New York--Friday was three years from the crash, and once again the stock market is reeling.
The last collapse was quick and frightening. But the economy everywhere except on Wall Street itself remained unharmed. That, ironically, undermined much of its credibility as a measure of anything but its own fragile opulence.
Now, however, even as Wall Street has been degraded and its slick investment bankers purged from the fashion pages of trendy magazines, it has begun to act with what seems unusual rationality, even if the conclusion is unpleasant.
The Dow Jones industrial average peaked at almost 3,000 during the summer. Subsequently released economic data concerning employment, orders for plant and equipment, retail sales and the like appear to have peaked at the same time.
Other rising indicators, most important those concerning industrial production, continue to obscure whether the economy contracting. But if a recession is confirmed by the data released in coming months, that approximate time frame will most likely be designated as its start, said Geoffrey Moore, head of the Columbia University Center for Business Cycle Research and a key member since 1939 of the small group that officially pinpoints recessions.
During the mid-1980s, stock prices may have been more descriptive of the nation's mood than were potential profits and real interest rates, the two things that determine an asset's economic value.
In retrospect, at least, the suspect valuations leading up to the 1987 crash receive scathing reviews. Not only were shares selling at an average (based on the companies in the Standard & Poor's 500 index) of almost 21 times earnings, about double the historic norm, but they also were remarkably high in relation to interest rates. The return available on the highest-rated corporate bond was about 45 percent higher than the average expected return on shares, according to statistical studies done by I/B/E/S, a company that collects earnings estimates from investment analysts.
That premium has all but disappeared. Forecast earnings now equate to a little less than 10 percent of the price of the average stock included in the S&P; 500 index. That's about the same as the current yield on the best bonds and, if anything, is a little conservative. Shares usually command a premium because of their prospects for appreciation.
But share prices have steadily paralleled the decline in forecast earnings, according to I/B/E/S, and that makes sense. As a company's profits diminish, so does its share value. That has occurred with comparatively sparse trading on the major exchanges, suggesting that neither bulls nor bears have been aggressively active.
"There is very little speculation in our markets today, " said John J. Phelan Jr., chairman of the New York Stock Exchange. "The markets are normal, [though] 130 million shares [traded a day] is a level of normalcy we don't want to have."
The tendency of share prices to slide before, or at least along with, an economic contraction has a long precedent. The standard joke among those who consider Wall Street irrelevant is that it has predicted a dozen of the last three recessions. In truth, its batting average since 1953 has been better than .500, with the market sometimes being too quick to plunge but only once being too slow.
"There are times when the market has its own imbalances, and it has nothing to do with the economy's imbalances," said Bruce Steinberg, head of macroeconomic analysis for Merrill Lynch. "But if you look at all the corrections, more often than not it gives the correct signal."
One reason the market may be more reflective this time is that it isn't being viewed as the cause of a contraction.
In late 1987, many economists were inspired by the crash to issue bleak forecasts. The most common basis for this was twofold. First, there was the wealth effect. The collapse in share prices, the argument went, would undermine the net worth of individuals, and they, in response, would stop spending.
Retail sales, a good indicator of this, expanded at a slower rate but until recently didn't contract. Diamonds, Impressionist paintings and other items that in most eras are relegated to the unessential category continued to sell for record amounts.
Second, the decline in stock prices was feared to have raised the cost of capital for business, raising costs and undermining investment, which would have a ripple effect throughout the economy. That theory collapsed in January 1988, when Towson-based Black & Decker launched an ultimately unsuccessful bidding war for American Standard, whose shares had been badly depressed during the crash. Within weeks, they were again at record levels. Another takeover boom followed. Depressed shares became open invitations to hostile raiders.
That has ceased. Banks have become cautious about extending credit. Unless a company managed to resist the trend of the past decade, keeping its debt low and cash high, it's unlikely to initiate, or receive, a takeover bid. If the market is going to rise again, it probably will have to do so because of the profitability of the constituent companies.
Since Wall Street operates by emphasizing future earnings, it may become a particularly good indicator of when the economy will improve. That's actually been the case during each of the recent recessions.
"While it has been imperfect as to when it's coming," said Merrill's Mr. Steinberg, "it's been perfect as to when it's ending. It has never failed to rise well before the end of a recession."
More precisely, according to Merrill's statistical runs, the market has turned at least four months before the end of each downturn. Thursday and Friday were good days on Wall Street. Perhaps February will be the beginning of a new economic spring.