Dow Drops 42, but There’s No Panic Selling
Following the perverse logic of Wall Street, where good news for the economy is often bad news for the market, stock and bond prices continued to tumble Monday, with the bellwether Dow Jones industrial average falling 42 points to its lowest close since last November.
But the panic selling some observers--including top White House officials--had feared would follow the long holiday weekend did not materialize. The Dow industrials plunged more than 80 points in early trading Monday, but prices recovered as some investors saw buying opportunities.
Stocks have been falling for several weeks on concerns that strong economic growth will rekindle inflation, and a glowing employment report on Friday, when the stock market was closed, sent shivers down the spines of many on Wall Street.
Inflation is the bugaboo of Federal Reserve policy-makers, who want to extend the recovery by keeping wages and prices under tight control. Indeed, the Fed is widely expected to raise interest rates further to head off inflation. At the same time, high interest rates are traditionally the enemy of the stock market, which competes with interest-bearing instruments for investors’ dollars.
Clinton Administration officials, led by National Economic Council Chairman Robert E. Rubin, spent the weekend trying to calm investors. That may have helped temper the decline in the stock market, which analysts said held up well under the circumstances, although declining issues beat out advances 2,108 to 371. The Dow closed at 3,593.35 amid heavy trading of 342 million shares on the New York Stock Exchange.
The same could not be said for the bond market, however. Prices for 30-year U.S. Treasury bonds plummeted $18.13 per $1,000, sending the yield, or effective interest rate, up to 7.40% from 7.25%--the highest rate since January, 1993.
President Clinton on Monday said interest rates--nudged up twice by the Fed in the last two months, in part with the intention of bursting the stock market’s bubble--already were too high and had provoked an “overreaction” in financial markets.
But Clinton has no direct control over the independent governors of the Federal Reserve Board, let alone investors, and many market watchers expect continued declines in both stocks and bonds, albeit nothing as drastic as the October, 1987, market crash.
“It has been such a severe three-day decline that we’ll probably get a rally sometime this week,” said Eric Miller, chief investment officer at Donaldson, Lufkin & Jenrette, a New York brokerage. “But it’s not at all assured that this is the low.”
In many respects, the recent market declines are a logical reaction to a long run-up in share prices--a “correction” in the parlance of Wall Street. Over the last several years, investors large and small have poured into the stock and bond markets, searching for higher returns at a time of low interest rates.
Now, however, many of those investors have found themselves overextended just when interest rates are going up.
The current market troubles began in February when the Federal Reserve nudged interest rates up slightly--a move that now appears mainly to have produced expectations of a further hike.
Large investment funds for wealthy investors, known as hedge funds, in many cases sustained big losses by betting against rising rates--bets largely placed with borrowed funds--and they’re now being forced to sell, driving prices down further.
Meanwhile, many other investors--including small investors in mutual funds and individual stocks and bonds--are sitting tight; they are not necessarily getting out of stocks and bonds, but they are not getting in any deeper. Thus there are few buyers of any description, a situation traders referred to as a lack of “liquidity” in the market.
“From the small guys to the big guys, the investment community has too much exposure to risk,” said Kevin Logan, chief U.S. economist for Swiss Bank Corp. “Everyone looks at the situation and says, ‘I shouldn’t buy any more at this level; I don’t know how high the Fed is going to lift rates.’ ”
At the same, recent innovations in financial services--notably the emergence of financial instruments known as derivatives, which allow professionals to pursue complex, computer-aided trading strategies across many markets at once--have rendered markets far more volatile. Price changes that might once have taken weeks to happen now occur in minutes.
Even with these uncertainties, there is little evidence that mutual fund investors, many of whom have grown accustomed to fat returns, are abandoning the market. Wall Street is hoping that remains the case, because wholesale redemptions of mutual fund assets could drive the market much lower.
But uncertainty and volatility are likely to reign for some time, and analysts will have to struggle to explain seemingly dramatic market activity.
On Monday, for example, many market participants were shocked by the steep decline in bonds, which were traded on Friday and had already fallen dramatically in response to the strong employment data.
Some attributed the fall-off to comments from the widely followed economist Henry Kaufman, who predicted that long-term bond yields could hit 9% to 10% before reaching the peak of the current cycle, though he said he expects a rally in bond prices in the near term.
Kaufman also said stock prices should not fall far in the near term because of strong underlying fundamentals, but that stocks remain vulnerable in the long term.
Still, “It is highly unlikely that the setback in stock and bond prices in the United States will truncate the current economic expansion,” Kaufman said. “This is because financial rehabilitation has gone a long way in improving the financial health of all key sectors of the U.S. economy.”
* BONDS HIT HARD: Owners of bonds and bond funds took huge losses. D1
