After `correction,' a wrong turn?

Analysis

February 28, 2007|By Kevin G. Hall | Kevin G. Hall,McClatchy-Tribune

WASHINGTON -- Yesterday's stock market plunge shows the start of a "correction," the age-old euphemism for a steep drop in stock prices, but it might also signal worse news.

A steady stream of recent data shows mixed signals about where the U.S. economy is headed. The old sage himself, Alan Greenspan, suggests recession could be looming.

Fasten your seat belts - some economic chop could be coming.

The Dow Jones industrial index fell 416 points, or 3.29 percent, yesterday; the tech-heavy Nasdaq composite sank 3.86 percent; and the S&P 500 tumbled 3.47 percent.

The drops mirrored a global decline in stock markets as the investor mood turned bearish. Investors, who have been murmuring about a coming "correction" for weeks, are concerned that the U.S. and Chinese economies might be entering a period of cooling.

Also, they underscore how connected the U.S. economy is with the broader global economy. U.S. exchanges sank after a nearly 9 percent drop yesterday on China's Shanghai composite index. It was Shanghai's biggest one-day drop in a decade, and investors worried that interest rates might soon rise to douse China's sizzling economic growth.

Higher lending rates in China matter to average Americans. Most large American corporations either manufacture there or purchase from Chinese contract manufacturers. Higher lending rates in China would slow economic activity there and raise the cost of doing business. The costs could be passed back to Americans as pricier imported goods.

Adding to the economic uncertainty, oil prices are climbing again, partly because of the Bush administration's escalating war of words with Iran. Just weeks ago, some analysts projected a return to $40-a-barrel oil, but it now trades at about $60 a barrel. AAA reports that unleaded gasoline averaged $2.37 a gallon nationwide yesterday, compared with $2.14 a month ago.

Other economic data are sending, at best, mixed signals.

The Commerce Department reported yesterday a 7.8 percent decline for orders of durable goods in January. It was the biggest dip in demand for business equipment in three years. The Manufacturers Alliance/MAPI said the drop was felt across industries such as transportation, high tech and industrial metals.

"There is no escaping the observation ... that growth in the manufacturing sector ground to a halt in September 2006 and continues to struggle as consumers rethink big-ticket spending and businesses turn risk adverse in their capital spending," said Daniel J. Meckstroth, the trade association's chief economist.

But the Conference Board reported yesterday that consumer confidence in January jumped unexpectedly to its highest level since August 2001. Also, the National Association of Realtors reported that existing-home sales in January rose by 3 percent, the largest monthly jump in two years.

That good housing news, however, was tempered by concern about delinquent mortgages. The Mortgage Bankers Association reports that 3.8 percent of all adjustable-rate subprime mortgages are in foreclosure proceedings, up from about 3 percent in 2005.

"It's not a great number, but it's enough to make a dent on the sales numbers, so we'll see [home] sales continue to drop through the end of this year," said Patrick Newport, an economist with consultancy Global Insight in Lexington, Mass. "So far what we've seen is [that] a lot of this has been contained to the mortgage market and particularly to the subprime market [of riskier borrowers]. No one has a sense of whether this will spread to other markets, like the prime mortgage market. So far it hasn't."

John Silvia sees the U.S. economy as being "on the edge of a knife." He's the chief economist for Wachovia, a large national bank based in Charlotte, N.C. He sees below-trend economic growth, corporate profits leveling off and short-term lending rates higher than longer-term rates. This phenomenon, called the inverted yield curve, historically has been a harbinger of recession.

"When you go into a fog, it's hard to make commitments as an investor," Silvia said. "It's not the time to make big bets."

That cautious view sounds remarkably like that of former Federal Reserve Chairman Alan Greenspan, who told businessmen in Hong Kong on Monday that a U.S. recession was possible late this year or early next year.

While the "r" word got the headlines, Greenspan also warned that risk premiums are unusually low, meaning that lenders aren't demanding higher returns for riskier investments as they should.

"Risk is no longer perceived as major risk, at least as it was in years past, and that, I must say, I find disturbing," Greenspan said, according to The Wall Street Journal. "We do not and cannot look into history without being very concerned when you see the absence of awareness and concern about risk that we see today."

The concern sounded remarkably like Greenspan's warning in the 1990s that stock market investors were suffering from "irrational exuberance," a warning of the bubble that burst and brought recession in 2001.

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