Why stocks and economy diverge

America's economy and its stock market have become, for now, separate universes that are anything but parallel.

Share prices have been tumbling. A broad-based index is down 34 percent from March 2000. The tech-heavy Nasdaq index is down 72 percent – a collapse of nearly Depression-era magnitude. Some $6.8 trillion of stock wealth has vanished.

The economy, meanwhile, has been on a clear path of recovery from its mildest post-war recession. Consumers have kept spending. Incomes are rising. Even hard-hit industry has enjoyed six months of rebounding output, with a June rise announced Tuesday.

The result is an exasperating dichotomy that is extremely rare. Hardly ever do stock markets falter early in an economic recovery.

The stark – and financially devastating – disconnect stems from several unusual forces now at work.

One key explanation analysts offer is that in the late 1990s, stock prices grew into an overpriced bubble, especially in high-tech shares. This started to burst in March 2000, and it is still deflating. Investors have been fleeing stocks, especially risky ones, for the greater stability of bonds, real estate, or hard cash.

Corporate malfeasance has added to the unease. At a time when investors might otherwise be looking ahead to rebounding earnings, many instead are questioning whether quarterly financial statements can be trusted. A wave of revised earnings reports, they worry, may not be over.

"People are very worried about how these accounting scandals play out in the next few weeks," says Susan Hickok, chief economist of Prudential Economics in Newark, N.J. Second-quarter earnings will be flooding into the news in coming days.

Concerned by these troubles, some overseas investors have started to sell US stocks, helping to drive the US dollar down to parity with the euro for the first time since February 2000.

Federal Reserve chairman Alan Greenspan, in his semiannual report to Congress Tuesday, sought to soothe battered investors and worried consumers.

The effects of last year's recession, the terrorist attacks, and concerns about corporate governance "will linger for a bit longer," he said, "but as they wear off, and absent significant further adverse shocks, the US economy is posed to resume a pattern of sustainable growth."

President Bush, too, has tried to bolster the confidence of investors. "Our economy is fundamentally strong," he proclaimed at the University of Alabama, Birmingham, Monday.

But will such cheerleading, coupled with positive economic news, such as Tuesday's jump in industrial production, turn share prices around?

A debate now rages on Wall Street over whether beaten-up stocks are now a "buy" – or whether they are still overpriced. Both sides can cite statistical evidence in their favor.

Whoever is right, stock prices can go their own way for years. For example, from February 1966 through August 1982, the Dow Jones Industrial Average slipped from 995 to 777 – 16 years of gloom broken only briefly by a high of 1052 in 1973.

Two bad recessions, and high inflation, marked that era, but the economy generally grew.

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