The Dow Jones industrial average’s record 86.61-point plunge Thursday appears to vindicate the view of those market watchers who believe that stocks have become more volatile than ever--and far more treacherous for individual investors.
“I’ve been saying for some time that I wouldn’t be surprised to see one-day moves of 100 points in the Dow,” said Robert Kahan, director of trading at the Montgomery Securities brokerage firm in San Francisco. “We almost got it today.”
Traders cite several reasons for the likelihood that the market will continue to see one-day point swings that would have been considered unheard-of just a few years ago.
For one thing, the Dow, which closed at 1,792.89, remains high by historical standards. As a result, a plunge of Thursday’s magnitude, while frightening, seems a lot less dramatic in percentage terms. Thursday’s decline reduced the Dow’s value by 4.6%--but still left it 15.9% above where it began the year.
By contrast, a one-day decline of nearly 35 points during a confrontation between President John F. Kennedy and the nation’s steel makers in May, 1962, sliced 5.7% off the Dow’s value, bringing it to 576.93. And the Dow lost 6.5% of its value one day in September, 1955, on news that President Dwight D. Eisenhower had suffered a heart attack.
1929 Drop: 12.8%
The Dow’s largest percentage decline in history was Oct. 28, 1929, when the widely followed indicator crashed 38.33 points, or 12.8%, to 260.64, heralding the start of the Great Depression.
But the most important factor responsible for the new volatility is the increasing prominence of institutional investors--pension funds, mutual funds and the like who are responsible for 70% of trading on the New York Stock Exchange--and the proliferation of such new investment devices as stock-index futures contracts.
These futures contracts are devices that allow professional money managers to protect themselves against the possibility of sharp swings in the marketplace and to lock in the value of their investments. Ironically, these futures contracts have contributed to the wild stock price swings because they have led to what is known on Wall Street as “program trading.”
The futures contracts essentially assure money managers and other investors of guaranteed prices for a portfolio of stocks, regardless of where the stock market goes. The value of those futures contracts is based on stock indexes; the indexes reflect the prices of hundreds of stocks. But on occasion, the futures contracts may sell at a substantially lower price than the stocks on which their corresponding index is based.
Traders Spot Gap
That happens when investors are particularly bearish, and it happened Thursday. Traders discovered that prices on futures contracts were considerably lower than the prices of individual stocks. So they bought up the futures and sold the stocks, with the price difference representing guaranteed instant profit. Their sales triggered a decline in the overall market and touched off a selling frenzy.
“In this information age, everything has become more and more compressed,” says Carol Murrow, a market strategist with the brokerage firm of Piper Jaffray Hopwood in Minneapolis. “Analysts have quicker access to information, and computers allow for program trading and instant technical analysis. It’s a much faster market, much more volatile.”
Against this background, “it is becoming almost impossible for the little guy to compete” against the professionals who can rely on more sophisticated investment tools, says Kahan of Montgomery Securities. “The best advice to the little guy who wants to invest in the market is to put his money in a mutual fund and let a big guy run it for him,” Kahan adds.
Kahan sees the market “working its way lower” in the days and weeks ahead. “It is not unusual,” he adds, “for selling to beget selling.”
Another analyst with a bearish view, Alfred Goldman of A.G. Edwards & Sons in St. Louis, says Thursday’s action was “official confirmation that we are going into a meaningful decline.” Says Goldman: “The market has had a party for four years. Now we’re going to pay with a hangover.”
But Jay Richardson Massey, president of the Philadelphia investment firm of Addison Capital Management, remains bullish. “We remain in a long-term bull market that will continue well into the 1990s,” he says, projecting market gains averaging 13% a year for at least five years.
With interest rates still low, stock market investors will be amply rewarded for taking a risk, Massey adds. “We will look back from 1991 and 1993 and wonder why we were even worried about 150-point or 200-point corrections.”