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Is US now stuck with irrational pessimism?

In some ways, today's swoon looks like the flip side of 1996's 'exuberance.'

By Ron SchererStaff writer of The Christian Science Monitor / December 5, 2008

SOURCES: Dow Jones Indexes, Fortune Magazine, Yahoo! Finance, Energy Information Administration, Internet Movie Database, Variety, Bureau of Labor Statistics, Department of Labor, Project Vote Smart/R

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Twelve years ago tomorrow, Federal Reserve Board chairman Alan Greenspan famously chalked up the boom in stock markets to "irrational exuberance."

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Now, with the US stuck in one of the worst bear markets in postwar history, the opposite seems to be true. Since Sept. 15, the Dow Jones Industrial Average has closed down more than 500 points on seven separate occasions. Two weeks ago, the averages were down nearly half from their peak. Brokers report thousands of Americans are closing their accounts, fed up with a market that has made their 401(k) accounts look like 201(k)s.

So is this the era of irrational pessimism? It's a hard question because there are so many uncertainties surrounding the future direction of the economy and consequently the direction of corporate earnings. If the economy spirals down next year, today's stock prices may look reasonable. If the economy's landing is softer, perhaps the pessimism is overdone.

"No doubt there is a lot of pessimism," says Fred Dickson, chief market strategist at D.A. Davidson & Co. in Lake Oswego, Ore. "The jury is still out if it's irrational."

One thing is clear: It's the era of uncertainty.

Take the economy, for example. Economists expect it will still be in recession in the first half of next year. But they're unsure if that will still be true in the second half.

"We're getting a better feel for the shape of the economy, but it's still not very good," says Mr. Dickson.

Key question mark: layoffs

One of the big unknowns: How high will the unemployment rate climb?

On Friday, the Labor Department will release the jobs numbers for November. The consensus forecast is for a loss of about 325,000 jobs and an unemployment rate of 6.8 percent. But future months will be much worse, say some forecasters. "There could be horrible job losses in the next two months," says Charles Knott, founder of Knott Capital in Exton, Pa.

Big job losses, he notes, can become dangerous to the economy as they lead to a "vicious circle," where companies see demand fall and then have to lay off more workers. An example of the pessimism: predictions for a double-digit unemployment rate. He doubts it will get that bad but says he will be watching the weekly new unemployment claims data. Currently, claims are running at an average of 518,000 over the last four weeks.

"If it gets up to 580,000 or 600,000 per week, it would show me there is too much momentum there and we need more stimulus," says Mr. Knott.

The current situation stands in sharp contrast to 1996, when Mr. Greenspan uttered his "irrational exuberance" line.

Back then, few economists had any doubt about the direction of the economy – it was going to grow. Investors were clambering for shares of technology stocks. The dollar was strong. The future looked rosy.

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