Changing times on Wall Street

ATLANTA -- Are the sharp declines in the stock and corporate bond markets foretelling a recession?

Not yet, says economist Donald Ratajczak, former head of the economic forecasting unit at Georgia State University. "But the trends are clearly not positive."

For one thing, consumers could cut spending more as they realize the fat gains in their investment portfolios are vanishing. That could further slow the economy, whose performance was stronger earlier this year, along with that of the stock market. Some investors see the financial markets as a leading indicator to where the economy is headed.

"If the market goes up, people feel wealthy," Ratajczak said. "They may go out and buy a large TV and replace that automobile more quickly. But if the market goes down, they may hold back getting that new computer, new software, or that new car."

The Federal Reserve, which has been boosting interest rates to stem inflation, already is betting on that. In the minutes to the Aug. 22 meeting of the Federal Open Market Committee, released earlier this month, the Fed said its staff forecast anticipates spending would be held back "by the waning and eventual disappearance of positive wealth effects associated with outsized earlier gains in equity prices."

Ratajczak also notes that some business loans, particularly those to rapidly growing technology firms, are based on the market values of those companies. "When those market values go down, those loans are more at risk," he said.

Credit quality already is deteriorating, evidenced by the lower third quarter profits posted by many banking firms.

Only last week, bank regulators said troubled large loans to corporate borrowers have increased substantially this year, with problems persisting in the health care sector and spreading to other industries.

One such loan was to Columbus-based Carmike Cinemas, which filed for Chapter 11 bankruptcy protection in August. Among its lenders were Atlanta-based SunTrust Banks and Wachovia, based in Winston- Salem, N.C., and Atlanta.

Credit ratings agencies Moody's and Standard & Poor's say that defaults on loans in the first half of this year soared to levels not seen since the recessionary years of the early 1990s.

In July, S&P said that at the current pace the default rate would stand at 2.4 percent -- a rate only exceeded by those of 1990 and 1991. Moody's said the default rate in the second quarter was the second-highest since 1991 and predicted that the rate will climb to 8.4 percent by June 2001.

Not surprisingly, prices of corporate bonds have dropped to levels not seen in about a decade.

As a result, the average yield gap, or spread, between higher- rated corporate bonds and benchmark Treasuries has grown more than half a percentage point to almost 2 percentage points, reflecting the higher yields investors are demanding to take on corporate debt.

Spreads on junk bonds, the lowest-rated debt, have grown even more, widening almost 3 percentage points this year to top 7 percentage points.

For example, the 4.5 percent convertible subordinated notes of West Point-based telecommunications provider ITC DeltaCom are now yielding more than 16 percent.

Yields spreads can only get wider as corporate bonds "seriously underperform" government bonds, said Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management in Newport Beach, Calif.

In fact, Gross, who manages about $200 billion, recommended that investors avoid corporate bonds "at any cost." He prefers Treasury bonds and mortgage-backed debt such as Ginnie Mae securities.

Largely due to the recent rise in defaults and bankruptcies, some analysts say a growing credit crunch in under way. That could further put the brakes on business expansion. And higher energy prices could, too.

Some economists note that when oil prices spiked up in 1973, there was a recession. In 1979-80, with the Iranian crisis, there was another spike in oil prices, resulting in recession.

Ratajczak doesn't think the economy will tip into recession this year or next. One reason is that he predicts energy prices will retreat.

But the economic slowdown will become more apparent this quarter, particularly in the durable goods manufacturing sector, where inventories in some cases are rising as demand weakens.

"We're going through the fourth quarter with actual layoffs and job losses to adjust for the inventories," Ratajczak says.

Ratajczak says the inventory adjustments by manufacturers aren't like to be drawn out as in the past.

"Technology has helped to make inventory adjustments quicker," he says.

The environment for stocks has changed a lot since early this year, when records were being set regularly. These are among the key differences now:

* Higher short-term interest rates.

* Higher corporate bond rates.

* Lower profit expectations.

* Lower economic growth expectations.

* Too much inventory in some industries.

* Tech stocks no longer considered immune to impact of higher interest rates.

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