JIM LEHRER: Now, Wall Street's struggles. It was only six weeks ago that the Dow Jones Industrial Average was rallying and closing in on 11,000. Since then, it's slumped, flirting today with the 10,000 mark. Last week, the Dow, NASDAQ, and the S&P 500 all fell more than 3 percent.
What's going on? Well, we get answers now from Diane Swonk, chief economist and senior managing director of Mesirow Financial, a financial services firm, and Hugh Johnson, investment strategist and chairman of Johnson Illington Advisors. Diane Swonk, you're on. What's happening? What is causing the market to drop these last several days?
DIANE SWONK: Well, clearly the uncertainty. We saw the economy soften up a bit in the month of March. This was to be expected to some extent because finally those higher oil prices showed up at the gas pump and did put a bit of a pinch on consumer pocketbooks.
We also saw CEO's hunker down. They didn't hire as much in March, meaning that productivity growth is still intact. In fact, in the face of higher oil prices, we've seen profit margins hold up remarkably well.
That defense of profits I think will at the end of the day come out and be good for Wall Street, but in the interim while we have to see the effects of that defense of profit margins, I think Wall Street is a show-me market these days. Show me the profits which have been outperforming expectations since the second quarter of 2003.
JIM LEHRER: They had been, right? You say they have been outperforming.
DIANE SWONK: Absolutely. They have been outperforming.
JIM LEHRER: So what is it that Wall Street isn't seeing then?
DIANE SWONK: You know, Wall Street has been very skittish. Human behavior is to extrapolate the most recent past and the future. It wasn't that long ago, in fact this month is the 5th anniversary of when the antitrust ruling went against Microsoft to help burst the NASDAQ bubble in 2000.
The fear of getting into another bubble market and having to endure such a correction has been very high on investors' consciousness. With that said, I think it's taken some steam out of the market any time we've seen some upward momentum. All of this taken, though, into context, who would have thought the U.S. economy would be doing as well as it is and resilient through $50 per barrel oil prices as beef been so far?
JIM LEHRER: Mr. Johnson, what would you add to what Ms. Swonk just said?
HUGH JOHNSON: Well, she's pretty much on the mark. We've all on Wall Street instinctively known when the Federal Reserve is leaning towards restraint, are raising short term interest rates and when oil prices are where that eventually it's going to have its impact on the economy and earnings and what's happening now as Diane alluded to is that we're starting to see it show up.
You see it show up, manufacturing is slowing down. March retail sales, for example, were very soft, suggesting that consumer spending is slowing. Obviously they're affected by prices at the pump. And we also see it of course in a lot of other things such as consumer confidence and business confidence.
So I think really Diane is on the mark. And so we're now seeing at long last the impact to some extent of rising short-term interest rates as engineered by the Federal Reserve but to a much greater extent the impact of high oil prices and investors are saying, "Time to play it a little bit on the safe side." This might lead to something a little bit more serious for the economy or profits.
JIM LEHRER: So the market is reflecting a real, its problems are coming out of real problems in the economy. This is not based on some psychological factor. Is that what you're saying, Mr. Johnson?
HUGH JOHNSON: Yes, I am. I'm saying that investors individually, we might not be impressed but collectively have an extraordinarily good record that's forecasting or telling us, signaling, messaging if you may, what's going to happen to the economy or profits. And they may be concerned now that the economy is not just going to slow but might have a sinking spell.
I don't think that's in the cards. Or they may be saying to us that profits might experience a decline. In other words we're going through a soft patch now, but it might get worse and that's the message or the signal investors are sending us. And it's one to be taken very seriously.
JIM LEHRER: Diane Swonk, do you agree generally with Mr. Johnson, that the way -- obviously if you have a lot of stock, that's a different issue. But if you're looking at the stock market strictly as an indicator of what's going on, is the indicator that we should all take out of this is that, "hey, the folks who have money invested in the economy through the stock market think the economy is having a problem, and that, in fact, is a real problem and we should take it seriously?"
DIANE SWONK: I guess I don't quite have as much faith. I do think psychology is playing a bigger role here. Remember during the bubble in the late 1990s those same investors thought the good times would never end. In fact, the grouping, the sort of collective behavior of stock buyers into the NASDAQ was, you know, almost insane. I never did buy in the NASDAQ by the way.
But that was just crazy at that point in time. And so we know that the stock market is in fact lagged much of this economic recovery; the stock market has not reflected all of the up side surprises we've seen on profits out there and the good news we've seen in inflation.
This is still an economy with -- all we've seen, you have to stand back as an economist and say, my gosh, what remarkable resilience and even an economy that survived through things many other economies wouldn't: 9/11, recession, bubbles bursting, corporate malfeasance.
It's now showing it's shown some signs of thriving with record profits and record cash flow and in fact hiring, although it's not what we'd like it to be, it is still there. And it wasn't there in the past. This just wouldn't have happened anywhere else in the world.
JIM LEHRER: So we should take this with a grain of Wall Street salt. Is that what you're suggesting?
DIANE SWONK: I would take it with a grain of Wall Street salt. I think investors are good to be a bit cautious at this time. They were burned once and don't want to be burned again. They don't want to be made fools of. That's a good thing.
