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The Logic of Rally's Continuing Longevity

November 24, 1996|TOM PETRUNO

Whenever stock and bond markets are on an extended roll--as they have been lately, worldwide--Wall Street analysts and financial journalists feel tremendous pressure to come up with a specific, and simple, explanation for the rallies.

"Mass hysteria" is always a good excuse, but it's also the easiest one. Too easy.

"More buyers than sellers" is another popular explanation, except that market purists would say there's one of each on either side of any transaction.

Much more plausible, at least on the surface, is the hypothesis that we've got a "global capital surplus" today--a huge sum of money sloshing around in the world economy, with nowhere else to go but into financial assets like stocks and bonds, indefinitely.

Of course, a surplus implies that, contrary to the long-held belief that you can't be too rich or too thin, a lot of people, companies and/or nations must be too rich, because they have more capital than they know what to do with.

Last week some of those desperately rich global investors lined up to buy Russia's first bond offering since the 1917 Bolshevik Revolution. Russia had expected to sell $500 million in five-year bonds, but so many buyers put in bids--despite the country's ravaged economy and massive social problems--that the Russians happily doubled the offering, to $1 billion.

Yet there was still enough money left in the world last week to raise money market fund assets $6.6 billion to a record $898 billion, buy $30 billion in new U.S. Treasury notes, fund the $13.3-billion new stock offering from Germany's Deutsche Telekom, send the Dow Jones industrial average up 123.73 points to a record 6,471.76 by Friday, and also to drive stock markets in Hong Kong, Madrid and Stockholm, among other places, to record highs.

Global capital surplus? It sounds like a good explanation. Except that it was only three years ago that talk of a global capital shortage was all the rage.

The fear was that if the newly post-communist, all-capitalist world economy continued to expand in the 1990s, there wouldn't be enough money to go around. Interest rates would soar, stock market gains would be limited, and people would pine for the good old days when fewer options were competing for investors' savings.

Could we really have gone from capital shortage to capital surplus so quickly?

Unlikely. Indeed, many experts reject the idea that capital is ever in shortage or in excess. "There's no such thing," says Michael Ivanovitch, economist at investment firm MSI Global in New York.

He and other economists argue that, by definition, total capital demands and total capital availability are always in equilibrium, at whatever the market clearing price happens to be. In other words, if you can pay the market rate of return--whatever it is at a given moment--you can lure capital.


The reason that stocks, bonds and other financial assets have been and continue to be so popular in the 1990s is simply that investors perceive that the long-term rates of return on those assets will beat the returns on the alternatives--mainly "hard assets" such as commodities, real estate, gold, etc.

So it isn't that capital has nowhere else to go except into stocks and bonds, but that they seem to most investors to offer the best chance for long-term growth.

(It's not a coincidence that as the Dow index was streaking to new highs last week, the price of gold dropped to 20-month lows.)

The question on every investor's mind, of course, is what finally stops the global bull market in financial assets? It has been temporarily halted several times in the past six years--in 1994, notably, and last summer. And individual sectors of stocks have boomed and busted. But circumstances have yet to develop that would deal the markets overall a true death blow.

Nor can many Wall Street pros see what would produce such a blow any time soon. To ruin investors' appetite for financial assets would almost certainly require a dramatic shift in peoples' expectations on at least two major fronts:

* Inflation. Rising inflation is the greatest enemy of financial assets because it erodes money's future purchasing power. The fact that inflation rates have declined worldwide in the 1990s is perhaps the single biggest reason for financial assets' boom, because price stability gives investors the confidence they need to buy and hold stocks and bonds.

Even in once hyper-inflation-ridden nations like Brazil and Israel inflation has fallen sharply in the '90s, notes C. Fred Bergsten, economist at the Institute for International Economics in Washington, D.C. "If you look around the world, there are not very many places you see inflation" as a serious problem, he says.

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