-Caveat Lector- from: http://www.dismal.com/todays_econ/te_101700.asp Click Here: <A HREF="http://www.dismal.com/todays_econ/te_101700.asp">The Ingredients of a Bear Market</A> ----- View print friendly format The Ingredients of a Bear Market By Dan Green 10/17/00 8:30 AM ET The economy is humming along in an expansion of unprecedented length. Unemployment is at its second-lowest level ever and seems to be holding steady. The stock market has had a stellar decade, and connections between nations are increasing rapidly. There is a new faith in the power of the economy to grow indefinitely and to raise living standards for everyone. Sound familiar? Those words could describe 1968 or 2000. The year 1968 marked the beginning of financial markets' worst decade since the Great Depression. Stock prices, as approximated by the S&P 500 Index, languished in a broad trading range for ten years. Admittedly, the chart below ignores dividends paid, but the point remains that, given the high inflation of the period, investors lost money in real terms. This year's hemorrhaging in the Dow and the Nasdaq has caused many investors to lose the hubris that led to expectations of enormous profit growth over infinite timeframes. Now that it is widely accepted that the bull market party is over, does it follow that investors are destined to suffer through a prolonged bear market? There are three worrisome parallels with the conditions that drove real share and bond values lower in the 1970s. Oil. Rising tensions in the Middle East bring the most obvious parallel to mind. In the 1970s, OPEC supply curtailments, both politically and economically motivated, drove real oil prices (in today's dollars) from $15 to more than $40 per barrel (they doubled again in the early 1980s). Real oil prices have risen from close to $12 per barrel to over $30 per barrel in just the past two years. If the situation in the Middle East deteriorates or the winter is colder than expected, the price of oil could jump dramatically. Although oil is less significant to the economy than it was 20 years ago, the Dow lost close to 400 points as oil prices rose, reminding everyone that oil is still the single most important commodity in the economy and the most feared source of inflation. Labor. The greatest achievement of this economic expansion is the 23.7 million net new jobs created since the last recession ended. This great expansion of opportunity has invited many underrepresented groups into the labor force and has even begun to lift real incomes at the bottom of the economic ladder. The worry, however, is that further improvement is harder to achieve. The unemployment rate is once again below 4%, where it hasn't held since-guess when-the end of the 1960s. The Phillips Curve is a hard theory to prove, and is certainly not universally accepted, but it is clearly more difficult to rapidly expand employment from a 4% unemployment rate than from the 7.5% that prevailed in 1992. Besides its extraordinary tightness, another characteristic of the labor market may perhaps bode ill for investors over this decade. After years of decline, the youngest cohort of workers is expanding in numbers and importance. While these new workers provide a measure of surety against overly tight labor markets, they are (with the notable exception of high-tech skills) considerably less productive than the older workers who are moving into retirement. This may constrain labor productivity growth, a hallmark of the new economy. Government spending. 1969 was the last year before 1998 that the federal government ran a surplus. A major cause of the debacle of the 1970s was massive federal spending on antipoverty programs and on the Vietnam War. Conversely, fiscal discipline has been one of the major underpinnings of the current expansion. The upcoming presidential and congressional elections threaten to upset this discipline. Both candidates have made promises that appear to doom the surplus and could lead to fiscal profligacy of the sort that overheated the economy at the end of the 1960s. Despite these parallels, there are three major differences that should shield investors and the economy from the travails of the 1970s. Stock markets may not recover the go-go enthusiasm of the past few years, but there is little to suggest that a prolonged and significant decline, as opposed to a period of stagnation, in financial asset values is in order. Monetary discipline. Loose monetary policy accommodated ambitious federal spending into the 1970s. The consensus among Fed policymakers to squelch any renaissance of inflation provides the best surety against a return of high inflation and retrenchment in the real economy. While stockholders have often been angry with Alan Greenspan over the past year, the policies he represents should themselves provide a reasonable guarantee of positive real returns on most investments over the coming decade. Institutional strength. Sophisticated financial markets, such as the asset-backed securities market, work in tandem with prudent monetary policy to ease any problems in the real economy. While high interest rates used to lead to actual credit shortages, today's much more flexible financial markets are able to allocate capital efficiently within a wide range of expected interest rates. Information. The shift to a services and information-dominated economy doesn't end the business cycle, but it should lead to quicker and less painful responses to changes in economic fundamentals. Improved information and management techniques have limited inventories, thus ameliorating boom and bust cycles. Armed with information, investors adjusted their expectations in record time this year, and may even have taken all the medicine they need in one difficult six-month period. The Internet's power to publicize prices limits producers' ability to raise prices and thus contributes to lower inflation. How well the information economy responds to old-school troubles with oil and the bursting of the Internet bubble is the key question going forward. Business Development600 Willowbrook Lane, Suite 600, West Chester, PA 19382-5500 Phone: (610) 696-8700 Copyright © 2000, Economy.com. The Dismal Scientist, "Best Free Lunch on the Web", and Dismal Market are registered trademarks of Economy.com. <A HREF="http://www.ctrl.org/">www.ctrl.org</A> DECLARATION & DISCLAIMER ========== CTRL is a discussion & informational exchange list. Proselytizing propagandic screeds are unwelcomed. Substance—not soap-boxing—please! 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