Stephen Dempsey is an associate professor of accounting in UVMs
School of Business Administration. His teaching and research interests
include corporate accounting policy, financial statement analysis
and the effect of income disclosures on stock market behavior.
In addition to his research in these areas, Dempsey has been working
the past several years developing and implementing a national
income-based performance measurement system for the U.S. Postal
The past year has been a very unsettled period for the stock market.
What do you see as the key factors that go into creating this
sort of volatility?
There are probably two or three important factors at play. The
first is just plain uncertainty about the general economy and
uncertainty about where the fast-paced changes in technology are
going to take us. The many different, sometimes contrasting, signals
confronting investors lead to different perceptions about proper
stock prices. Because trading is basically about optimists buying
from pessimists, the extent to which their views differ has an
impact on day-to-day price movements. Of course, if the two camps
are widely polarized, then price fluctuations can be extreme.
A good example weve seen recently is Internet stocks. Many have
been suggesting that these stocks are way overpriced by historical
standards and that a correction is imminent. But if theres
another large group of traders out there that thinks the Internet
will completely change the way we do commerce, then they might
feel current prices are justified by long-term earnings prospects.
Its just a matter of very different beliefs about where and how
much future earnings are going to be.
A second reason for volatility has to do with liquidity pressures.
Individual investors are now playing a very significant role in
the market due to things like defined contribution retirement
plans and increased access to information and trading technology.
With the large amount of money thats flowing into the market
and the ability of individual investors to direct the force of
that money nearly instantly via computerized trading, you can
see some wild swings.
Related to this is the effect of investor psychology. A lot of
individuals are not necessarily informed traders and they can,
for purely emotional reasons, affect mood swings in prices. Some
of this has been documented in terms of overreaction of markets.
Research finds that markets tend to overreact to news one way
or the other if the news is significant.
What about the influence of world events such as the health of
Boris Yeltsin or President Clintons situation?
Events of this sort certainly have an effect on the markets, but
the degree of effect is often too large to be rational on economic
grounds. The president, of course, is simply not the central economic
force in our system of government, yet the market sometimes acts
as if he is. In terms of the current Clinton situation, you could
predict a market downfall as soon as the Lewinsky matter broke.
But why? And then you have things like the presidents confession
of sin at that prayer breakfast meeting causing the market to
shoot up, and you wonder how this could possibly be rational market
behavior. To explain those sorts of things is difficult to do.
Really, on a macro sense, the economy is like a billiard table.
There are a lot of balls on that table, and hitting one of those
balls can have a profound affect on the positioning of all the
others. But you cant necessarily predict where theyll all end
Weve been particularly influenced by global crises recently.
I think its very hard for most Americans to know how something
like the southeast Asian crisis will influence their lives.
Again, the billiard table is a good analogy. Our economy, the
southeast Asian economies and the economies of Latin America are
all interdependent. But its very difficult to interpret the end
result. For example, a lot of people were saying that the plight
of Russia shouldnt really have a big impact on us because their
economy is so small, only $900 billion or so. The total Russian
economy is about the size of the Netherlands, and their total
market capitalization is less than half the size of Microsoft
Corporation. So, yes, Russia is insignificant from that standpoint.
But when you consider that youre still talking about a military
superpower here, a country with nuclear warheads, its economic
instability is not limited to its own well-being. It very much
affects the rest of the worlds health. You cant discount Russia.
What are your thoughts on the Asian crisis?
Philippines, Indonesia, Korea, Japan
all of these economies
are experiencing their own unique woes. Many of the problems are
brought on by ill-functioning markets. The corruption, cronyism
and nepotism in some of these countries has to be addressed. You
have to make the economic system consistent with the political
systemthey have to work in concert. Democracies dont function
well with centralized markets, and free, well-functioning markets
cannot coexist with corruption and cronyism.
Japans problems are somewhat different. The banks are the primary
source of capital and they are really the primary stockholders
in Japan. Unfortunately, this makes for an inefficient allocation
of capital since the collective wisdom of a larger market isnt
at play. The banks have to clean up a mess of bad loans and are
undergoing restructuring. Many think Japans on the rebound now
after nearly ten years of stagnancy. But its economy is a huge
mass, and when you have to move a huge mass it takes a lot of
Do you think Americans will feel the impact more through the trade
disruption or the potential effect on other economies?
I think most are concerned with contagion, the domino effect.
Of course, the Asian problem gives rise to the Latin American
problem because Latin American countries are exporters of commodities
such as basic metals. So their well-being is tied to the well-being
of Asia and, of course, ours is too.
So, what we have here is very confusing to try to sort out or
predict. But problems like these are in a sense good. Its always
cleansing to have problems like this; I even look at the presidential
situation weve been through as a kind of cleansing process. Its
good to go through because you have to pay attention to causes,
and then you can correct them. So, these countries, I think, will
start improving their economic systems so that theyre more compatible
with growth and global capitalism. In Europe its happening right
now. From what I read Europe is really poised for good things
in the future.
Will they be competitive with the U.S. in the near future?
Yes, I think so. The eleven countries that make up the union are
about the size of the U.S. and their combined economy is about
the same size also. With the Euro there will essentially be no
barriers to trade. This reduces transaction costs because firms
dont have to be concerned with all the currency exchange rates
and the losses they might take. Earnings in Europe are growing
at about 21 percent compared to our earnings growth rate of about
5 percent. A lot of the things that served as our growth fulcrum
in the 80s the restructurings, mergers, and the like are taking
place there now.
So, an investor might want to consider investing in Europe?
I think that its probably wise to invest there. Its always wise
to diversify internationally as well as across different sectors
of the economy.
In the face of all the volatility of the market, whats your advice
to investors who are investing for the long term to fund their
Volatile markets are only volatile in the short run. As you take
a longer term perspective, volatility becomes less and less of
an issue. When you have volatile markets you should just stay
put, stick to it for the long run. Consistency outperforms shrewdness,
if you define shrewdness as trying to make a bunch of short-term
plays in a long-run period of time.
Investors need to make a self-assessment of how much risk they
can bear and you can bear a lot of risk if you keep your computer
turned off and the news turned off when it starts talking about
History is a good teacher because its remarkably stable. What
does history tell us about stock market performance? The average
rate of return since 1926 has been about 11 percent for large
firms and 13 percent for small firms. In that period there have
been about as many bull markets as bear markets (about twenty-three
of each). The average bear market is a decline of 25 percent,
it only lasts an average of nine months and then quickly recovers
an average of 36 percent.