The View from Fed-Watcher Jeremy Siegel

The Wharton prof is optimistic about inflation, but he thinks the market is in for more gyrations

By Margaret Popper

Jeremy Siegel, professor of finance at the the University of Pennsylvania's Wharton School, is the author of Stocks for the Long Run (McGraw-Hill, 1998). He has also been an adviser to Federal Reserve Chairman Alan Greenspan. Business Week Online's Margaret Popper caught up with Siegel on Dec. 19, the day of the most recent Federal Open Market Committee meeting. They discussed his opinions on Fed policy, the state of the economy, and his predictions for economic growth and the stock market in 2001. Here are edited excerpts of their conversation (a video of this interview is also available):

Q: Were you surprised by the Fed's statement after the most recent FOMC meeting?


Greenspan signaled a couple of weeks [before the meeting] that the Fed would likely change its stance. Just in that two-week period, there was a deterioration of the [economic] indicators and the markets that led some to believe they might even lower interest rates [at the meeting] -- although clearly the odds were against it. The best you could probably hope for is what actually did happen, which is a move to a bias toward easing.

Unless things deteriorate very rapidly, the earliest we can get any drop of rates is going to be...the very end of January, when the FOMC meets again. There's a bit of disappointment in the market [because people were hoping] that perhaps Greenspan would've wanted to take out an insurance policy against a rapid deterioration with a rate cut late in December. The market had gone up in anticipation that something was going to happen, and when the very good thing didn't happen, the market sold off. A lot of volatility is normal in the short run after a Fed announcement. Especially when policymakers are changing the policy bias.

Q: Is the Fed still worried about inflation?


Well, you know, in its Dec. 19 statement, the Fed said that while some inflation risks persist, they are diminished by the more moderate pace of economic activity and by the absence of any indication that longer-term inflation expectations have increased. What the Fed is referring to is that the bond market and government bonds aren't reflecting any increases in inflationary expectations.

Things are looking very good on the inflation front. First of all, oil is definitely down. Natural gas is up...but oil is the key energy commodity here. The unemployment rate is a lagging indicator. But jobless claims are a very sensitive early indicator and they very definitely are up. The intermediate-producer prices and accrued-producer prices -- at the earlier stages of production -- look very, very good. So the inflation news has actually gotten much more positive.

Q: Will we see a recession in 2001?


Well, when we go down from 8% growth [in fourth-quarter 1999] to 2% [in fourth-quarter 2000], it's a lot. But a working definition of recession is really negative growth. Some people call it a "growth recession" when we go from high growth to low. There have been many times in the past when 2% would have been very good growth. We're disappointed in that now because we've experienced much faster growth. The question everyone is asking is whether this is just a temporary downward blip...or are we really going back down to a long-term trend [of 2% to 3% growth] and all this New Economy stuff was just so much talk.

Q: Is there anything about the New Economy that you think is real?


It is real. The communications revolution is going to be very significant. And it's going to improve productivity. Year-over-year, we're at a 4.8% increase in productivity, still extraordinary.

Q: How much does globalization affect our economy?


Global issues are becoming more important, but they're not dominant. Most firms still derive most of their sales domestically. And the domestic business cycle and domestic monetary conditions are by far the overwhelming important leaders in the market. [In 1998 we had] an extremely acute crisis of mammoth proportions in global markets. And the U.S. sailed through it very, very well. It shows you how strong a basic economy we have that we can really snap back from something as severe as that international collapse -- which was the biggest...that we probably had in the past 50 years.

Q: What will happen to the stock market in 2001?


That depends on the extent of the economic slowdown. It's going to take quite a few months to see that. The market is still going to have to digest some more earnings markdowns in the coming months. Technology stocks, despite having come down a lot, still have to contend with high valuations, and they're still going to have to come down. It's going to be very, very hard to make a lot of good money in the market then.

Q: How do bonds compare with equities as an investment these days?


The high-grade market certainly was better than the stock market in 2000, there's no question about that. If you've been in governments, it's been extremely good. If you've been in junk, it's been bad. It depends on the quality of the bond that you happened to be in in 2000.

Looking toward 2001, some analysts say rates are going to go down even more. Look at the 10-year Treasuries, down to a 5.2% yield. How low do they think it's going to go? In my opinion, we'll have to have a tremendous economic slowdown for them to go down much more.

Q: How does such a large percentage of Americans owning stock affect the economy?


The stock market has more effect now than it ever did before. More people are investing, and the people who are investing have more invested. It's a bigger fraction of household wealth than it has ever been in the past really. Our...fascination with the stock market has taken hold.

Popper covers the markets for BW Online in our daily Street Wise column

Edited by Beth Belton

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