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Stack: Recession inevitable?
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October 14, 1998: 1:07 p.m. ET
Top investment researcher James Stack predicts recession unless Fed eases rates
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NEW YORK (CNNfn) - As markets around the world continue their downward spiral, market analysts at home and abroad are looking for the Fed to aggressively ease interest rates in order avoid a possible recession.
James Stack of Investech Research, a leading investment research firm, told CNNfn's "Business Day" about pronounced wage inflation and the dynamics of a steep bear market.
Stack argued that there exist several factors which could lead to further market decline: a weakening dollar, shaken consumer confidence, and shrinking corporate profit margins combined with accelerating wage inflation.
The following is a transcript of the interview:
DEBORAH MARCHINI, CNNfn ANCHOR: Here to talk about what's holding things back is James Stack, president of Investech Research.
So you sense the Fed's playing with fire here?
JAMES STACK, PRESIDENT, INVESTECH RESEARCH: Well, the Federal Reserve has its hands full. On the surface, it looks like an aggressive easing would be cut in stone. We have virtually no apparent inflation. In addition, Wall Street would certainly like to see an easing, and we have Treasurys already a full percentage point below the federal funds rate.
Unfortunately, the pressures the Federal Reserve is also focusing on is the tightest labor market in 30 years, with wage inflation running at 4 to 5 percent. We have money supply growing at over a 10 percent rate and now, potentially at least last week, with the dollar falling 14 percent against the yen, we could have the dollar displaying its own currency problems.
MARCHINI: What do you think though about the job front? In particular, we're starting to hear news of layoffs, not only on Wall Street but elsewhere, as corporations with shrinking profit margins seek to cut costs.
STACK: Well, in a slowing economy, wages hit corporate profits and that's what has the corporate sector worried. What has the Federal Reserve worried is the historical fact that in the past 50 years, we have never seen the unemployment rate climb over 1/2 of a percentage point without a recession.
In essence, we haven't been able to resolve this dilemma of how to ease wage inflation without going into a recession, at least not until this point.
JOHN DEFTERIOS, CNNfn ANCHOR: In the meantime, we see the steepest bear market in history, according to your numbers. And you're looking at some other numbers built into consumer confidence, not for now which are high, but for the future. And you say it points to a negative market.
STACK: Yes. Let me explain the fact about steepest bear market. It started out falling 19 percent in 45 days. Now, not even in 1987 or 1929 did the market fall that far that fast. Now, fortunately, since late August, the market has leveled off, at least the blue chips have, while secondary stocks and small-cap stocks have continued downward to new lows as recently as last week.
The majority of stocks are still showing a lot of downside leadership. A large number of stocks are hitting 52-week lows every day on the New York and Nasdaq Exchange. Those are typical bear market numbers.
DEFTERIOS: We saw Merrill layoff employees yesterday -- 3,400. It is your belief that financial services play a much larger role in today's economy.
STACK: Well, it's not just the financial sector. It's also the impact on consumer confidence. The next recession, at least this time around, is more likely to be born on Wall Street than on Main Street. And the reason for that is the size of the stock market. Today the stock market is about $9 trillion, much larger than the annual GDP (gross domestic product) of about $7 trillion. It's never been that large in relationship before.
It means that even a 25 percent drop in the Dow, which would be considered a mild bear market, could have more potential economic impact than any decline on Wall Street in the past 60 years.
MARCHINI: Do you think the economic impact from the market action we've seen so far has etched a recession in stone?
STACK: No it hasn't etched a recession in stone, but we are seeing the initial impact in the numbers that the Federal Reserve is watching, particularly in consumer confidence. Consumer expectations -- their future expectations have been falling faster than how they feel about their current situation. In fact, the difference between those two components of consumer confidence is that it's the most negative reading in 30 years. Now that leads the path into recession and that has the red flag up for 1999.
MARCHINI: That's your forecast, a recession next year?
STACK: It'll be difficult to avoid unless the Fed aggressively eases.
DEFTERIOS: And we also see that the Nasdaq Composite is an interesting number because you talked about a recession going forward. Price to earnings ratios for all domestic Nasdaq stocks are still in the 60s, which is very high historically.
STACK: That's exactly right and that's from data directly from the Nasdaq Exchange.
MARCHINI: All right then, you don't think that's a very good sign. You think that means that stocks have further to fall?
STACK: Stocks are still very overvalued, at least compared to past history.
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