Pessimism sparks market jitters

Last week I suggested that the party, as far as Ireland was concerned at any rate, wasn't over until we switched from champagne to sparkling wine. Since I wrote those words it seems like the party-poopers are swooping from all directions, because the economic commentary since the beginning of the year has been almost unremittingly gloomy.

Admittedly it's mainly the US that has handed back the hats, the streamers and the crackers, but everyone is getting more and more worried that they're leading the way into a year when we have to discover the virtues of the hairshirt relative to the Charvet shirt once again.

Actually, I thought that would be last year. Like everyone who worked in financial services I was worried about the excess valuations on ephemeral companies that didn't seem to have much of a market plan beyond the fact that the latest technology would be involved somehow. Every so often I was persuaded out of my gloominess and into thinking that maybe everything would be all right and I berated myself for being so negative. But now everyone has come back to earth with a bump and it's thanks to Alan Greenspan, the man who was scared by excess share valuations in 1996 and who seems to have been provoked by falling share valuations in 2001.

Despite all of the praise that has been heaped on the chairman of the Fed for his steering of the US economy over the past nine years, he wasn't able to prevent the bubble from bubbling and bubbling again in the 1990s, even with his "irrational exuberance" comments and interest rate hikes. Sometimes the only thing you can do with a river in full flow is to hope that it will hurtle down the channels you've provided, rather than flood the entire countryside.

Alan achieved that to a certain extent. But now we're waiting to see whether he'll be as good at managing the more difficult times as he was with the good times.

The biggest contribution that the Fed made to managing the good times was its policy of transparency. This meant that the market was always prepared for moves in US interest rates and acted accordingly. It limited volatility (something we've seen quite a lot of in the past few months) and it made businesses comfortable with medium term plans because they knew that there were no unexpected rate shocks on the horizon.

Rate changes only occurred at the regular Federal Open Markets Committee (FOMC) meetings. That's why I often remarked in the past that the market was never really surprised by rate moves, even ones flagged in the media as "unexpected". They may have been unexpected simply because the market itself was weighing up the possibility of one or two different dates, but everyone knew that it would be at an FOMC meeting.

Most people were pretty sure that the Fed would cut rates early this year too - but this time it truly was unexpected because it was so sudden and thus, without losing the run of myself entirely here, somewhat scary.

Sure, the initial reaction was to drive markets higher but I can just see how traders sat and looked at prices going up and thought that it wouldn't last. Of course not, when the question they were all asking themselves was "Why now, why between FOMC meetings?" The Fed itself has said that moves between meetings only happened in exceptional circumstances.

Which gave the theorists great fuel for debate. How exceptional must the decline in the US economy be to jolt the Fed into such action? They've talked about weakness in sales and production but that's not enough to satisfy most people. Those who really want to scare you are now shaking their heads and talking about a crisis in the banking system, huge losses and credit squeezes. Bank of America was under scrutiny, as that old reliable "derivative losses" was hauled out of the cupboard again, while more and more analysts are looking at the nitty gritty of the economy and trying to figure out if there's something there that the Fed knows about but they don't.

Probably not. But if a recession is on the cards in the US and that is what the Fed is trying to avoid, action between meetings has only made investors even more nervous. They might have cheered the action but they're going to remain cautious.

The interesting thing about the economy and about markets is that no matter how much forecasting we do we usually get some element of it wrong. Normally it's the timing. A sudden surge of sentiment in one direction or another can often push markets to levels by the end of a week that forecasters are targeting for the end of a year. Never underestimate the herd mentality.

Given a diet of upbeat stories promising untold riches over the past few years, it was impossible to stop investors being overconfident at the end of 1999. A few more weeks of the sort of stories we're seeing now and the purse strings will be pulled very tightly closed for the rest of this year.

Still, nobody ever gets it right. Although many of the science fiction writers over the past 50 years successfully predicted some minor elements of the future, they still got most of it wrong. None of them predicted the microchip, which has been the basis for all of the technological advances that we've made.

Nearly all of them thought we'd have electronic doors to every room in the house and compliant robots (with miles of wires, tubing and valves) to do our bidding.

When I was a child my aunt brought me to see 2001 A Space Odyssey. If the movie had predicted the future accurately I'd be looking at brochures for a holiday on the moon this year rather than two weeks in the sun on planet earth.

The only part of that movie that was chillingly correct was the notion of psychopathic computers (with or without Microsoft Windows).

It's cold, it's gloomy, it's January. But I did read a report which predicted that house prices in Ireland would rise by 10 per cent again this year. The estate agents are still holding out for the bubbly.