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Al-Ahram Weekly 11 - 17 November 1999 Issue No. 455 
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Published in Cairo by AL-AHRAM established in 1875 |
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Al-Ahram Weekly 11 - 17 November 1999 Issue No. 455
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| Published in Cairo by AL-AHRAM established in 1875 |
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Egypt Region International Economy Opinion Culture Features Profile Travel Books Sports People Time Out Chronicles Cartoons Letters Riding for a fall
By Sameh NaguibLast week's release of United States economic data showed unexpectedly strong GDP growth, but very little evidence.
Nevertheless, after the steep decline during September and early October which saw the Dow Jones index fall from 11,300 to less than 10,000, Wall Street staged a remarkable recovery over the past three weeks. The Nasdaq composite also rose sharply, reaching a record high as it passed the 3000 mark. A rush to buy computer, internet and other hi-tech stocks fuelled the rise.
Wall Street optimists have been predicting that the Dow Jones could double or even treble over the coming few years, amid claims that the economy can sustain its present rate of growth without any risk of crash, inflation or recession. A new economic paradigm has emerged, it is said: the US economy has gone beyond the boom-slump cycle and is entering a new era of long-term prosperity and stable growth. The "force" behind this change, according to the theorists, is of course nothing less than the information technology "revolution".
It must be noted however that the rise in the Dow Jones over the five years preceding the 1929 crash was very similar to the rise we have seen since 1994. In the seven years up to 1929, US GDP rose at an average annual rate of 4.7 per cent and unemployment averaged below four per cent. Then as now, there were optimists making similar claims about the prospects for the US stock exchange, and the economy in general.
Federal Reserve Chairman Alan Greenspan, who is a firm believer in the positive productivity effects of recent technological advancements, has pointed out however that they are less important than developments around the turn of the last century, which saw the emergence of the automobile, the aircraft, the telephone and the beginnings of radio technology.
And indeed, if we look more closely, it is clear that the effects of information technology on Wall Street have been contradictory, to say the least.
Two weeks ago, two of the Nasdaq's most powerful stocks -- Microsoft and Intel -- made their debut as part of the Dow Jones index. The compilers explained that this was to make the Dow "more representative of the evolving US economy". These stocks, together with SBC Communications and Home Depot, replace four traditional companies that had figured in the index since the 1930s: Chevron, Goodyear, Sears Roebuck and Union Carbide. This move could have significant implications for the future performance of the Dow, as high-technology stocks have traditionally been far more volatile than others.
At the same time, internet stocks have played an important role in the present massive overvaluation of the stock market. Constantly hogging the headlines over the last year, the "dot coms" have given a new meaning to the term "virtual reality", as their market capitalisation has soared off into the stratosphere, leaving any plausible fundamental business valuation far behind. Thus, for example, in early April, the market capitalisation of Priceline.com, which sells airline tickets on the internet, and has tiny revenues, was twice that of United Airlines and just slightly less than that of American Airlines. America Online was worth nearly as much as Disney and Time Warner combined, and more than GM and Ford combined, whereas Yahoo was worth a third more than Boeing.
We are thus confronted with a stock market in the throes of a phenomenal, not to say historic, overvaluation. Between August 1982 and April 1999, the S&P 500 index, which brings together a broad range of blue chip companies, rose by nearly 1000 per cent, whereas the profits of the companies themselves increased by less than 180 per cent.
It is not surprising then that the US economic boom and the spectacular Wall Street upturn is being met with increasing scepticism. One major factor worrying economists is the collapse in private sector savings, which reached minus four percent of GDP this year. This essentially means that consumers and investors are spending more than they are earning, and filling the gap with a rapid increase in debt. This is the first time private net savings have been negative in the last four decades.
The combination of this collapse in savings together with an overvalued stockmarket and a sky-rocketing increase in debt suggest that Wall Street and the US economy in general may be in for quite a rough ride.
The effect of a serious downturn on Wall Street on the rest of the world economy could be devastating. It should be remembered that the economies of South East Asia have only started to emerge from their 1998 collapse, and US demand is crucial to their further recovery. The same could be said of the Japanese economy, which is still in deep trouble. A US downturn would be like pulling the plug on the entire system.
However, despite so many warning signs, it pays to be cautious in making economic predictions. Irrationality, after all, is the very heart of the free market system. One can hardly complain if playing the market is like being blindfolded on a roller coaster -- it was never likely to be anything else, after all. Instinct and common sense may tell you that what goes up must come down. But you can never tell just when you are about to reach the peak -- or how steep the next fall will be.
