Stocks rallied moderately yesterday, helped by assurances from Federal Reserve Chairman Ben S. Bernanke that the economy remains solid and could strengthen later this year despite a warning from his predecessor about the possibility of recession.
Mr. Bernanke, calmly and deliberately confronting his first major market test since taking office a year ago, appeared to pass as Wall Street regained composure from the drubbing Tuesday that sent the Dow Jones Industrial Average plummeting 416 points.
The Dow, in posting a 52-point gain yesterday, also shrugged off fresh evidence of weak economic growth and the biggest plunge in new-home sales in 13 years. Major markets in Europe and Asia did not fare as well and posted further losses yesterday.
“We are looking for moderate growth in the U.S. economy going forward,” Mr. Bernanke told the House Budget Committee. “There has been no material change in our expectations for the U.S. economy since I last reported to Congress” in an optimistic assessment two weeks ago.
Mr. Bernanke added that the markets continue to function well. While he is “concerned” about a meltdown in the subprime mortgage market, and the Fed is monitoring the situation “very carefully,” he said he doesn’t see any impact yet on the broader credit markets or the economy. He said he thinks interest rates overall remain low and credit conditions remain liquid for both consumers and investors.
“It’s a concern, but at this point we don’t see it as being a broad financial concern or a major factor in assessing the course of the economy.”
Assuming the subprime credit crunch stays contained and the housing market stabilizes, Mr. Bernanke said he expects growth to rebound from subpar levels by the end of the year. The Commerce Department reported yesterday that growth clocked in at a subdued 2.2 percent pace in the final quarter of 2006 — far below the 3.5 percent originally estimated — and most economists expect it to stay that low or fall further in the first half of this year.
Mr. Bernanke said the report of sluggish growth is “consistent with our overall view of the economy,” but “there’s a reasonable possibility that we’ll see some strengthening of the economy sometime during the middle of the year.”
By contrast, former Fed chairman Alan Greenspan had contributed to the sell-off in the markets on Tuesday by telling Hong Kong investors that U.S. profits have peaked in a sign that the business cycle is winding down and could end in recession by year-end.
“When you get this far away from a recession, invariably forces build up for the next recession, and indeed we are beginning to see that sign,” Mr. Greenspan said in response to a question. “While, yes, it is possible we can get a recession in the latter months of 2007, most forecasters are not making that judgment.”
Mr. Bernanke appeared to exonerate Mr. Greenspan by noting “there didn’t seem to be any single trigger” of the market rout, which reverberated worldwide after starting in China on Tuesday.
New York Fed President Timothy Geithner also sought to soothe the markets yesterday, noting the “remarkable resilience” of the U.S. economy and the “exceptional liquidity” that continues to fuel growth.
A second Commerce Department report yesterday that new-home sales plunged by 16.6 percent to a 937,000 annual rate — the lowest in four years — did not shake the Fed’s official posture of confidence that the economy will skirt recession despite a marked slowdown in growth since the summer.
Some economists are not as optimistic and predict that further evidence of a deep downturn in housing and anemic growth in other sectors such as capital spending will force the Fed to reconsider and cut rates later this year.
Bernard Baumohl, managing director of the Economic Outlook Group, an economic advisory firm in Princeton Junction, N.J., agreed with Mr. Bernanke that the economy is fundamentally sound and worries about recession are overblown.
“The chance of a recession this year is no higher than 20 percent,” he said. “What triggered the drop in equity prices had little to do with economic fundamentals and more to do with what happens when investors get complacent about financial risk.”
The loose lending practices that led to record defaults on subprime mortgages and the crunch in that market are an example of the misjudgment of risks by investors who provided funding for such loans, he said. Other investors are taking risks by borrowing heavily to invest in stocks — driving margin debt levels to $285.6 billion in January — the highest level since the dot-com boom in March 2000.
“It was the classic ‘don’t worry, be happy’ market environment,” Mr. Baumohl said. “Clearly, the market was ripe for a correction.”
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