Analysts deem market downturn essential for a healthy economy

by Peter Frost

After a record year in 1999 and a strong start this year, the U.S. stock market absorbed a major setback Friday, with the Dow Jones Industrial Average and the Nasdaq each recording their largest single-day point drops in history.
Some might argue the downturn of the stock markets in recent weeks is the perfect cure for inflationary pressure and unsustainable economic growth, and most analysts and economists confirm the market correction was essential to the economy’s health.
“I know it seems counterintuitive, but (the drop) is actually positive news for our economy,” said Paul Seguin, associate professor of finance in the Carlson School of Management.
Seguin argues the markets — especially the Nasdaq — are highly overpriced, and the recent sell-off brought stock prices down to a more credible level.
He said in order for economic growth to return to a safer level, the Federal Reserve Bank will raise interest rates by at least 0.5 percentage points by the end of the summer.
The Fed has already raised interest rates five times since last June, in hopes of cooling the United States’ red-hot economy. As of two weeks ago, those changes hadn’t arrived yet, as the markets chugged along at a record-setting pace.
But fears of rising rates finally set in, as the tech-heavy Nasdaq fell 34 percent off its record high and the Dow fell 10 percent from its high.
Total market valuation losses surpassed $2 trillion.
“Basically, the market is now reacting to the fact the overheated economy is causing the Fed to raise rates,” Seguin said.
In theory, when interest rates are raised, purchasing should slow, markets should correct and inflation should be kept at bay.
Among consumers, a rate hike encourages saving rather than spending for two reasons.
First, consumers are discouraged from making large purchases that require taking out a loan. When interest rates are higher, so are loan payback rates — including student loans.
But the effect will be little felt by University students, Seguin said.
Next, when the Fed raises the interest rate, increases in other rates are triggered, including those in savings accounts.
This encourages people to keep their money in savings accounts instead of investing it in the market or making big purchases.
When people are taking money out of the market and aren’t purchasing a company’s goods, market valuation decreases — as indicated in market indices in the past two weeks.
But analysts say the markets were overvalued anyway, and a decrease was necessary.
“There was nothing fundamental that can explain what happened to stocks since November,” said Daniel Peris, securities analyst at Argus Research Corp. in New York.
“The Nasdaq became ridiculously overvalued, and a correction was due,” Peris said.
He said there was almost no effect on core businesses in the United States like General Motors or 3M, and the current dip in the market will have no effect on students.
“I do not expect any downturn in the markets this year,” Peris said. “The companies that fuel our economy are still very solid, profit-earning companies. There is no reason to worry.”

Peter Frost covers business and welcomes comments to [email protected]