I think that's one thing, you have to remember the more that you slow down the expansion in the middle, the more you elongate it going forward. So as much as this seems like a bit of breather here I think it actually sets the stage for a longer economic expansion over the next several years, which is not necessarily a bad thing.
JIM LEHRER: I wish I could ask Mr. Johnson if he agreed with you but we have lost Albany for the moment so it's just you and me right now, Ms. Swonk. So in terms of the market itself, what do you expect it to do in the short run from this day on?
DIANE SWONK: You know, the worst question an economist can be asked is what is the market going to do tomorrow because I have no idea, but I can tell you as long as the economy stays on track with sort of three to four percent growth; it will slow in the second quarter.
We do have a soft patch that has been reflected. I think that's important but as long as we sort of reaccelerate a bit, we have nice self-feeding momentum out there; record cash flow on corporate balance sheets.
They don't have to borrow money to spend it. Good news out there. As long as that continues I think we're going to see a nice rally, a rebound in these equity prices. By year end we'll be questioning ourselves once again and saying, "What is that pessimism all about."
JIM LEHRER: Yeah. In other words, you're saying that it's possible a new bubble could even develop. You're that optimistic about what is going to happen on the market.
DIANE SWONK: There is the down side. The cloud in the future is that in fact I think we could see some self-feeding momentum that feeds back into this market where probably a year or two from now we start questioning is it irrational exuberance again?
I think there's enormous potential, a lot of similarities, low inflation, high productivity growth economy that we have today with what we saw in the 1990s that set the stage for that bubble to take root.
JIM LEHRER: Another question, Ms. Swonk. A lot of people have suggested that the stock market is going to always be a little frail at least for a while. I see Mr. Johnson. Can you hear me, Mr. Johnson?
HUGH JOHNSON: Yes, I can.
JIM LEHRER: Well, Albany wasn't as far -- we lost you there for a few minutes. I'll switch this question to you, Mr. Johnson.
The question was that there was a lot of speculation that the Enrons, the WorldCom, all these scandals, these accounting scandals and corporate scandals was going to really shake confidence and make people reluctant to go back into the market in a big way, and that was going to have a psychological effect. What's your reading of that now, Mr. Johnson?
HUGH JOHNSON: It did have an impact. And I think that's a big reason we saw the decline in stock prices in 2002 and 2003. I think the stock market actually overdid it to the down side, and it was driven largely by the revelation of those scandals and swindles and from there, of course, we stage a very strong rally, 2003 and 2004.
I think that's largely behind us. Now, it is still, Jim, a cloud that's hanging over our head. We see the AIG scandal with Hank Greenburg. That's still a bit of a problem.
But I think those scandals and swindles and their impact on confidence is largely a thing of the past or the revulsion stage of that terrible bubble that we went through and I think we're getting more back to normal and confidence is starting to come back.
JIM LEHRER: Trust is coming back, Mr. Johnson?
HUGH JOHNSON: Yeah, I think trust is coming back. But you know, after it was damaged to the extent that it was in 2001 and 2002, it certainly takes a long time. We learned that from the 1930s. It doesn't get restored right away.
It takes not days, not weeks, not months but it takes years to restore that confidence. You're seeing that come back with the market doing well but it's doing well in stops and starts so confidence being rebuilt, but it takes an enormous amount of time.
JIM LEHRER: You were agreeing there with your head a while ago, Ms. Swonk, on this. You agree some trust has been restored?
DIANE SWONK: I think actually the prosecution of many of these corporate criminals has been actually very good. It was in the past when we saw these white collar crimes not pursued that, you know, you undermined the trust.
I think the fact that people like Bernie Ebbers now found guilty, you know, can't say you're CEO of a company you happen to lose $11 billion at WorldCom.
This accountability, higher accountability at the top levels where not just the rank-and-file can be fired but now the senior managers of companies and the CEO's of companies are being held accountable in ways they never were before ethically and for the bottom line.
I think that's good news for investors, shareholders exerting their power over CEO's.
JIM LEHRER: Mr. Johnson quickly in the few seconds we have left, what you missed while you were gone a while ago is the issue of what's going to happen with the market in the immediate and in the long term. I know that's the worst question -- nobody likes to be asked that. Be my guest. Ms. Swonk answered.
HUGH JOHNSON: I wish I had a coin and I could flip it. But I think I'm very positive. I think we'll get through this period of investor worries, worries about the economy, worries profits. I think that will occur over the course of the next quarter.
And I think we'll end the year, the last half of the year will be a good year and it will end up as being a positive year for stocks although not as positive as 2004 or 2003, so a good year but not a great year.
JIM LEHRER: I think if I heard you both correctly there's a little bit of agreement there. Am I right, Ms. Swonk?
DIANE SWONK: Absolutely.
JIM LEHRER: Good.
DIANE SWONK: We walked around the corner and ended up at the same spot.
JIM LEHRER: Okay. Fine, Well, look, thank you both for being with us. Sorry about our technical problems, Mr. Johnson but I think we got it covered.
HUGH JOHNSON: All right.
JIM LEHRER: Thank you. Thank you, both.