The numbers are jarring. The NASDAQ is down by a third year-to-date. The
Bloomberg Internet Index has plunged by some 60% over the past year.
Yet, contrary to widespread expectations among Wall Street veterans,
individual investors aren't fleeing the stock market in a panic, despite
the bust in tech stocks, slowing economy, and dimpled chads.
For instance, net new cash flow into equity mutual funds in October was $19
billion, a modest improvement over September's number. The Dow Jones
Industrial average remains in a two-year trading range. Aerospace and
defense, property and casualty insurers, oil and gas, health care,
alcoholic beverages, and home-building stocks have done well this year.
It appears as if the central thesis of the "bubble bears" is wrong. The
bubble bears argued that the madness of crowds drove the stock market to
record heights in the 1990s. When sanity eventually returned, frightened
investors would stampede out of the market, sending the economy into a
recession or perhaps even a depression.
To be sure, all of us can tell tales of appalling investor ignorance. But
it's a mistake to underestimate individual investors in the aggregate. With
the benefit of hindsight, the foundation for the stock market's gains in
the 1990s was strong productivity growth, low unemployment, and tame
inflation. Now that the Fed has engineered a slowdown in the economy,
investors are knocking down market valuations to more reasonable levels.
Investors may be overreacting on the downside - emotions do push markets
away from the fundamentals - but they are
far from panicking.
What's more, individuals saving for the long haul are right not to
panic. The Federal Reserve's monetary policy can have a substantial impact
on the economy in the short run. But in the long run, the main economic
impact of the Fed's monetary campaign is on the inflation rate, and the
bond market is telling us that the inflation environment will stay benign
for years to come. Meanwhile, entrepreneurship is flourishing and business
efficiency is improving in the new economy, and that's good news for stocks.
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