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Thursday, June 20, 2002

Down and Down We Go Again: New York: or Remember Amos Tversky

This has to be the quote of the week:

"When the sky is falling usually you try to duck," said Hugh Johnson, chief investment officer at First Albany Corp.


"We come in at 6:30 a.m. as optimists and we leave at 4 p.m. depressed," said Michael Palazzi, head of Nasdaq trading for SG Cowen Securities

Obviously the rest we're getting used to.

NEW YORK (Reuters) - Stocks were lower at midday on Friday after a deadly car bomb blast outside the U.S. consulate in Karachi, Pakistan, and a drop in consumer sentiment rattled investors already fretting over corporate profits and the U.S. economy.

A report showing that consumer sentiment fell sharply in early June raised fresh concerns about a pullback in consumer spending -- which underpins two-thirds of the economy -- and helped push the broad market and the technology-heavy Nasdaq Composite index to lows not seen since Sept. 27.
Source: Yahoo News LINK

or as the FT puts it:

US stocks tumbled in early trading on Friday after raft of downbeat news, including a revenue warning from Sprint, a car bombing in Pakistan and a sharp fall in consumer confidence.... Some traders called it the "perfect storm" of negative news: bad economic data, a profit warning and international tensions. Also adding to the market's slide was downgrades in the telecommunications sector by Merrill Lynch and JP Morgan, which crushed telecom stocks."

So now it's consumer confidence too. But how much weight should we really put on this (see yesterday's post).


The latest turn in sentiment about the US economy has encouraged speculators to bet that the Fed's policymaking Open Market Committee (FOMC) will make no significant changes at its June 25-26 meeting.

This has to be a joke doesn't it? But even so it's in poor taste. As the title indicates are we now approaching Amos Tversky time: ie is this the moment when the pain gets so acute, that all but the most hardy pack their bags and go home, or do we have to wait a little longer for this.

Even the economist is joining the chorus of US gloom and doom merchants:

Foreigners, worried about the size of America’s current-account deficit—4% of GDP and growing—have started to sell dollar assets. Partly as a result, the American currency hit a 17-month low against the euro, at $0.95, on June 12th, marking a decline of nearly 14% since last July. And, just when investors need reassurance, the continuing drip-drip of corporate and Wall Street scandals sends exactly the wrong signal. With investors feeling so bearish, stockmarket indices around the world have lost most of the gains made after a concerted round of interest-rate cuts followed the terrorist attacks on New York and Washington last September. This week the Nasdaq-100 index closed at its lowest level since January 1998. The Dow Jones Industrial Average fell by 3.4% last week alone and this week touched a seven-month low of just below 9,500. Markets in Europe and Asia were also effected. This week ended on a grim note, with markets everywhere in turmoil.

Plus the same old dollar story:

The dollar is very vulnerable to a change in sentiment about the relative attractions of American assets. In the past year, there has been a shift in the flows into the United States. Foreign direct investment financed 91% of America’s current-account deficit in 1999. By last year, that had fallen to 43%, having been supplanted by more fickle capital flows. Foreigners own no less than two-fifths of American Treasury bonds, a quarter of corporate bonds and 13% of American equities.

As you already know, I don't buy this part of the story, If America falters, then who takes the load? But for the other part, when will the pain really start to tell. Over a year ago, Stephen Roach was making drew our attention to the seminal work of the late lamented Amos Tversky. So now:

"Enter the late Amos Tversky -- the renowned Stanford psychologist largely credited for inventing the discipline of behavioral finance. A central tenet of this body of work is “prospect theory” -- the inarguable notion that consumers derive satisfaction from both current income and changes in their financial wealth positions. Through direct sampling of investor responses to hypothetical and real financial market situations, a powerful “loss aversion” motive can be identified: Consumers have been found to be far more sensitive to reductions in wealth rather than increases. The psychological angle is not hard to fathom. Tversky argued that the pain of loss is a far more powerful emotional response than the joy of gain. The issue for economists is when the pain begins to sink in......

America has just gone through the mother of all stock market bubbles. The average investor has not been willing to concede that the recent correction is for real. Up until very recently, dip-buying was considered the greatest opportunity of all in this secular bull market. Little wonder that mutual fund redemptions have been limited, at best. The behavioral psychologist in me would suggest that denial might well be the most powerful human emotion of all. The American individual investor simply did not want to accept the possibility that the magic was gone.

If that denial cracks -- and I fear that it will -- the negative wealth effect could be lethal on the downside. I have called this the “asymmetrical wealth effect” -- whereby a down stock market hurts the real economy by more than an up market helped it. This asymmetry is grounded in both theory and fact. The theory comes from Tversky -- the notion that once the pain finally sinks in, it could evoke a far more powerful response than expected. The facts rest on the lack of traditional saving for an aging and stock-market-dependent American population -- households who also lack the once secure safety net of defined-benefit pension arrangements. These are dangerous preconditions for an asymmetrical wealth effect, in my view -- one that could deal a lethal blow to the US economy."

