Now, a shakier stock market
Anticipating a slowdown, investors are wary of paying high stock prices. Firms lower earnings expectations, too.
Add one more problem for the US economy to surmount: fear and trembling on Wall Street.Skip to next paragraph
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Until this month, the rising value of Americans' stock portfolios had helped ease their concerns about eroding home values. But in October – a month with some bad memories for investors – stock prices, after hitting an all-time high, have started dropping.
Normally, economists discount implications of a falling stock market over a short period of time, since market volatility may not be reflected on Main Street. But this time, there is an aura of concern because the economy is already showing signs of wear and tear. A further drop in the market might adversely affect consumer sentiment leading up to the most important part of the year for retailers.
Some economists say the Federal Reserve, which usually does not react to Wall Street's machinations, may factor in the effect of the falling market when it sets interest-rate policy next week.
"The stock-market decline does pose additional risk to the economy because of the effect on wealth and the loss of confidence," says Lynn Reaser, chief economist at the Bank of America's Investment Strategies Group in Boston. "But the economy has shown significant resilience."
The Dow's fall so far this month is relatively modest – about 373 points or 2.7 percent. But last Friday, the venerable average fell 366.94 points to 13522.02. This is down more than 750 points from its high set on Oct. 11, although the Dow rebounded a bit on Monday with a rise of 44.95 points.
The sharp drop in the average is partly the result of Wall Street beginning to address the downside risk to the economy, says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla. "The market is really reflecting a general sense of concern about the economy," he says. "A weaker stock market implies the Fed may be more inclined to cut rates again – not to prop up the market, but to address the forces pushing the market down."
A weaker economy implies lower corporate earnings, which is directly tied to stock prices. The recent stock-market decline reflects the fact that portfolio managers expect lower earnings, says Fred Dickson, chief market strategist for D.A. Davidson & Co. in Lake Oswego, Ore.
"Wall Street is just waking up to the fact the economic climate has slowed down," says Mr. Dickson.
Some companies are already talking about an economic slowdown in their earnings discussions. After posting disappointing earnings last week, Caterpillar said the odds of a recession had moved to 50-50. The Peoria, Ill., company, which makes heavy equipment and engines, said the market for some of its engines was the worst since World War II. Dickson says he became very cautious after Federal Express said it was experiencing a significant slowdown in land-based shipments.
Analysts are already starting to pare down their estimates for holiday spending. On Monday, Citigroup estimated that holiday spending would be 4 percent higher than last year but that retailers would only see a 2 percent same-store increase in sales. This is about 1 percentage point slower than a normal expanding economy, the bank says.
Consumers are only just beginning to feel the impact of sharply rising oil prices. Last week, crude-oil prices crested at over $90 a barrel. By Monday morning, the price of crude had fallen back by nearly $2 a barrel. But the price of gasoline last week was up about 5 to 7 cents a gallon. Home-heating oil is at a record high.
Economists will get yet more information on the housing downturn this week when new data is released Wednesday on existing home sales for September. Early estimates are for fewer homes sold and rising inventories. On Thursday, there will be additional information on new-home sales – also expected to drop further.
"The numbers on housing are still likely to be soft," says Ms. Reaser. "But we think, within six months, housing sales should start to stabilize, and it will still take most of next year to work through the inventories."
One continuing cloud over the housing market is the angst in the credit markets. Although Citigroup, Bank of America, and JPMorgan Chase have announced a plan to raise as much as $100 billion to buy troubled mortgages, last week investors refused to buy anything but the highest quality debt.
"The mortgage credit crisis basically reignited at the end of last week with a global flight to quality, which spilled back into the stock market," says Dickson. "There are still a lot of questions about how the banks are going to navigate through these issues."
The stock market has a history of histrionics that don't necessarily spill over to the real economy. The most notable example, points out Wachovia Bank in a research report, was the crash of Oct. 19, 1987, known as Black Monday. In the aftermath of the market's nose dive, there was no recession – in large part because Fed Chairman Alan Greenspan flooded the market with low-interest money.
Wachovia says the Fed's reaction to this year's concern – the credit-market woes – may prove to have a similar effect on the economy as the reaction to Black Monday. A year following that crash, the economy was growing by more than 4 percent a year, points out the bank. It wasn't long before Mr. Greenspan was raising interest rates to cool things off.