This morning, a lot of investors probably feel like the guy in the credit card commercial whose reverie of cavorting with Nastassja Kinski is cut short when he gets a pitcher of ice water in the face. Equity markets, which had been riding a long boom, were hit Monday by a wave of panic selling that slashed stock prices by more than 7 percent and forced a historic halt in trading on the New York Stock Exchange. And the decline may not be over.
The good news is that Alan Greenspan won’t be preaching anymore about the dangers of “irrational exuberance.” A recent survey found that mutual fund investors were expecting an average annual return of 34 percent from stocks over the next 10 years–a preposterous scenario. For millions of small investors who had never endured a real market plunge, Monday’s experience was a bruising but inevitable collision with reality.
The proximate cause of the selloff seems to have been the crash of the Hong Kong stock market, itself spurred by the currency crises afflicting one East Asian economy after another. The danger to the U.S. economy from the Asian turmoil is real but not great. The deeper explanation for “Gray Monday” was a general sense that stock prices were too high to be justified by corporate earnings. When the market rises so far so fast, investors start looking nervously for the pinprick that might pop the bubble.
But there is no reason to expect the economy to follow the stock market downward. Inflation remains at bay, growth is steady and corporate earnings have been healthy. The market drop should also persuade Greenspan that he doesn’t need to boost interest rates to prevent overheating and sober up giddy investors.
That doesn’t mean Americans will be unaffected by events in Asia. The devaluations of various currencies will make it harder to export to these countries and expose U.S. corporations to tougher foreign competition in their home market, neither of which is good for profits.
But foreign trade still accounts for just 13 percent of national income, and Asia (apart from Japan) accounts for less than a quarter of our global commerce. In recent years, the U.S. economy has prospered despite stagnation in Japan, high unemployment in Europe and the Mexican peso crisis. America’s economic performance is mainly dependent on America’s domestic fundamentals, which are largely sound.
After they tote up the damage, investors will notice that though they are poorer Tuesday than they were at breakfast Monday, they are nonetheless wealthier than they were when 1997 began. The markets recognized Monday that the potential of the U.S. economy is not infinite. Over the long haul, though, it still looks like an excellent investment.
