Pointing Toward Prosperity

By S.C. GWYNNE/WASHINGTON.

If the economic news is really so bad, why is Wall Street so giddy? The grim tidings of late January and early February were enough to depress anyone: 232,000 more Americans lost jobs, housing starts sank to their lowest level since 1982, consumer confidence plunged to a 10-year low, the bank-insurance fund was proclaimed nearly broke and a costly war threatened to deepen a record federal deficit. Yet through it all, U.S. share prices marched merrily upward, rising 6% so far this year.

The explanation is that investors aren't looking at the present. They're focused on the future -- and they like what they see. Conventional wisdom on Wall Street holds that the market anticipates the effects of economic changes six months ahead, suggesting that the market bottom of Oct. 11 foreshadows a recovery beginning around April. Whatever the timing, investors clearly expect a remarkably short, shallow recession. They're not infallible, but collectively they seem to embody wisdom they may individually lack. Says James Grant, editor of Grant's Interest Rate Observer: "The question of the hour is whether the market is right. One always stands humbly before the market."

An important reason for investor optimism is the Federal Reserve Bank's vigorous efforts to reverse this recession. In December the central bank cut the interest rate it charges member banks and reduced some of the reserves it requires them to keep, freeing around $13 billion of lendable funds. It reduced its interest rates again by an unusually large 0.5% in February and pumped further billions into the economy by buying securities on the open market, causing the prime rate and mortgage rates to drop. With the central bank so powerfully stimulating the economy, betting on a downturn seemed foolish. As they say on the Street: Never fight the Fed.

Investors were also reacting to nuggets of promise among the gloomy economic headlines. An index of help-wanted advertising turned upward for the first time in five months. A survey by Chicago's Federal Reserve Bank of 28 well- regarded economists and analysts concluded that this recession could show a decline in gross national product of as little as 0.6%, vs. the average recessionary swing of 2.6% from peak to bottom. The amount of goods sitting in warehouses is extraordinarily low -- as a proportion of sales, it's the lowest in more than a decade -- and economists expect it to fall further in the next several weeks. Explains Kenneth Goldstein of the Conference Board, a national business-research organization: "Inventories are so scarce that any demand will result in an immediate injection of new production orders."

Which raises the question of where that demand might come from. The most significant drag on the economy, say managers, economists, investors and consumers, is uncertainty. People seem paralyzed, partly by the war, partly by worry over the mess in the banking industry. In a TIME/CNN poll conducted last week by Yankelovich, Clancy & Shulman, 63% of respondents said they expect the economy to get worse, vs. 31% who expect it to improve. Says John McCoy, chairman and chief executive of Ohio-based Banc One, among the nation's most prosperous banks: "The numbers may indicate a moderate and short recession, but can you believe the numbers? The issue no one knows about is the length of the war. Whether it's car dealers or retailers, everyone is just not doing anything."

Some executives insist that the war is not a serious business concern for them since their major fear -- that hostilities would multiply the price of oil -- proved unfounded. "We've never felt that war was as important as the Fed or financial markets," says Jerry Jasinowski, president of the National Association of Manufacturers. But the attitudes of individual buyers determine the shape of America's consumer economy, and they still seem tied to the war's progress. Darryl Hartley-Leonard, president of Hyatt Hotels, figures that "if the war were to end in April, there would be such euphoria that it would kick us right out of this recession."

Wall Streeters are comforted that some of the smartest investors seem to be confident. Warren Buffett, the Wall Street legend who in a lifetime has turned $9,000 into more than $3 billion, recently bought major stakes in troubled industries. He invested an estimated $250 million in Wells Fargo & Co. and $300 million in Champion International, a paper-products company. Laurence Tisch and his family-controlled Loews Corp. have sunk hundreds of millions of dollars into Bank of Boston and Continental Bank. Concludes security analyst Bruce Benteman, who tracks the nation's wealthiest stock pickers: "Everyone thinks our problems in banking and real estate are worse than they've ever been, but the smartest investors are saying these aren't anything that can't be dealt with."

Most economists prefer to stress the uncertainty in the economy, but pin them down and their consensus is that growth should resume sometime in the second quarter. Not rapid growth -- perhaps at an annual rate of only 1% or 2%. But when it comes, it will be a welcome change from the 2.1% shrinkage in the last quarter of 1990. Precisely how soon the U.S. recession will end seems to depend most on whether the war is long or short. While the answer to that one is anybody's guess, America's investors have emphatically made a judgment.

With reporting by William McWhirter/Chicago