Is economy up or down? Experts: Gap between statistics, volatility of stock market will close

Posted: Thursday, August 01, 2002

WASHINGTON -- To Alan Greenspan and other economists, the recovery is on track. But for investors bruised by the recent slide in stock prices, the wheels seem to have come off.

All year long there's been a huge disconnect between how the economy is faring and the stock market is performing. That gap is bound to close, say economists, who offered a couple of scenarios on how it might happen.

Optimists foresee Wall Street investors beginning to take more heart in the economy's long-term soundness and producing a sustained stock market turnaround. The accompanying boost in business confidence and investment would power the economic recovery.

Treasury Secretary Paul O'Neill predicts the economy's underlying strength will see the nation through its difficulties.

''In our history we have seen times when there is a disconnect between the stock market and the fundamental productive power of our economy,'' O'Neill said. ''This is such a time, but over time, the market will again focus on our economy's fundamentals.''

Pessimists sketch out another scenario. Consumers and businesses, whose faith in corporate leaders and confidence in the economy have been shaken, retrench. They slash spending and investment, thrusting the economy back into recession.

Economists don't consider that likely but they aren't ruling it out. What could make it happen, they say, is the shock of another terror attack or a sharp and prolonged drop in the stock market, which would probably result in a flurry of layoffs.

''Clearly, there's a disconnect between the statistics on the economy and the state of financial markets,'' said Bill Cheney, chief economist at John Hancock Mutual Life Insurance Co.

''It will get resolved one way or the other. I think there is a lower probability that the bad news on stocks will knock down the economy,'' Cheney said. ''But you can't rule it out completely.''

Middle-of-the-roaders envision some other scenarios: Economic activity slows in the second half of the year but investors come around and the stock market stabilizes. That motivates some businesses to boost investment and hiring, lending a helping hand to the recovery.

Or, a volatile stock market and eroding confidence in the economy prompt consumers and businesses to exercise more caution in their spending and investments, a development that would slow -- but not derail -- economic growth.

Falling stock prices and worries about jobs helped push consumer confidence, as measured by the Conference Board, down to a five-month low in July.

After driving down stock prices to five-year lows over the past 10 weeks, investors appeared to be beginning to feel more at ease.

Galvanized by hopes that the market's worst days are over, investors bought stocks enthusiastically Monday, sending the Dow Jones industrial average surging more than 400 points for the second time in four sessions.

The Dow closed down a modest 31.85 points on Tuesday, with investors rattled by the drop in consumer confidence. A tough new law to combat corporate fraud, on top of recent arrests of cable TV executives accused of looting their company, should help rebuild investor confidence.

''In the end, it will probably turn out that the economic situation wasn't as gloomy as some CEOs and investors thought was the case, but not as good as some economists predicted,'' said Lynn Reaser, chief economist for Banc of America Capital Management.

Greenspan, the Federal Reserve chairman, told Congress recently that the economy is on the road to a full recovery.

In the meantime, he's hopeful the economy will weather any fallout from the sour stock market and the lingering effects of last year's recession.

''The effects of the recent difficulties will linger for a bit longer, but as they wear off, and absent significant further adverse shocks, the U.S. economy is poised to resume a pattern of sustainable growth,'' Greenspan said.

Greenspan and his Fed colleagues expect the economy this year to grow between 3.5 percent and 3.75 percent when measured from the fourth quarter of 2001. That compares with a 2.5 percent to 3 percent forecast in February.

The dozens of economic reports released each month point to an economy that is on the mend.

By and large, the nation's manufacturers -- hardest hit by the recession -- have gained ground, boosting production for six straight months. Weekly claims for jobless benefits are going down. Companies are beginning to add jobs -- though very slowly -- after cutting them last year. Auto and other retail sales have been holding up, and home sales remain solid, thanks to low mortgage rates.

Last week, Freddie Mac, the mortgage company, reported that the average rate on a 30-year fixed-rate mortgage slid to 6.34 percent, the lowest level in 31 years of record keeping.

Meanwhile, inflation is low; companies' productivity is increasing; companies' profits, which were hit hard by the slump, are improving; and businesses are paying workers more in wages and benefits.

Until recently, Wall Street investors have shrugged off much of this encouraging news.

''What we've seen is a shift from the irrational boom of the late 1990s to the unreasonable gloom of 2002,'' said Tim O'Neill, chief economist for the Bank of Montreal. ''I think the gap will close by the market adjusting up to the economy, rather then the economy adjusting to the market.''

''I'm going to try and have a little faith,'' said economist Ken Mayland, president of ClearView Economics. ''People will realize the economy is doing OK and the reconnection, or the gap will close, in the form of the stock market rising.''

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