Could it be that the moment Steven foresaw over a year ago is now, finally, approaching. I'm afraid I don't buy all the lethal dose stuff (and I'm non too sure about behavioral psychology), but the pain could be real enough, and its economic consequences important. After all, following the rage/bravado stage of the early 'war against terrorism', could it now finally be sinking in that we live in a dangerous, and unequal, world, and that we're not doing enough, or on enough fronts, to try to make it safer.

Really here I can't do better than the bard:

Surely some revalation is at hand;
Surely the second coming is at hand.
The second coming! Hardly are those words out
When a vast image out of Spiritus Mundi
Troubles my sight: somewhere in the sands of the desert
A shape with lion body and the head of a man,
A gaze blank and pitiless as the sun,
Is moving its slow thighs, while all about it
Reel shadows of the indignant desert birds.
The darkness drops again; but now I know
That twenty centuries of stony sleep
Were vexed to nightmare by a rocking cradle,
And what rough beast, its hour come round at last,
Slouches toward Bethlehem to be born?
The Second Coming

Discuss This Time is it More Than a Stock Correction


Well here goes on my first couter consensus call. THE DOLLAR ISN'T GOING TO FALL THROUGH THE FLOOR. Got that. There isn't going to be a dramatic re-adjustment of the dollar, not any time soon anyway. The dynanics of currency movements are different from the terrestial dynamics which gives us Newton's Law of 'what goes up must come down'. You see in the universe of exchange rate movements, at least as we know it today, for one thing to go up, something else (or somethings else) must come down. And here we have the rub. As matters stand right now, there's just nothing else ready to come up (of course gives us 10 to 20 years and in Asia generally there could be lots of things). But right now, it ain't ready babe, so we're stuck with what we've got.

This of course is different from the universe of the 1930's, where everything could come down together - against gold (my thanks to my brother William David - the philosopher banker in the family - for pointing this one out to me).

So when we're asked:

"So what else could go wrong?

That is the question on many investors' minds as they assess what is keeping the stock market in the doldrums, despite positive outlooks for the economy, inflation and corporate earnings.

What appears to be holding the market back are more intangible concerns, including fears of another terrorist attack, distrust of corporate executives and worries about the accountants who have been reviewing their books.Now add to that list of fears a potential plunge in the value of the dollar. Since its high for the year at the end of January, the dollar has fallen 9.4 percent against the euro. The dollar is down 7 percent against the Japanese yen since its 2002 high in early February. So far, the decline has been orderly

But Stephen S. Roach, chief economist at Morgan Stanley, says the chance of a dollar plunge has grown recently — to a 15 percent probability from 5 percent. While the odds are low, the impact should be considered.Mr. Roach defines a plunge in the dollar as a decline of 20 percent or more in its value against the euro and the Japanese yen by the end of this year. Based on a starting date of May 24, that would put the dollar/euro rate at $1.15 and the dollar/yen rate at 100 yen to the dollar. In late trading Tuesday, the euro was worth 94.82 cents and there were 125.32 yen to the dollar."
Source: New York Times LINK

Now few can hold Stephen Roach in more admiration than I do His basic instinct that all is not well in the land of well being, is much nearer the mark than almost any other commentator in recent months. He has almost single handedly driven the ecnomic debate during the last 18 months into the areas where it had to go. But to err is human, while to err twice is unforgivable ( or almost).

Again, no one who reads this column on a regular basis could doubt that the two economists who I respect most are Stephen Roach and Paul Krugman (my top economist of the twentieth century was Zvi Griliches, who, well check him out here and note the cat and the bare feet), but I still think they're BOTH making the mistake of assuming the future is to much a re-run of the past. And here we have to part company (enter stage right my third favourite economist Brad de Long, this is the piece that woke IK from his dogmatic slumbers ). There is something NEW in the air. And what's more the little that is new, helps us understand a lot, lot more of what we thought we understood in the past.


What was that little ditty that brought instant fame to the Back Street Boys: 'Let's Get Down'. Well now it seems the message has spread to London:

"Britain's FTSE 100 index tumbled more than three percent to fresh eight-month lows on Friday as the prospect of further losses on Wall Street added to the gloom surrounding banking, telecom and oil shares.

Mobile giant Vodafone dived 4.8 percent to 90 pence, hurt by news its Japanese J-Phone unit had raised subsidies on about half the handsets in the Japanese market in response to competition.

By 6:40 a.m. EDT, the benchmark index <.FTSE> was down 149.3 points or 3.13 percent to 4,622.6, back to levels seen late in September last year when prices shot back up from a post-September 11 low of 4,220.

The index has now lost around 300 points or more than six percent over the week and market watchers see no respite as investors sink into gloom about the outlook for economic recovery and the prospects for UK interest rate rises."
Source: Yahoo News LINK

Actually the bonobos have been 'gettin down' for generations, but thats a story for another day.

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