Soft Landing Or Belly-Flop?

Somebody call a doctor quick; the markets are in desperate need of a house
call. The driving force behind the across-the-board weakness in tech stocks
continue to be those darn earnings warnings. And folks, don’t let anyone
fool you with kid gloves – the snowballing preannouncements we’re seeing
this quarter are the worst we’ve seen in quite some time. The subsequent
punishment that’s being dished out by jittery investors has been swift and
oftentimes a gross overreaction. That raises real concerns as to why
Sheriff Greenspan persists with a tightening bias when the so-called ‘soft
landing’ is quickly shaping up to be a painful belly-flop.


Let me illustrate a simplistic example. Just last Christmas, I was
strolling through a shopping mall doing some last minute holiday gift
buying. In a fascinating display of the irrational exuberance that was then
running rampant in sexy high-tech stocks, I’d hear snippets of drifting
conversations from strolling shoppers discussing their latest hot
investment tips like some offline financial stock-picker’s bazaar. One
teenage girl boasted to a friend that her Dad had bought XYZ stock only
last week, and since then, it had been off to the races. I’m not one to
eavesdrop, but it seemed that virtually everyone with a piggybank was in
the frothy market back then looking to make a quick buck. And, it stands to
reason that most of those eager beavers were blindsided during this latest
Nasdaq tumble.


A friend of mine yesterday began discussing his struggling portfolio; and
during the course of our conversation, he offered up a story that reminded
me of my aforementioned holiday example, but illustrating just the opposite
sentiment. He drove to the mall the other day to buy two shirts and two
ties. As he finished up shopping, he briefly thought of his portfolio’s
current state of affairs, and in that very moment, opted to buy just one
shirt and one tie. This, coming from a prominent retired attorney whose
extensive wealth is hardly hog-tied to the slumping market. But beneath the
surface of this seemingly benign example may lie a microcosm of the
wealth effect
.


The wealth effect is based on the idea that recent drastic declines in
stock portfolios will diminish the warm and fuzzy feeling of wealth and
security that the average consumer has, which might lead them to put off
buying that new car, repainting the house, or postponing that getaway to
Oahu. The theory predicts that that could lead to a ripple effect in the
flow of goods and services and a contraction in the economy at large, where
more people will be out of jobs, incomes decline, and you’re on a collision
course with a recession. Many pundits scoffed at the concept years ago,
saying that while stock prices are important on Wall Street, they mean very
little on Main Street. That may well have been the case when stocks
corrected in 1987, but today, more people are investing in stocks than ever
before in history.


Greenspan is working toward letting some of the air out of an overheated
economy – the longest economic expansion we’ve ever seen during peace time.
He’s working toward making sure our GDP isn’t built on little more than a
pocket of hot air supported by lofty valuations in risky stocks. The real
concern by the Fed is, should the irrational exuberance continue unchecked,
how would the economy perform if the wealth effect were diminished due to a
violent shake-out in asset values much further down the road. Maybe that
soft landing actually has been achieved. After all, my friend did opt to
buy one shirt and tie instead of two, and that’s better than none at all.


Any questions or comments, love letters or hate mail? As always, feel
free to forward them to [email protected].


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