The Pendulum Economy

By Daniel Kadlec

If you're worried about your investments because interest rates seem to be moving higher, get over it. Ordinarily, the prospect is worth fretting about. Rising rates can take the steam out of corporate profits, the stock market and the whole economy. But the rate jitters that surfaced last week are actually good news. They represent just the latest swing in a highly emotional market that for three years has thrived on alternating fears about which way the economy would grow: too fast or too slow. As long as the pendulum doesn't swing too far in one direction, your nest egg is safe--from the interest-rate monster anyway.

There are other reasons to worry, and I haven't been shy (though, you may conclude, I haven't been right) in citing them. Lofty stock valuations, untested shareholders and heavy insider selling are among my concerns. On the interest-rate front, though, there seems little cause for worry. The new jitters stem from modestly robust economic figures that suggest a rate increase is in order to slow the economy, and rumors that Federal Reserve chief Alan Greenspan is leaning that way. So what? Six months ago, Asia was falling apart, and everyone thought the economy would sag so much that the Fed would cut rates. Six months before that, the economy was looking brisk, and the Fed did in fact nudge rates higher. But only a year before that, the economy looked anemic, and the Fed was cutting rates.

Back and forth go the worries, while in reality the economy has been riding a fine line of perfection: slow growth, low inflation, steady profits. In retrospect it's clear that the constantly reversing worries were a signal that there was nothing to worry about. Bearing that out are stock market gains averaging 31% a year since 1995. One day there will actually be a problem, and rates will move up to crush inflation or down to rub out a recession. Either way, stocks will take a beating at some point in the cycle. But we're not there now. Inflation is asleep. You can almost hear it snore. There's just no reason for Greenspan to push rates higher. He knows it, and that's why he has made only one rate move in two years--remarkable inaction for a man who worries famously about "asset inflation" leading to a bubble economy. Yes, Greenspan may bump rates up just to prove he can do more than talk. But any such move would be isolated--like the one a year ago--not a series, which is what the stock market can't stand.

Investors may be warming to this notion. The Dow, having plunged last Monday, was levitating by Friday. In another sign that the market's pendulum of emotions remains firmly balanced, Wall Street's view on the too-hot, too-cold question is as divergent as ever. Merrill Lynch rushed out a report saying profits are in trouble and interest rates must surely decline. Goldman Sachs discerns continued bliss as far as the eye can see. Morgan Stanley Dean Witter is convinced that inflation and higher rates are just around the bend. That's all I need to hear. There's enough muscle on both sides of the hinge to keep any momentum from carrying too far. I'll worry when the pros all line up on one side.

Daniel Kadlec is TIME's Wall Street columnist. Reach him at [email protected]