WHAT GOES UP....
August 4, 1998
On Wall Street today, the Dow Jones Industrial Average recorded its third biggest single day point decline in history. Economics correspondent Paul Solman and guests discuss the reasons behind the stock market's fall.
A RealAudio version of this segment is available.
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Federal Reserve Board.
PAUL SOLMAN: Well, the direction is down, but why and how far? For that, we now turn to Bob Froehlich, chief investment strategist for the mutual fund group at Scudder Kemper Investments in Chicago, and Robert Brusca, chief economist for Nikko International in New York. Gentlemen, welcome to you both. Mr. Brusca, let's start with why. Why did the stock market suddenly drop today and respond to something the rest of us seem to have missed?
Reasons for the stock market's decline.
ROBERT BRUSCA, Nikko International: I think you'd have to describe today's action as being sort of market-driven and a bit technical. We had a big down day yesterday. The stock market tried to be up in the morning, and it was up by over 50 points. And when it couldn't hold that gain, it just caused waves of selling and pessimism, and there wasn't anything particular today. There wasn't any particular news, but there's been anxiety. The stock market had had a number of hundred or nearly hundred point up and down days over the last week or so. The advance/decline lines in the stock market, i.e., the ratio of stocks going up to those going down continues to slide, showing that there are more stocks falling than rising. And we've had this trend of pessimism in place, and today it culminated into a pretty big down day in the Dow Jones and most of the other major averages.
PAUL SOLMAN: But you're talking about the stock market as if it's a person that was depressed, that was pessimistic, and you used "it" as if it were an organism, itself. Is that how you think of it?
ROBERT BRUSCA: Well, sort of. You know, it's an economic, a sociological phenomenon. You're looking at the behavior of masses of investors. You know, the economic information has been less supportive this market for some time. When Alan Greenspan spoke about two weeks ago, he had mentioned how rosy the scenarios are. I believe that the Ibis, which is a survey of earnings looking out, built up from the bottom up by analysts looking at their individual company estimates for earnings, as looking for an average of 14 percent over the next five years or so, which is extraordinarily optimistic. The economy, meanwhile, is long into this expansion as the expansion gets old. Usually productivity falters. It doesn't increase. The dollar is very strong. The strength of the dollar means that it's harder for U.S. firms to compete against cheaper goods from overseas, and that depresses earnings. It cuts them down. So the question is why in these times were stocks valued so high. Why have people been so optimistic on earnings when you can cite a number of fundamentals that would seem to suggest that the market should have been a little bit more circumspect? And I think what we're seeing is a return to reality. I think it's good. I think a 300-point drop in one day is not necessarily good. But I think this market has to price in some sense of risk. We can't have a stock market that can only foresee the most wonderful things in the world.
PAUL SOLMAN: Okay. Mr. Froehlich, the wake-up call, the return to reality, is that what's going on, and why again today?
Political uncertainity in Japan and the U.S. plays a role.
BOB FROEHLICH, Scudder Kemper Investments: Well, I think the reason today is there's a couple of events that I think have exaggerated the movement in the market over the last couple of days, and that's the political uncertainty that's happening in Japan and the political uncertainty here in the United States. Investors hate uncertainty, and the fact of the matter is the changing leadership in Japan has caused more questions than it has answered anything. And so we have a big international uncertainty, and the culmination of the events with President Clinton and Monica Lewinsky here has created another big question mark. We're almost back to where we were in January with this scandal. And so you've got two very big political question marks going on in the two largest economies in the world, and so I think that has exaggerated the downward movement. Earnings-
PAUL SOLMAN: But just let me interrupt to ask you, Japan has been a problem area for about eight years now, and they've had a wobbly economic picture; they've had real question marks as to who was in charge politically. I mean, that didn't happen yesterday or today.
