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Danger Lurking In The Markets

Economic Trends


Could a sell-off end the expansion?

For economic forecasters, the course of the U.S. economy over the coming year seems a relatively easy call. At least that's what appears to be implied by the close accord among the experts recently polled by BUSINESS WEEK, who foresee a year of moderate growth, moderate inflation, and a low and steady jobless rate (BW--Dec. 30).

What many are ignoring, however, claims economist Irwin L. Kellner of Chase Manhattan Corp., is the rising volatility of the financial markets and the upturn's growing vulnerability to a market correction. While the real economy, he says, has apparently settled into a relatively narrow growth path, the financial markets have become increasingly skittish--often fluctuating wildly in the wake of the latest economic release or statement by government officials.

The bond market's gyrations provide one example. After starting 1996 below 6%, the 30-year government yield surged to 7.19% by early July, fell back to 6.35% in November, and then rose to almost 7% in late January. Meanwhile, in trading through Jan. 24, an exuberant but visibly nervous stock market posted no fewer than five 100-point swings between daily highs and lows in the Dow Jones industrial average, compared with just one 100-point swing in the same period in 1996 (chart). Indeed, on Jan. 28, the Dow surged 90 points during the day, before closing down 5 points.

What worries Kellner is that all of this is happening at a time when the financial markets have unprecedented "leverage" on the real economy. According to the Investment Company Institute, nearly 40% of households now own stock, compared with less than 30% in 1992. At the same time, total bond market capitalization has soared from 100% of gross domestic product in 1980 to more than 150%. And total stock market capitalization recently surpassed 100% of GDP for the first time in history.

By enhancing household wealth and consumption and reinforcing business optimism, the stock market boom has played a major part in extending the life of the current expansion, Kellner believes. But its very importance, he argues, raises the risks that a panic-inducing sell-off could cause severe consumer and business retrenchments.

"The message of market volatility," he says, "is that for the first time since 1929, we may be in a situation in which turmoil on Wall Street could conceivably bring a cyclical expansion to an end."By GENE KORETZReturn to top

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Labor-force growth has taken off

Fears that low unemployment will touch off accelerating wage hikes are exaggerated, argues economist Maury Harris of PaineWebber Inc. He notes that the U.S. labor force grew by about 2% in the year ended in December--about twice as fast as the adult population. The surge in job-holders and job-hunters limited the decline in the unemployment rate last year to just 3/10 of a percentage point, despite a 2.25% rise in the number of persons at work.

As Harris sees it, the pickup in labor-force growth, which reflected rising participation by both adult women and men, was inspired by the incentives of moderately rising real wages in a tighter labor market. (Adjusted for inflation, average hourly earnings rose 0.4% last year on top of a 0.5% gain in 1995.) And the same incentives, he claims, are likely to induce faster than normal labor-force growth this year--helping to allay wage pressures as the economy expands.

Meanwhile, stronger work requirements for welfare recipients seem to be moving more able-bodied persons into the job market. And Harris notes that there's still a sizable pool of potential workers untapped by employers. Indeed, the Labor Dept. counts some 4.7 million adults who are currently out of the labor force but say they want a job--including 1.5 million who looked for work at some point in the past year.By GENE KORETZReturn to top

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