"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." - Charles MacKay (19th century thinker).
After the mad dot.com euphoria of last spring, the investment community has passed through a brief period of sanity and moved straight into the realms of irrational fear. If you were to believe the assorted punditry, the US economy is headed for a recession and there's no two ways about it.
During the Asian crisis of late 1998, the same analysts were convinced that dire things would happen to the Western world. A recession was considered a certainty, while some predicted another Great Depression.
Those who said that the downturn would be mild were scoffed at. When the UK Treasury forecasted growth of 1.4 per cent in 1999 it was ridiculed and accused of politicising its forecasts. Actual UK growth was 2.2 per cent.
The doomsayers were shown to be wrong. For emerging markets, the Asian crisis was very serious but, for the Western world, growth progressed. The Asian crisis is relevant now because there is cause to believe that people are being overly pessimistic again.
Why did most analysts get it so wrong in 1998? The main reason is that they thought the downturn would be like its predecessors (such as the recession of the early 1990s). Business and consumer confidence surveys were very weak and the word "recession" appeared everywhere in the newspapers.
However, the big difference was that inflation was under control in 1998. The recessions of the 1970s, 1980s and early
1990s resulted from interest rates being raised to combat inflation. In 1998, by contrast, central banks were in a position to cut rates sharply to soften the blow from any Asian fallout.
This time around, Alan Greenspan and the Federal Reserve are in a position to cut interest rates once more (as they displayed two weeks ago). While the slowdown is primarily a result of higher interest rates rather than an external shock, there is no persistent inflation problem that needs to be addressed. Core US inflation is running at a very respectable 2.6 per cent.
For most people, the surprise rate cut of January 3rd was seen as indicative of the seriousness of the situation. With hindsight, I am confident that we will see it as a positive turning point.
Yes, US growth is slowing. But then, few sensible people believed that growth rates of 56 per cent were sustainable. While a moderation of growth is inevitable, an outright recession (defined as two consecutive quarters of negative growth) is highly unlikely.
There may also be a way to profit from current scepticism. A crisis, as the Chinese believe, is also an opportunity. Nowhere is this proverb truer than in the field of stock market investment. The question is whether the perception of a crisis in the US has reached the point where level-headed people have an opportunity to invest?
I believe that point has been reached but one needs to be selective in choosing sectors to invest in. Although the technology sector has borne the brunt of the declines to date, this sector probably has further to fall. Most dot.coms will never make a profit and, as such, their valuations can never fall far enough. They have no intrinsic value.
However, some "old economy" sectors are trading on price-earnings ratios that look quite attractive (compared with their historic average). US banks, hit by fears over their lending to Californian utilities, construction and leisure are all pretty cheap. In Ireland (where equity prices have also been affected by US scepticism), the banks represent a good bet, even after the gains of last year.
Kevin Daly can be contacted at k.daly@ucl.ac.uk
