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%.
