SAN FRANCISCO -- Think of 2000 as a year-long Wall Street version of the
Survivor Series -- not the reality TV kind, but the
variety. Highly margined, momentum players and fund managers took the bulk of the metal folding chairs to the head, but just about every investor and guru suffered a few body slams.
Is the Bull Back? Wall Street Has High Hopes for 2001
The Death of the Old Way
Land of the Giants: 2001 to Be Proving Ground for Pumped-Up Brokerages
Slow and Steady Emerson Is Adding a Little Juice to Its Growth Engine
Will Greenspan Retain the Belt as Market Champ?
Despite having sustained a few
atomic elbows himself,
Federal Reserve Chairman
seems likely to end 2000 in retention of Wall Street's heavyweight championship belt.
As 2001 approaches, many investors are putting their hopes, dreams and (stone) cold, hard cash in a belief in Greenspan & Co. An article in today's
Wall Street Journal
suggesting the Fed may take a more aggressive stance in combating the slowdown sent equity futures solidly higher in preopen activity.
Dow Jones Industrial Average
sustained the early momentum, rising 2%, while the
gained 0.8%. But the
Nasdaq Composite Index
fell 1.1% to 2624.56 after rising as high as 2726.20, suggesting many traders still believe tech rallies are for selling into, rather than participating in.
It's not shocking that prospects, however faint, for a Fed rate cut tomorrow got investors excited today. Lower rates have historically benefited stocks, a market truth crystallized by the central bank's three rapid-fire easings in the fall of 1998, which dropped a "DDT" on concerns about the financial crises in Asia and Russia, and the resulting implosion at
Long Term Capital Management
. The rate cuts inspired one of the greatest rallies in history; from respective lows in the fall of 1998 to the highs in March 2000, the Nasdaq rose nearly 240% while the S&P 500 gained more than 55%.
But one man's effort to combat systemic risk was another man's
moral hazard. To critics, the 1998 bailout of Long Term Capital was only the most glaring example of a series of policy initiatives that fostered a mind-set that the Fed will always rescue investors if things get really nasty. Other notable examples include the 1994-'95 peso crises and the Fed's
aggressive stance regarding liquidity in the pre-Y2K months.
The moral hazard issue "is the single most important story of the last five years and the next five years," said Bill Fleckenstein, of
in Seattle. "If, in fact, the Fed through its reckless and irresponsible approach to monetary policy has in fact created the biggest bubble in the history of the world, which I think it did, then the aftermath has profound consequences."
Despite the general reverence he's afforded, it's not hard to find folks on Wall Street who are critical of Greenspan. Bulls such as Erik Gustafson of
Stein Roe & Farnham
are equally vociferous in their criticism of the Fed as the mega-bears, even if for completely different reasons. To some, that suggests Greenspan has handled monetary policy as deftly as
played politics. To others, it suggests market players are increasingly losing confidence in Greenspan, which may be the only thing more dangerous than any moral hazard he's fostered.
Fleckenstein, a noted short-seller and longtime Fed critic, recalled central bankers in the U.S. and Japan each lowered rates dramatically in the 1930s and 1990s, respectively, in ultimately failed attempt to revive their post-bubble economies.
Wrestling fans recall even
Andre the Giant eventually lost a match. Once his unbeaten streak was broken, so was the mystique and he went on to lose several more. Whatever your thoughts on
, the Giant's experience shouldn't be forgotten by those enamored of Wall Street's current champ.
You Gotta Believe
Criticisms notwithstanding, most investors continue to put their trust in (
please excuse me
) Uncle Alan.
Beyond anecdotal stories of Greenspan being mobbed by autograph seekers and this morning's futures trading, faith in the chairman was evident in
survey of fund managers for December. While 28% of respondents saw the potential for a credit crunch similar to 1998, and 23% a chance of full-blown recession, a whopping "86% expect the Fed to ease policy sufficiently to offset any credit problems, as they did in 1998," Merrill reported. U.S. fund managers are "substantially downgrading their GDP and earnings growth forecasts for 2001" and yet, "a record balance see stocks as undervalued and plan to buy," the report concluded.
Basically, this is the "Fed trumps fundamentals" argument, which brings us to the present.
Federal Open Market Committee will adopt a neutral bias tomorrow seems a foregone conclusion. But investors anticipating an actual rate cut are likely to be disappointed, as the still-uncertain fiscal policies of
-- notably the timing and magnitude of proposed tax cuts -- and the inflationary implications of rising natural gas prices likely will cause the Fed to keep the fed funds rate unchanged.
David Jones, chief economist at
Aubrey G. Lanston
, who defended the 1998 rate cuts and Greenspan's overall stewardship of the economy, believes the most likely scenario is one in which the Fed adopts a neutral bias Tuesday, pronounces the risks have shifted to slowing growth at is meeting Jan. 30-31, but doesn't begin actually lowering rates until its March 20 gathering.
That cautious approach will stem from Greenspan & Co.'s continued belief in the soft- vs. hard-landing scenario, Jones suggested. Second, the Fed wants its actions to be seen as "heading off signs of slowing in the economy, but not as an excuse for a rally that turns into a bubble," the economist continued. "The Fed does not want to go through that again. The fact there was a moral hazard will temper the way
Greenspan cuts rates this time."
Would You Buy a Used Car From This Man?
If the Fed takes a steady-as-she-goes approach, it risks falling behind the proverbial slowdown curve and allowing a harder economic landing in 2001 than might otherwise occur.
Greenspan devotees may be shocked to learn this, but it wouldn't be the first time.
From February 1988 to February 1989, the Greenspan-led Fed raised the federal funds rate to 9.75% from 6.50%. The Fed then reversed course and began easing in June 1989 -- and continued to do so until the Fed funds rate hit 3% in September 1992 -- but was unable to prevent a recession that ran from July 1990 to March 1991, according to the
National Bureau of Economic Research. Many observers believe the Fed caused, or at least worsened, that harsh economic downturn with its overreaching rate hikes in 1988-89.
Given the Fed tightened fed funds from 4.75% to 6.50% in a series of rate hikes beginning in June 1999 and ending in May 2000, a possible repeat of the 1988-'89 scenario concerns Jones and others.
The central bank "could be making the same mistake now," said Mickey Levy, chief economist at
Banc of America Securities
. "It is a worry that they ease, but too gradually."
Judging an economic slowdown through the first half of 2001 is "already baked into the cards," Levy declared "the biggest risk is if the Fed inadvertently tightens" by not easing.
Fed policy is already too restrictive relative to the so-called natural interest rate, said Levy, referring to an economic theory that there is a rate at which the economy can grow at its maximum output without causing inflation to accelerate. (Note, "natural" is not to be confused with "real" interest rates -- fed funds adjusted for inflation -- another measure by which some economists say the Fed is too tight.)
Given a decelerating money supply --
MZM growth has fallen to around 7% vs. about 15% in late 1999, according to
Hays Advisory Group
-- amid lowered expected rates of return, the Fed keeping monetary policy on hold "makes no sense" and amounts to a
tightening, Levy said. The Fed is "slightly behind
the curve now, and if it drags its heels in easing, will fall further behind," increasing the risk of recession.
The point of all this is no one is infallible, not even (especially?) Alan Greenspan.