Later today, the Federal Open Market Committee (FOMC) will meet
to determine monetary policy. Expectations are that the Fed will
maintain its laissez-faire approach and leave interest rates
unchanged. In a few months, I think we'll look back at this
inaction as a significant opportunity to stimulate the economy that
was missed by economic policy-makers.
I don't believe the Fed fully appreciates the crisis of
confidence that dominates the current investor psychology. Although
investor optimism plunged in July and has remained low, the summer
stock market rally has disguised the continued weakness of investor
confidence. Even now, as the market seems ready to test its July
lows amid new signs of economic weakness -- declining new
construction and weaker auto sales -- the situation with Iraq, not
the economy, has everyone's attention in the nation's capital.
Given the current international situation, it's just too easy for
policy-makers to pretend, believe or hope that the crisis of
confidence on Wall Street has dissipated.
The Crisis of Confidence Continues
Earlier this year, everyone on Wall Street was talking about the
crisis of confidence and the way it was impacting investors, but
since the market's summer rally, no one seems concerned about
investor confidence. But it appears that investor optimism should
be a major concern to the economic policy-makers, according to the
results of the most recent Gallup/UBS Index of Investor Optimism
survey.
In the September survey*, 70% of investors told Gallup that the
issue of questionable accounting practices in business is still
hurting the U.S. investment climate a lot. Amazingly, this is down
only 10% from July (at the peak of the WorldCom scandal), when 80%
of investors said questionable accounting was hurting the
investment climate a lot. In fact, more investors say they are
worried about accounting issues right now than in May, when 60% of
them said questionable accounting was hurting the investment
climate a lot.
More than one in three investors (36%) also say that conflicts
of interest between Wall Street firms' research departments and
investment banks are hurting the current investment climate a lot.
This is down a little from July (42%), but still higher than the
percentage of investors who were worried about such conflicts of
interest in May (28%).
Of course, there are many other issues that a third or more of
investors believe are hurting the U.S. investment climate a lot,
including corporate earnings, the possibility of a U.S. attack on
Iraq, and the threat of more terrorist attacks.
Key Points
The economy and the stock market are feeling the effects of many
worrisome issues right now. These uncertainties create all kinds of
risk premiums and related costs for the economy. As a result, no
one should be surprised that the economy is not doing as well as
many economic prognosticators had expected.
In one sense, it may be that the investor crisis of confidence
is just another one of those shocks to the economy that Fed
Chairman Alan Greenspan referred to recently when he discussed the
great resiliency of the U.S. economy. Still, I think the crisis of
confidence on Wall Street remains extremely dangerous for the
economy as we look toward 2003.
Everything suggests that investors' psyches are very fragile
right now. Half of all investors say that the economy still has not
hit bottom, and 44% say the economy is going to get worse before it
gets better. Worse yet, investor confidence may take another hit
when the implications of the problems at some of the nation's
largest financial services firms are fully understood.
Yes, the Fed should worry about investor confidence. In fact, if
it really understood that the overwhelming majority of investors
are still suffering from a serious loss of confidence in the equity
and corporate debt markets, it would not hesitate to lower interest
rates immediately. It would also encourage Congress to act
immediately to further bolster investor confidence.
*These results are based on telephone interviews with 1,004
investors, aged 18 and older, conducted Sept. 1-15, 2002. For
results based on the total sample of investors, one can say with
95% confidence that the margin of sampling error is ±3%.