BOB FROEHLICH: It's been with us for eight years, but what hasn't been with us for eight years is the opportunity to change the course in the direction of Japan. When the voters spoke and with the resignation of Hashimoto, there was a window of opportunity to usher in a sea change, to roll back the consumption tax, to put permanent tax cuts in place, to not attempt and save the poor banks, to actually put a system in place like we had in the United States. And, instead, we're seeing more of the same. And so I think Japan missed that window of opportunity. And I think investors are telling Japan that they missed that window of opportunity, and that's one of the reasons our market is selling off. It's the concern with the events in Japan, the reality is Japan is not turning around anytime soon.
PAUL SOLMAN: Mr. Brusca, what do you think, Monica Lewinsky, Japan, did something-did the market suddenly think differently about them, or more seriously, or worry more about them today than yesterday or Friday say?
ROBERT BRUSCA: Well, it was over a week ago that Mr. Obuchi was elected as the new prime minister and he's from the LDP, and because of that, a lot of people didn't really think that there was going to be very much change. So, grant you, I may be a little bit more connected to these circumstances. I was in Japan a week and a half ago and I work for a Japanese securities firm-
PAUL SOLMAN: Right. Nikko is Japanese.
ROBERT BRUSCA: Yes. But I do think it's pretty well known by people that this was not going to be a watershed change. You're getting somebody from the same party. And it was last week that Mr. Miasawa, who's the new finance minister, had made some comment about perhaps not intervening in a foreign exchange market, and yet, it was the day the stock market fell. So I think you have a hard time really making close connections to those things. Even, you know, the Clinton/Lewinsky developments didn't actually come to a head today. This has been around. So I think we're dealing with a market that's beginning to deal with changed circumstances. If you look at charts on the markets, you see that the Dow Jones Industrial, the utilities, the transportations, these different measures of the stock market all have reached peaks a week or so ago, and they've been sliding since then. So this wasn't a one-day phenomenon, but this was a culmination. And I think that when you try to look at the fundamentals for this stock market you find that there are some problem areas. You know, we do require a lot of capital from overseas. You start talking about the stock market; you have to start talking about international events. We need the equivalent of a large Russian support package to finance or balance of payments deficit every single month. You're talking $15 billion and more per month that we need to get from abroad on a net basis.
PAUL SOLMAN: So that's a general rim picture your painting. And today people suddenly began to react to it more than they have in the past, is that what you're saying?
ROBERT BRUSCA: Yes. There's nothing that was a catalyst for this day, other than the market dynamics, itself. And, as you know, people use charts, they use various technical things to follow this market, because day in and day out fundamental things don't change that much. And if you look at these different charts on the market and they give you what we call support and resistance, and today the market just went through a very important line that could have supported it, and it didn't. And so the selling just accumulated.
PAUL SOLMAN: And that's a little too fancy for us. Mr. Froehlich, I mean, the technicalities of that kind of analysis-but, Mr. Froehlich, do you agree with Mr. Brusca's grim longer-term picture? And I have a specific question, which is: Who is Ralph Acampora, which-whom I've been reading about today in the clips preparing for this?
Who is Ralph Acampora?
BOB FROEHLICH: No, I don't at all, and I think, quite frankly, he's responsible for half the movement today because-
PAUL SOLMAN: Who is?
BOB FROEHLICH: Ralph Acampora of Prudential, because he's been very bullish, saying the market would be over 10,000, and now he's calling for anywhere from a 20 to 30 percent correction in the stock market, and-
PAUL SOLMAN: So he's-just to clarify because I don't who he is-he's an analyst who has been predicting the stock market will go up, who suddenly turned around and predicted it would go down?
BOB FROEHLICH: That's correct.
PAUL SOLMAN: And people literally-millions or billions of dollars were traded on that basis?
BOB FROEHLICH: Well, yes, he's been very accurate in the market, and so he's very well watched, and so the markets, I think, stood up and took notice, and so I think that's part of the movement today. The other thing that's happening, though, that I think we're losing focus on is earning season is over. It's behind us. Second quarter earnings are history. Now we have to look forward to what's happening in the third quarter. So whenever that happens, you always tend to have some volatility in the market. What tends to rally the stock market in this point in time are economic releases. That's not going to happen. The reason the market is selling off the way it is with no quick rebound like we usually get is the economic releases are tainted as a result of the General Motors strike. Any release that comes out we can't read into it what we'd like to read into it because the impact of the strike is going to be with us for probably another six weeks or so, so I think again the events of this down draft in the market are over exaggerated not just because of the political leadership issues in the United States and in Japan but in an in-between earnings season we don't have the luxury of letting economic releases rally the stock market.
