance, in April I believe, September of 1999 we saw a CPI come in a few tenths of a percentage above expectations.
ELIZABETH FARNSWORTH: The Consumer Price Index.
MICHAEL ENGLUND: The Consumer Price Index. And the economy has been so strong that the notion is any evidence that we see that inflation is picking up is going to be enough to trigger the Fed. They’re going to decide enough is enough. What is remarkable about the U.S. inflation data is how under control the inflation outlook really seems to be. Core inflation continues to slow. In 1999, the real two inflation stories were oil and tobacco. Tobacco prices rose because of the tobacco price agreement that occurred late in ’98 and ’99. Factor in those special factors, core inflation is really under control. The problem for the market now is that they are walking on eggshells. The concern is that if we do see some sort of a trigger for the market and the concern was perhaps the December employment report would be that trigger, the Fed is going to move. And now we put the employment part behind us. But, of course we’re going to have more reports over the next couple of months.
ELIZABETH FARNSWORTH: Do you agree with that, that the market is walking on eggshells, Ms. Fosler?
GAIL FOSLER: Yes, I think the market really wants to get a pattern of data that demonstrates that a lot of the sort of bullish factors of last year, the low inflation, the strong productivity growth, which has fed the strong economic growth is going to be still in place this year. But I think we are looking forward to an interest-rate increase. I think one of the big maybe changes in the sentiment this week was that with the strong Christmas season and coming off Y2K with no particular glitches that some of the bears came out of their caves and they growled very loudly and they talked about maybe a full percentage point increase on the part of the Fed and I think this really scared people. And so now with these numbers out today, there’s a sort of consensus that is forming around 25 basis point increase. I think maybe the Fed will raise interest rates 25 basis points and leave them there for a while. And I think the market is really sort of heaving a sigh of relief that some of these more bearish forecasts don’t appear to be in the cards right now.
ELIZABETH FARNSWORTH: Mr. Englund explain 25 basis points and tell us whether you hear the bears growling still.
MICHAEL ENGLUND: Okay. A 25 basis point hike is a one-quarter percentage point increase in interest rates. The Federal Reserve has displayed a tendency to change rates by a quarter point with each move. And the market has now, more or less, fully discounted a quarter point hike at the February FOMC meeting. The next likely time for the Fed to raise rates would be March. We are assuming that they’ll wait at March, but our assumption is that they tighten again in May. That has been somewhat of a pattern for the Fed to tighten it at every other meeting. We think that will probably continue until the markets are able to come to grips with what is happening with the economy and inflation. I think as long as we are concerned about a rise in inflation on the horizon, we’re going to have this kind of market environment where we are looking at unemployment reports, looking at CPI reports each month on the assumption that any bad news is going to immediately translate into a change in interest rate.
ELIZABETH FARNSWORTH: It’s so strange, bad news could be very low unemployment rate.
MICHAEL ENGLUND: Certainly high inflation is not good for anyone, but the employment report does produce this quagmire. Essentially the stock market, markets in general like a strong economy but when you’re near the end of a business cycle, we’re now by February we’re going to leave the longest business cycle in U.S. history, the tendency is to be looking ahead to the risk of recession. And generally just before a recession what we will see is a run-up in inflation, hikes in interest rates and the economy will turn down. So that’s really what’s in the headlights right now for the financial markets.
ELIZABETH FARNSWORTH: Gail Fosler, do you want to react to that. I have another question for you, so, quickly.
GAIL FOSLER: I think that it’s important to realize that we really don’t have any signs of recession. And we certainly in fact, if anything, are finding that the signals are still very positive. The Conference Board produces the Consumer Confidence Index, and the index says leading economic indicators — last month our Consumer Confidence Index was at an all-time high. We seem to be in an environment of all-time highs. Our Index of leading economic indicators is really pointing up. So we have a lot of positive signals for the year 2000.
ELIZABETH FARNSWORTH: You touched on this before, but is some of the volatility we’re seeing inevitable with the speculative stocks like the NASDAQ stocks?
GAIL FOSLER: Yes, you know, I think that where you have a market that is very diverse and you have a focus in that market for both opportunity and risk, that you will get disproportionate declines where the market senses that — that risk. And the tech stocks have really been… I sort of call it the new frontier, you know? There’s gold in them their hills if we go back to the gold rush analogy. And that’s the tech stocks today, but a lot of these stocks don’t have a lot of the traditional fundamentals that investors are accustomed to looking at. Of course it’s almost an inside joke that they don’t have any earnings and so people are taking big risks on a lot of these stocks. And it’s not surprising to see these stocks back off. After all, the technology stocks, if one looks at the technology stocks in the S&P 500, they’ve almost doubled as a proportion of the S&P 500 because they’ve gone up while a lot of other stocks have not. So, people are being drawn in to the technology market and I think when they get to see some risk on the horizon they want to back away.
ELIZABETH FARNSWORTH: The changes of this week in the NASDAQ Index aren’t as great as they seem, are they? It’s partly in relation to how much it grew last year.
MICHAEL ENGLUND: Well, that’s only the case when we watch point changes both in the Dow and the NASDAQ. People tend to focus on the actual number of points the index have changed. And NASDAQ and the Dow in general for the last four or five years have risen so sharply that we have to grow accustom to seeing 100-plus point changes in both of these indices — and the NASDAQ in particular being up over 80% last year, the changes we’re seeing in NASDAQ have increased pretty dramatically. So the swings these week are not out of context in percentage basis for some of the more volatile weeks this year but they’re certainly dramatic when we look at them in point terms.
ELIZABETH FARNSWORTH: Okay. Thank you both very much for being with us.
GAIL FOSLER: Thank you.
MICHAEL ENGLUND: Thank you.