Toshio Matsuda, Commentator & Intl Economist

Straight from the Shoulder No.470

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Stock prices in Japan and the United States have been on the rise of late. Stemming from observations that the subprime loan problem has turned the corner, the risk of the U.S. economy sliding into much feared recession territory has eased and other views, this is ultimately said to be the result of funds beginning to move from the bond market into stocks.

It is important to understand, however, that even if capital flows from bonds into stocks, the net rise in overall financial assets is zero. In other words, adding up the losses in assets from declines in bond prices and the gains in assets from upward moving stock prices produces a net increase of zero. Therefore, entertaining a sense of security in the U.S. economy because stock prices have continued to climb in recent months is a reckless route at best.

Drawing judgments on the state of the U.S. economy demands scrutiny of the domains of consumption and employment. Both corporate performance and the gross domestic product (GDP) depend completely upon spending and jobs. In this regard, the housing price index for the January-March quarter fell by more than 14% compared to the same three months last year, and shows no signs of leveling off.

As I pointed out in this column the issue before last, sales of the “Big 3” automakers (General Motors, Ford and Chrysler Motors), core members of the U.S. manufacturing industry, have been in a tailspin of late, with announcements of a considerable number of layoffs expected soon. At the same time, the price pass-through from the rising costs of crude oil and raw materials has supported a sustained increase in consumer prices as well, with the interest on the 10-year government bond, the benchmark of long-term interest rates, climbing above four percent at last. With a continued tightening in U.S. family finances linked to major hidden asset losses from the crash in housing prices, the higher cost of living and fears of worsened job loss, the chances of an upward swing in consumption right now can pretty much be described as nil.

While the Federal Reserve Board has continued to cut interest rates as an antirecession policy, the U.S. economy now finds itself up against runaway inflation. The Fed, meanwhile, finds itself between a rock and a hard place, in that it can neither hike nor lower interest rates as things stand now. This leads us to the question of what to make of current robust state of stock prices against the backdrop of such realities in the U.S. economy?

The inevitable conclusion is that, for investors, the “sense of security” fostered by rising share prices is a definite danger.

In the previous edition of this column, I furnished a layman’s summary of upcoming economic trends in Japan and the United States through August, including industries likely to chart growth from here on (namely, the solar energy sector). I will be pleased if this information serves as a useful reference for those active in stock investing as well.