PAUL SOLMAN: Releases, you mean, press releases?
BOB FROEHLICH: No. Releases of GDP-you know-
PAUL SOLMAN: Data.
BOB FROEHLICH: The data that comes out, because right now all the data is infected as a result of the General Motors strike, and so there isn't a rallying point for this stock market to say, boy, the third quarter is going to look better, look at this economic release; it really sets a right tone for us. As a result of that, I think you get the market to exaggerate its downward movement.
PAUL SOLMAN: So false pessimism is what you're claiming?
BOB FROEHLICH: Absolutely.
PAUL SOLMAN: Mr. Brusca, we've been hearing people say that the market's overvalued for months, years, and as recently as Friday night on this very program. Are your colleagues beginning to say-I don't mean just at Nikko-but your colleagues generally-beginning to say, ah, the long-awaited correction is finally with us, the end of the great bull market-do you hear it more than you were hearing it?
ROBERT BRUSCA: Well, I think people are thinking that way. You know, you-as I said, a lot of people when they try to make these assessments in the market look at these very technical kinds of indicators. In the very short run that's all you have. Otherwise, you'll look back and you'll say, gee, that was a bear market, you don't know when you're in it, other than using some of these technical numbers to look at, but I think that one of the things I'd like to say here is that it's very hard to take this huge stock market that has investors all across the United States and across the United States and across the world than to say that the reason that it was selling is because one analyst at a securities firm said some bad things about the market, or to say that these people who are investing don't understand that data are contaminated because of the GM strike, which now is over, and is going to come back and bring us stronger numbers the next couple of months. Everybody knows this. I don't believe for a minute that this is a cause for the market to fall down. I think people are looking at the fundamentals and realizing that we're getting ourselves into a narrower and narrower channel, and it's harder and harder to maneuver this economy and the stock market in this narrow channel. We require all kinds of money, billions of dollars every month, 15 to 17 billion dollars a month on a net basis at the same time the dollar has been moving up. As the dollar moves higher-
PAUL SOLMAN: I want to get Mr. Froehlich in. You've made this point before. Can you just finish your sentence there.
ROBERT BRUSCA: As the dollar moves higher, it hurts corporate earnings, and it's not a salvation for the dollar to move lower. So if that happens, we'll have capital flight, so you've reached the point-
PAUL SOLMAN: Okay.
ROBERT BRUSCA: --at the crossroads where only two bad things can happen.
PAUL SOLMAN: I got it. Mr. Froehlich, I just wanted to end with you. How can the stock market be roaring ahead for so long and then suddenly reverse course? I mean, the economy doesn't move 3 or 4 percent in one day, and yet the stock market does.
The greatest buying opportunity in '98?
BOB FROEHLICH: I think clearly investors are nervous. The important things I the fundamentals that were in place that took our stock market to 9300 just a couple of weeks ago are still in place. We have a low interest rate environment. We have inexpensive energy, and we have consumer confidence and all time highs and consumers represent 2/3 of our economy. I think the market got a little bit in front of itself. I think it over-exaggerated where it should have been. And so I think it should be a little bit under 9000. But it certainly shouldn't be at the levels it's at today, and I think the fundamentals that we have in a low interest rate environment, where energy is so cheap and you have consumers so strong and so willing to drive our economy, I think we'll look back at this, whether you're a technical analyst or not, as the greatest buying opportunity in '98, and when the market's at 10,000 at the end of the year, you'll wish you would have been in when the market was at 8500.
PAUL SOLMAN: Well, maybe we'll check back in with you at the end of the year and see which one of you is right. Thanks both very much.