Interest and inflation

Enrique Diaz-Alvarez enrique at ee.cornell.edu
Mon Apr 17 10:16:27 PDT 2000


Michael Pollak wrote:


>
>
> But I think the plunge also provides two provisionals answer to Enrique's
> question of "How can 7% interest rates affect the stock market when people
> expect 20% returns?" The first is that people do expect interest rate
> hikes to slow economy as a whole, at least the old economy most of us live
> and work in -- and I think they have some dim idea that, if times are not
> as good for normal companies and their employees, neither will have as
> much money left over to spend on e-stuff. Of course, an intelligent
> investor would say Hell, why should that matter, they don't buy enough for
> us to make a profit now, we'll just lose less. But as Enrique has pointed
> out several times, the average investor isn't quite that smart
> sophisticated -- side-by-side with his belief in "momentum," he actually
> believes these companies are doing something.
>

I'd like to point out that the evidence so far seems to support me. Even before the inflation data came out, there had been five rate increases and the near certainty of more to come. Yet consumer credit exploded at the fastest rate ever in January and February, retail sales rose furiously, spending continued to outpace income by an astouding margin, margin debt went up at 10% a month, and crucially, inflows into stock market funds were the fastest ever, much faster than last year. I don't have figures on the other two sources of demand for stocks, corporate repurchases and furriners, but the strong dollar suggests that at least the latter continued strong.

The reason for the market decline is, I think, that supply finally overwhelmed demand, with too many insiders dumping and too many IPOs coming to market. Trimtabs.com seems to have gotten it right, though they update their site very infrequently for freeloaders like myself. You could argue that the rate increases have had something to do with the relative lack of cash takeovers, but it's a bit of a stretch, and in any case the additional inflows into stocks are more than enough to compensate for it.

Note that even after the decline began, inflows into stock market funds were very healthy, apparently (those figures are not terribly reliable). It will be very interesting to see if they continue so after this debacle. If people (heaven forbid!) decide to redirect some of them towards their credit cards, watch out below.


>
>
> In short, it's possible to maintain that interest rates still have their
> bite *and* that the last five quarter point increases did nothing.

Friday's drop *may* be adscribed to fear of rate increases. Not so the other 25%.

Enrique

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