Five trading days straight down, followed by 15 almost straight up. The market's reaction to terrorist atrocities may not be the most, but it is surely not the least, important indicator of changing perceptions in the aftermath of that brutal wake-up call.
The broad market is up about 13% from its Sept. 21 low, but technology indices -- networking, Internet commerce, software and semiconductors -- have approximately doubled that performance. The
have struggled back to just about their Sept. 10 levels.
The market was percolating along nicely last week until an anthrax scare in Rockefeller Center hit the tape -- and that reaction very well may encapsulate the dilemma in thinking about "prudent person" strategy today.
My conclusion is that it is no longer prudent for professionals or amateurs to be short equities against whatever is one's pertinent benchmark or bogey.
Clearly, it is not possible to think about the market as if nothing had happened on Sept. 11. The world may not have changed on that day, but perception of the world surely did. Risks that, like cruise missiles, had been below the radar asserted themselves in a horrifying and indelible way. Market analysts struggle for historical parallels in past wars, but so far no one has raised any particularly interesting insights. It is a new kind of conflict, with new rules; previous experiences don't seem to be pertinent.
So, just for the exercise and the
of insight, let's work through an analysis as if nothing had happened. Because I just stipulated that it is not possible to do so, let's do the impossible.
Since early September, we have seen two additional 50 basis-point reductions in the
target rate for the cost of money. The lid has come off the federal budget's lockbox, with expenditure increases and tax reductions now likely to result in a stimulative swing, in the effect of Uncle Sam's purse on the private sector, which should top 2% of GDP.
The design of these stimulative efforts promises to be more effective than the tax rebates already circulating, in that the ideas now under discussion hit segments of the population with high marginal propensities to spend, and the budget expenditures are directed to activities with high multiplier effects. If you can forget Sept. 11, for purposes of the exercise, you have to recognize that September saw really big changes in economic policy.
The status quo ante for the economy was one in which the formerly vibrant part of the domestic private sector, consumption, was fading while the formerly weak sector, investment, was well advanced in its adjustment. Anxiety was rising about labor market weakness and the implications thereof for an economy that had been dependent on the household sector, exclusively, for more than a year.
But less widely remarked was the fact that production already had been cut back so sharply that run rates were well below selling rates: Business was disgorging inventories so quickly that a turnaround in production was imminent or sales would be lost for lack of supply. Mr. Greenspan testified that the economy just possibly might have been balancing at a low level when the terrorists struck.
So if we can forget Sept. 11 for a moment and recognize the big policy changes that have occurred in the context of Chairman Greenspan's conditional characterization of the economy, it seems to me we go back to the spreadsheet and plug in some bigger numbers for next year's growth and inflation, and for revenues, and probably even for profits.
Sept. 11 crystallized a deepening bear market psychology among analysts, strategists and economists. Those with relatively constructive views were fighting a rear-guard action against the flow of the data, but they were routed by the action of the terrorists. Both bulls and bears marked down their numbers such that, it seems to me, there is now a much better chance of an upward earnings revision trend developing from here than if a slower, more grinding capitulation had taken place. Either a better earnings revision trend sooner, or more positive earnings surprises.
The ammunition for a major market advance is there in volume. Broad money supply measures have accelerated this year to double-digit growth rates. Cash on the sidelines in both retail and institutional accounts has burgeoned as the Fed has injected liquidity into the banking system and as investors have turned increasingly cautious in their allocations.
The yield on these balances has now fallen back to "I Like Ike" levels, hardly a sufficient return to meet the liability-growth assumptions of defined benefit plan sponsors or the somewhat less well-defined expectations of defined contribution plan owners. Cash, in such longer-term contexts, is the unstable asset.
The exercise conducted here is not satisfactory because it explicitly leaves out the very important, indeed critical, issue of the psychological effect of terror on economic activity. But the lack of a template, a historical framework, doesn't excuse us from trying to figure it out. There is no reliable basis for adjusting numbers for the Sept. 11 effect.
The employment and retail sales reports were not good, but how much better might they have been but for Sept. 11? The terrorist hit to profits was almost surely big, but how big? What might the world have been looking like to us in mid-October if we had not lost our comfortable innocence in September?
There is a lot of confusion out there. Signs point in many directions: Bond markets are seeing inflation, or perhaps growth, risks that commodity markets don't seem capable of even imaging. There has been remarkably little turbulence in exchange rates among dollar, euro and yen.
Lacking reliable guideposts for the world as it is newly perceived, I tap my cane and feel my way. And what I come up with is this: Given everything else that has happened since Sept. 11, if it weren't for the psychological effects of those atrocities, the consensus likely would have shifted to a much more upbeat outlook for employment, output, revenues, earnings and, yes, even stock prices.
It is, of course, entirely illegitimate to ignore those psychological effects. But if they were to be mitigated, if some sort of catalyst caused them to diminish or reverse, then given current conditions, it is a straightforward conclusion that stocks would tend to clear at higher prices, perhaps even quite a bit higher.
The past three weeks' action, and Friday's anthrax reaction, provide a sense of the opportunity and the risk involved. There are upside as well as downside risks inherent in current conditions, which is why I say it is intemperate if not imprudent to be short equities in here.
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to send comments on his column to