Wall Street Exuberance Valid, Economist Says
The exuberance, it seems, is not irrational after all, according to the man who provides economic forecasts to many of the nation’s biggest corporations.
“The stock market, I think, is fairly valued,” Dr. Roger E. Brinner told the Pacific Northwest Regional Economic Conference Thursday.
“It’s not like 1987,” he said, “which was a truly, heroically overvalued stock market.”
Brinner is the executive director and chief economist of DRI/McGraw-Hill, a leading global provider of economics-driven analysis to corporations, governments and investment managers.
He supports his market assessment by pointing to the relationship between bond yields and corporate price-to-earnings ratios.
In the weeks before the 1987 crash, he points out, bond yields neared 10 percent, and price-to-earnings ratios, paradoxically, were also rising to a level of 25-to-1, for a 4 percent earnings price.
“So you could either invest in a company and get a 4 percent yield, or buy a bond and get a 10 percent yield,” Brinner said. “That six-point gap told you a major, major correction was in order because the normal spread since 1980 has been only two percentage points.”
Today, he said, with bond yields at 7 and price-to-earnings ratios at 20-to-1, for a 5 percent earnings price, the markets are right on the two-percent standard.
“So we are in normal territory,” Brinner said.
Brinner spoke at the opening luncheon of a gathering of academic and business economists from throughout the Pacific Northwest. Sponsored this year by Washington State University, the event returns to Spokane for the first time in 15 years. Sessions continue today and Saturday at the Red Lion Hotel, Spokane City Center.
While optimistic about the future of the financial markets, Brinner warned that the nation’s long-lived economic expansion won’t last forever.
“The business cycle is not dead,” he said. “It is fitfully sleeping, and could be awakened at any time.”
In the United States, he said, three factors historically contribute to the creation of recessions. They are credit crunches designed by the Federal Reserve to fight inflation; international crises, such as an OPEC oil price hike or Iraq’s invasion of Kuwait; and “grand experiments in fiscal policy.”
Throughout the Clinton presidency, he said, the latter two factors have been absent.
“All we’ve had is the credit markets, and they have been, by historic standards, moving through rather mild cycles,” Brinner said.
With only one factor at work over the past five years, Brinner offered evidence that for every percentage point the bond yield moves, the nation’s gross domestic product (GDP) moves by one percentage point in the opposite direction, with a one-year lag time.
“So what does that tell you is ahead for 1997?” he asked rhetorically.
Bond yields rose from 6 percent at the beginning of 1996 to 7 percent at the beginning of 1997. That means during the course of 1997, Brinner predicted, growth in the GDP will cycle down from 1996’s 3.5 percent to 2.5 percent.
“And that’s certainly a soft landing by anyone’s definition,” he said.
He sees the Fed tapping the brakes with quarter-percent rate increases at least two more times over the next 12 to 18 months as it continues to be nervous about inflation based on rising wages, rising consumer debt, rising corporate profits, and a fully-employed economy.
The real key to long-term extension of the economic expansion and market rally, he said, is a reduced federal budget deficit. Budget balance by 2002, he said, “could add 50 percentage points to the stock market.”
, DataTimes