Despite today’s impressive NASDAQ bounce-back from its opening 140-pont plunge, the roller-coaster ride in high-tech equities is unlikely to have run its course just yet. Notably, the NASDAQ’s recent slide, down 12% since mid-July after posting a 35% recovery from its May lows, has been accompanied by a significant ratcheting-down of Fed tightening expectations. Barring a blow-out employment report tomorrow, the Fed is all but certain to forego action at its session later this month, and at this point seems increasingly unlikely to unfurl its rate-hike dagger again this year. That was underscored by surprisingly dovish remarks yesterday by Fed Governor Laurence Meyer, leader of the Fed’s Phillips-Curve hawks.   

The absence of explicit “Fed fears” in explaining the decline is no source of comfort.  It suggests that the oft-decried “excess demand” has indeed been wrung out of the economy, a point driven home by the string of technology leaders warning of the evaporation of expected “excess” earnings. For the tech bellwethers grouped in the NASDAQ 100, with an average p/e ratio of 150, even a “soft-landing” to 3.5-4% GDP growth could entail a painful rediscounting for forward growth expectations. Importantly, though, it’s not only the New Economy high-fliers that have been caught in the recent downdraft. The Russell 2000 small-cap index, sporting a much more prosaic average p/e of about 20, is down nearly 10% from its mid-July levels, an indication that a scaling back of expected growth is impairing the market’s overall risk tolerance. This would tend to be confirmed by the fact that only the Old Economy, low-risk Dow Jones average has been left unscathed. A sustained period of heightened risk aversion would not only reflect expectations of slower growth, it would also directly contribute, raising the cost of capital to levels inhibiting productivity-enhancing, entrepreneurial innovation.

That said, and although the equity market volatility likely signals a period of less vibrant expansion going forward, there also can be no doubt that the U.S. economy continues to exhibit impressive stores of fundamental strength. The stronger-than-expected 5.2% gain in second quarter GDP, for example, looks to have been attributable almost entirely to productivity increases arising from the investment boom in high-tech, labor-saving capital equipment. Confirmation should come in next week’s release on productivity and labor costs. Although completely overlooked by mainstream analysts and their media organs, this impressive finding on GDP appears to have found its way to Larry Meyer, who told a group in Anchorage this week: “The economy is different from what it was in the past. It is capable of growing faster on a sustainable basis than it was, it is capable of operating at higher utilization rates and lower unemployment rates without higher inflation.”   

EURO OK. The euro’s drop to just above $.90 is more a matter of a hardening dollar than a softening euro, and has likely come close to running its course. In the short run, the euro’s decline amounts to a penalty on the dollar value of European investment returns. From a somewhat longer-term perspective, though, it could present an opportunity for dollar-based portfolio investors to gain an exchange-rate discount on purchase of European assets.

In the midst of the European common currency’s slide from recent highs above $.95 in late June, the euro on net has remained stable in gold terms, at around 300 per ounce. At the same time, dollar gold has declined from just under $290/oz. to below  $274.  Perceived “weakness” of the European unit of account, in other words, has simply reflected appreciation of the dollar in real, commodity-based terms.

The currency’s current position carries little inflation risk, as euro gold remains within 5% of its five-year average price around 285 per ounce. Rising statistical inflation in Europe is primarily non-monetary in nature, reflecting higher oil prices and climbing returns to productive assets (particularly real estate) in previously static euro-zone economies such as Ireland and Spain. At this point European markets are viewing the recent euro/$ volatility with studied equanimity. The yield differential favoring the Benchmark 10-year German bund relative to its U.S. Treasury counterpart has actually widened modestly, with German paper now yielding about 85 basis points less than U.S. That may represent a bet that, going forward, odds favor the European currency showing a bias toward strength rather than weakness against the greenback. As it is, growth within the EU this year is expected to accelerate to at least 3.5% y-o-y, up from last year’s average growth rate of less than 2.5%.  While the U.S., at least for now, might continue to post a higher absolute level of expansion, a narrowing of the growth differential should tend to boost relative demand for the currency. Moreover, with momentum for supply-side tax cuts building across the continent, expected returns to capital within the euro-zone should be getting a lift, attracting further euro investment demand.