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Could This be Rational Exuberance?

4 minute read
MARK R.MITCHELL

Sometimes economics can boil down to a matter of feelings, and investors around the world have been feeling pretty goodor at least a lot better than they were when apocalypse seemed imminent. With America’s war in Afghanistan proceeding satisfactorily and predictions of more terrorist attacks proving unfounded, money has been flowing back into U.S. stock markets, sending them to levels above where they were before Sept. 11. Asia’s investors, who tend to feel good when their American counterparts feel good, have followed suit. In Singaporewhich is limping through the biggest economic downturn in its historythe stock market is up more than 10% since Sept. 21. Markets in Taiwan, South Korea, Hong Kong and India are all bulls, their indices having soared more than 20% from their most recent troughs.

Economists aren’t big on feelings; they like numbers. That’s why many of them believe the stock market recoveries don’t say much about the underlying health of the world’s corporations or economies. Pessimists note that companies everywhere are still churning out profit warnings. They add that, with stocks in the U.S. selling at an average of around 23 times projected earnings, and companies in Asia trading at even higher premiums, the current rallies are unsustainable. One analyst I spoke to last week was particularly critical of the markets, saying they were overly suspectible to simple-minded news analysis by brokers and traders. He pointed to the fact that markets around the world surged after an American Airlines flight plowed into a New York neighborhood on Nov. 12. Clearly, this catastrophe was bad for the travel industry and the economy as a whole. Yet news that the crash was not the work of terrorists seemed enough to feed traders’ exuberance.

We have been warned of “irrational exuberance” before, most notably by U.S. Federal Reserve Chairman Alan Greenspan in 1996. Back then, it didn’t make a lot of sense that investors were pouring their money into unprofitable companies run by recent college grads with half-baked ideas about how to sell stuff over the Web. But the lunacy became a self-fulfilling prophecy. The market expansion padded the wallets of many, who in turn bought a lot of products they probably didn’t need. This benefited established corporations and fueled an additional four years of growth in both the equity markets and the broader economy. Nobody is expecting another big tech boom, but what if the current market giddiness continues? What if Osama bin Laden is captured or killed, breathing still more life into global equities? Even the most curmudgeonly economists concede that consumers would probably start buying again and that this could lead to an earlier, more vigorous recovery than anyone was predicting during the darkest days of September.

Things are already looking brighter in the U.S. Retail sales in October were up a surprising 7.1% over September helped along by auto dealers’ free financing on car purchases. The University of Michigan’s closely watched consumer sentiment index rose for the second straight month in November, beating predictions. And there are signs that U.S. corporations are beginning to reap the benefits. The number of Americans filing for first-time unemployment benefits has fallen for four straight weeks, meaning that companies aren’t laying people off as urgently as they were in September. The improvements have a lot to do with Greenspan’s generous interest rate policies and the fact that low gas prices have put some extra cash in consumers’ pockets.

This is great news for Asians, whose pain has been caused in part by tight-fisted shoppers in the U.S., the market for the majority of the region’s products. Significantly, prices of D-RAM chips, a key export for several nations in Asia, rose about 70% last week amid signs that American computer makers have sold off their inventories. This, along with the progress on the war front, has helped South Korea’s stock market, heavily dominated by semiconductor companies, surge 31% since Sept. 21, the day nearly all of Asia’s markets hit their low point. However, Asia’s economies are still in dire straits; unemployment rates continue to rise and have reached or surpassed record levels in Hong Kong, Taiwan and Singapore, and corporate bankruptcies are being announced on a daily basis. Government responses to these economic woes have been grossly inadequate across the region, with reform efforts in Japan and Indonesia grinding to a halt. In Hong Kong, where some of the world’s highest prices continue to drive away investors, officials remain bizarrely convinced that deflation is their biggest enemy. Still, the power of a little exuberance should not be underestimated. And come to think of it, is feeling good about dodging apocalypse really all that irrational?

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