Editor’s note: Rachel Beck is the national business columnist for The Associated Press.
NEW YORK — A bullish complacency among investors worldwide came to a sudden halt this week after Alan Greenspan spoiled the fun by warning of a possible U.S. economic recession later this year.
In a matter of hours, his forecast wreaked havoc on global share prices. Chinese stocks plunged 9 percent from record levels in their worst session in a decade and U.S. markets suffered their biggest declines in years.
Some of what spooked investors was the former Federal Reserve chairman’s change in tone. Until recently, he had been adding some froth to the big gains in stocks by giving an upbeat economic outlook and downplaying the risks from declining growth.
That positive view seems to be history – unless he flip-flops again.
It has been more than a year since Greenspan left the helm of the Fed after an 18-year tenure, and he now runs a consulting firm that bears his name.
But that doesn’t mean he has shied away from the spotlight. He still publicly voices his views on economic trends, and what he says certainly carries weight in financial markets.
That was clear this week when Greenspan warned that the current six-year economic expansion is in danger of expiring by year’s end.
"When you get this far away from a recession, invariably forces build up for the next recession, and indeed we are beginning to see that sign," Greenspan said via satellite link to a business conference in Hong Kong. "For example in the U.S., profit margins … have begun to stabilize, which is an early sign we are in the later stages of a cycle."
Investors weren’t expecting such a bearish view from Greenspan, who has stressed in recent months that strong profit margins and capital spending are signs of good times to come. He also has repeatedly noted that the "worst is behind us" in the economic impact of the housing market slump.
Greenspan also has downplayed the recessionary link to the inverted yield curve, which happens when interest rates on longer-term U.S. Treasury notes fall below those of the overnight federal funds rate and short-term Treasury bills. Even though major financial troubles have historically followed such inversions, many economists now have brushed off ties between the two around even though the curve has been inverted for months.
But this week, Greenspan sang a new tune – "recession" – and that was enough to send some investors running for the first time in a long while.
There hasn’t been anything in recent months that could rattle stocks significantly. Investors have chosen to focus on the mergers and acquisition boom, the pullback in oil prices that have somewhat tempered inflationary risks and some healthy economic data – and discounted most everything else. And as the rally in U.S. markets that began last July has shown no sign of slowing, more investors wanted to take part.
Before Tuesday’s sell-off, the Dow Jones industrial average had soared 19 percent in the last eight months to a record high, while the broader-market Standard & Poor’s 500 index had jumped 18 percent to six-year highs since July.
Now many market-players are taking a step back, at least for a moment. Stocks on Tuesday had their worst day of trading since markets reopened after the September 11, 2001, terrorist attacks.
Greenspan’s remarks also panicked global investors, who worry about a cooling of both the U.S. and Chinese economies. A day after sending Shanghai’s Composite Index to a record, the benchmark index tumbled 8.8 percent for its largest decline since February 18, 1997.
But there may be something positive in Greenspan’s warning. Investors needed a bit of an attitude adjustment, and he jump-started the process.
It’s not that the outlook ahead is all gloom, but since many market participants have gotten caught up in their buying spree, they’ve overlooked some potential concerns.
While the U.S. economy grew at a surprisingly strong 3.5 percent annual rate in the fourth quarter of 2006, a survey released Monday by the National Association for Business Economics showed that experts predict economic growth of 2.7 percent this year, the slowest rate since a 1.6 percent rise in 2002.
The Commerce Department on Tuesday reported demand for big-ticket manufactured goods fell by a sharper-than-expected 7.8 percent in January, the biggest drop in three months. And the housing market remains in a tough spot, especially given the recent implosion in subprime mortgages, with a realty group reporting that average selling prices for existing homes fell last month.
Investors might not see it this way now, but Greenspan’s warning might actually help them in the end.
That could happen if it gives his successor, current Fed Chairman Ben Bernanke, the opportunity to save the day by cutting interest rates to offset potential weakness. While that wasn’t the direction the Fed has seemed to be leaning, it surely is what investors want.
—
Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org
