World stock markets have been experiencing Irrational Exuberance II. That's the downward leg that inevitably follows the irrationally exuberant overvaluing of businesses, markets, and funds.
The downward leg always risks being just as irrational as the upward one. To judge when enough down-valuing is enough, ask a few questions:
*** Is XYZtec Corp. really worth 10 percent less than it was yesterday?
*** Is the Chinese economy going to stop growing at a healthy clip?
*** Will Thai banks, Japanese insurers, and Hong Kong property dealers fail to correct excesses? (As their American counterparts corrected similar misjudgments in the past decade - all with government help, of course.)
*** Will Alan Greenspan and other central bankers raise interest rates, pinching profits and costing jobs, if their nations' economies begin to reflect the doubts (and, in some instances, panics) that have savaged stock markets?
Likely answers: no, no, no, and no.
Pension savings to the rescue
Then there is perhaps the most important question:
*** Where will all those multibillions of dollars worth of systematic retirement savings that come off the top of paychecks every month go, if not eventually back into stock markets?
True, the percentage of pension money that goes into high-grade corporate bonds and government securities will probably rise for quite a while. But where will the bulk go? Not into real estate, gold, Beatles memorabilia, or mattresses. The portion earmarked for index funds and growth or value stocks can't stay in cash for very long.
So, as we said in this space last week, it's a time to be very cautious about investment for retirement, house-purchase, education, or emergency use. But not a time to abandon careful programs for those purposes.
The real period of caution about markets is more likely to arrive next century as the postwar baby boomers of North America, Europe, and Japan approach retirement and begin to think of drawing down retirement savings after building them up for a decade or two.
Yes, you might say at this point, all very logical. But does the rational trump the irrational when the latter appears to be in full cry?
Perhaps not overnight. But mental contagion cannot long sway sensible men and women. The problem in markets is that sensible people will retreat too far (or advance too far in the next runup) simply because they think the great mass of "other investors" is going to do so.
Remember, though, that government and private sector watchdogs exist to stop the so-called madness of crowds from getting out of hand. And they have more knowledge and tools than ever to do so.
China and trade
The fact that China's President Jiang Zemin has arrived in Washington just as President Clinton's quest for a renewed free hand on global trade reaches a crucial point has its own relevance for world stock markets. Doubts about trade, in fact, lie at the heart of much of the market's turmoil.
The pessimistic arguments tend to reinforce each other, namely: The Asian Tigers, having ill-managed their remarkable gains, will not soon again attract outside capital. Their own banks will be less able to supply capital to their export businesses. Hong Kong firms will lose export markets in the Asian neighborhood. So will China's businesses, just when they need to go on expanding to absorb millions of workers mustered out of the army and failing state businesses. All this, in turn, will cut sales for US and European transnational firms selling to Asia. Wary banks and investors will continue to pull back from Brazil, Argentina, and many otherwise unrelated markets that had been growing nicely this year.
All very gloomy.
But such pessimism is unwarranted. President Clinton should use current anxieties to expand his efforts to win passage of fast-track trade legislation. The reasoning is impeccable. Lowered barriers mean more trade to help all parties pull out of their slowdowns, creating both jobs and better living standards.
President Jiang's nation has already lowered interest rates to stimulate growth and provide all those needed jobs. China has kept its currency cheap to stimulate exports. The Asian Tigers, having seen their own currencies tumble, are in a better position to expand export sales. With more income, they will eventually expand their buying of US and European exports, particularly in the hi-tech, service, and creative sectors.
Despite academic assurance that markets are efficient, it's never possible to be sure that markets are correctly valued. But the economic realities seem to ensure that beyond the current market correction lies more measured growth. Unless, of course, investors abandon all clarity of judgment. There's no reason for that.