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After a long ascent, America's stockmarkets are spinning hither and thither, unnerving investors around the globe. What has changed?
DO NOT blame Hurricane Bertha, the remnants of which howled through Manhattan last weekend; the release in May of the tornado-worshipping film "Twister" was a far better portent of things to come in America's stockmarkets. Share prices have been slipping since late that month, and their volatility has increased sharply. Wall Street was hit this week by one of the most violent financial whirlwinds in its history.
On July 15th the Dow Jones industrial average declined by 161 points, or 2.9%, to 5,350. The following day, it opened modestly higher, but by midday had dropped another 85 points, and by early afternoon it was in free-fall. Then sentiment suddenly changed: spurred by buying in futures markets, the Dow rose beyond its opening level by 89 points and finally closed eight points higher, at 5,358. By July 17th, the market had recovered some of its poise, rising a modest 18 points.
The fallout from all this activity spread way beyond America's borders. Although Europe's stockmarkets have been reasonably robust of late, Germany's DAX index fell by 3.2% on July 16th and London's FT-SE 100 index dropped by 1.8%, partly because it closed before the Dow's late rally. Japan's stockmarket has also proved twitchy: the Nikkei index fell by 1.6% on the same day.
The recent volatility of the Dow, reflected in heavy share trading (see chart) has left even Wall Street's hardened veterans puzzled. Why is the Dow now some 9.2% below its peak of 5,833 on May 23rd? Why has the Nasdaq index, which contains many big, high-technology stocks, fallen some 13% this year? And why have European and Asian markets, which had seemed to be immune to Wall Street's gyrations in recent months, been hit by the turbulence this time round?
As usual, the biggest factor affecting all of these markets is America's economy. Most observers agree that it is growing fast, although there is some disagreement about exactly how fast. On July 16th the government revised its forecast for annual GDP growth for 1996 to 2.6%, up from 2.2%. Few Wall Street economists dissent, unless it is to argue that growth will be even higher. The same day brought news that in June, the 12-month consumer-price inflation rate fell to 2.8%.
In theory, such a combination of steady growth and low inflation should be unmitigated good news for corporate earnings and for bond yields, and hence for the stockmarket. In theory, too, the benefits should be felt beyond the United States. Many European exporters suffered badly last year when American factories cut production to shrink their stockpiles. They have thus been counting on America's rebound to help drag their economies out of the doldrums.
So why have stockmarkets suddenly spun out of control? One reason is that investors are no longer certain that America's impressive performance will continue. This week's good inflation news, for example, seem to contradict figures released on July 5th, which showed that employment and wages had risen sharply in June. That announcement sent government-bond yields soaring. By July 17th, however, 30-year Treasury yields had fallen back to around 7%--roughly where they were two weeks earlier. Nevertheless, some economists think that America's Federal Reserve will raise interest rates soon.
The outlook for corporate earnings, too, is far from clear. Motorola, Hewlett Packard and Digital Equipment, three big technology firms, announced weaker than expected profits in the week beginning July 8th. The thought that earnings assumptions had been too optimistic sent the Dow tumbling on July 12th.
Yet plenty of investors still think that America Inc will surprise the doomsayers. Abby Cohen, a strategist at Goldman Sachs, an investment bank, points out that by July 16th only 17% of the companies in the broad S&P 500 index had reported their earnings. Of those, positive earnings surprises outnumbered negative ones by two to one. Indeed, on July 16th and 17th the market was cheered by strong results from big companies such as Ford, General Electric and Intel. This helps to explain why, although it retreated, the market did not suddenly collapse--and why it is capable of bursts of strength.
Outside America, investors are equally perplexed. Electronics firms in Japan have been affected by the same factors that hammered American technology stocks. The prices of semiconductors, which account for a big chunk of their profits, have fallen sharply. This week's stockmarket weakness also suggests that Europeans are no longer sanguine about the outlook for their firms' profits, given the impact that weakness in America could have on their own exporters. To make matters worse, the D-mark rose sharply against the dollar, reaching DM1.49 on July 17th, compared with DM1.52 a week earlier.
Here too, however, the outlook is far from clear. Oliver Kamm, a strategist at HSBC James Capel, a stockbroker, thinks that much of the expected growth in Western Europe's corporate earnings will come from fatter profit margins as firms restructure, rather than from rising revenues. This suggests that export growth may not be crucial to the health of European bourses.
Nor is it obvious how markets will react now that the apparently inexorable connection between new investment and rising share prices has been dented. During 1995, when the S&P 500 index rose by 34.1%, $131 billion of net new money flowed into America's equity mutual funds. In the first five months of this year, a further $121 billion of new money has poured in, but the S&P has barely moved. That may partly be due to a rash of flotations and secondary share offerings by American firms, which have mopped up much of the new money.
In the eye of the storm
Investors looking for clues as to what markets might do next are watching the world's central bankers closely. As The Economist went to press on July 18th, Alan Greenspan, the chairman of the Federal Reserve Board, was due to make his semi-annual appearance before Congress. He was widely expected to emphasise the Fed's hawkish stance on inflation; more subtle hints have in the past been enough to send the stockmarket reeling. As Byron Wien, a strategist at Morgan Stanley, an investment bank, puts it, "Most bull markets don't die of natural causes, they are killed by the Fed."
In fact, the central bank may not raise rates any time soon. Its inclination to do so may have been tempered by the same reports of weak earnings that drove down share prices. If the Fed sits tight, this will increase pressure on Germany's central bankers to take matters into their own hands. Even before this week's turmoil, many pundits were urging the Bundesbank to cut interest rates. Now that the D-mark has risen sharply against the dollar, Hans Tietmeyer, the bank's president, may be more willing to oblige. Indeed, on July 16th, as the dollar plummeted and the D-mark soared, he suggested publicly that the next move in rates was likely to be down--a surprisingly candid statement from a tight-lipped Bundesbanker. The bank's next formal meeting to discuss monetary policy will be on July 25th.
The thinking of central bankers should become clearer in the next week or two; so should the outlook for corporate America, as more firms unveil their results. In the meantime, investors are almost certainly in for a bumpy ride.
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