Job Boom Sends Wall Street Into 171-Point Tailspin

Stock prices plunged on Friday in the worst one-day decline since 1991, as news of a surge in U.S. job creation sent market interest rates soaring amid expectations of faster economic growth.

The Dow Jones industrial average tumbled 171.24 points, or 3%, to 5,470.45, although it fought back from a 217-point afternoon loss.

In the government bond market, yields rocketed more than a third of a percentage point on some securities, a gigantic one-day move that also boosted some mortgage rates to near 8% and threatened to raise other consumer interest rates in the weeks ahead.

For professional and individual investors alike, the day was a harrowing downhill ride that produced uncounted billions of dollars in securities losses--and also provided another painful reminder of how differently Wall Street and the average American view what is “right” for the economy.

The government’s report that the economy created 705,000 new jobs in February--double the number expected--panicked some bond and stock investors because it raised the specter of a fast-growing economy that could mean steadily rising interest rates and higher inflation--the biggest threats to financial investments.

Yet opinion polls recently have shown that Americans are almost universally worried that the economy is too weak and hasn’t been creating enough jobs. The issue of job growth has become a major political theme in the presidential campaign, so much so that President Clinton, speaking in Northridge on Friday, lauded the 8.4 million American jobs that he said were created over the past three years but failed to mention the markets’ plunge.

From Wall Street’s point of view, a slow economic advance has been the favored pace in the 1990s because it keeps interest rates and inflation subdued.

And because the February employment report was so strong, “it completely floored the markets,” said Gerald Guild, a senior vice president at the Advest Group brokerage in New York.

Although many individual investors take a long-term approach toward investing--one of the major reasons why financial markets have rallied so powerfully in this decade--the day-to-day moves in the markets are dictated by short-term traders who control hundreds of billions of dollars in stocks and bonds.

Investors Stay Calm

Analysts said the shock effect of the employment report immediately triggered selling by those traders, and that it cascaded throughout the day.

However, most mutual fund companies said individual investors showed little overt reaction to the markets’ mayhem Friday. Boston-based Fidelity Investments, the nation’s largest fund company, experienced only a “slight increase in fund redemptions” at the end of the day, a spokeswoman said.

Many Wall Street pros argue that the stock market’s 5 1/2-year-old bull surge, which had lifted the Dow index from 2,365 in October, 1990 to a record 5,642.42 as of last Tuesday, doesn’t necessarily have to end because interest rates are temporarily climbing.

In fact, stocks could benefit from an improving economy because that would also boost corporate profits, experts noted.

“I think individual investors’ reaction will be, ‘If we’re not going into recession, I think I’ll buy more stocks,’ ” said Alfred Kugel, investment strategist at Stein, Roe & Farnham in Chicago.

Watching the Fed

Despite the size of the Dow’s point decline on Friday--its third-largest point loss ever--in percentage terms the 3% decline did not rank even among the top 10 historically. Even so, it was the Dow’s biggest one-day percentage drop since it fell 3.9% on Nov. 15, 1991.

And the prospect of a continuing rise in interest rates could subject the recently hot stock market to further short-term selling by investors eager to cash out some of their huge profits, experts warned.

At the heart of investors’ sudden worries is how the Federal Reserve Board, the nation’s central bank, will react to the jump in new jobs reported for February.

The Fed, which controls short-term interest rates, has been cutting those rates since last July in an effort to keep the weakening economy from sliding into recession. Lower rates helped fuel a 33.5% surge in the Dow Jones stock index last year, the biggest gain since 1975.

This year, Wall Street had widely expected the Fed to continue lowering rates because the consensus view of the economy was that it was still sluggish at best.

But the February employment report appeared to belie the idea of a weak economy. Although many analysts argued that the job gain was a statistical fluke, or that the new jobs created were temporary and perhaps related to the recent severe winter weather in the East, the number was so huge that most economists said it couldn’t be downplayed.

At the very least, many experts now believe that the Fed will put off any additional interest rate cuts in the near term. The central bank will meet on March 26.

“The Fed will be on hold until further notice,” predicted John R. Williams, economist at Bankers Trust Co. in New York. “The central bank has been in a [credit]-easing mode since last July, but that period of accommodation is over.”

Yet one influential Fed official on Friday attempted to minimize the employment report’s potential impact on the Fed’s decision-making process.

Economic Signals

Robert Parry, president of the Federal Reserve Bank of San Francisco, told members of the Securities Industry Assn. meeting in Litchfield, Ariz. that the job gain was “a surprise,” but that investors would be making “a big mistake” to read too much into the numbers.

“The economy is not off course in any direction,” Parry said.

Still, some analysts say financial markets have gotten many clues in recent weeks that the economy is coming back to life.

“All of the signals have said that we didn’t have as much weakness as we thought, and that we were beginning to see somewhat of a rebound,” argued David Jones, economist at bond dealer Aubrey G. Lanston & Co. in New York.

Indeed, after diving in 1995, government bond yields have been rising steadily since mid-January as more traders have begun to question whether the Fed would need to push interest rates much lower to help ensure economic growth.

The benchmark 30-year Treasury bond yield, which ended 1995 at 5.95%, had already crept back up to 6.46% by Thursday, before soaring to 6.72% in Friday’s dramatic sell-off, a six-month high.

Some analysts said the frenzy of selling in bonds reflected the degree to which speculators have come to dominate trading in the multitrillion-dollar bond market worldwide in recent years.

Rather than invest in bonds for long periods, many investment firms attempt only to play the market’s “momentum,” bailing out of bonds as market rates begin to rise and then pouring back into the market only after rates have begun to decline significantly.

The result has been manic swings in bond yields in the 1990s: a steep decline in 1992 and 1993, a surge in 1994 and an abrupt plunge last year.

“This is kind of a symbol of who’s in charge in the bond market,” said James Bianco, a principal at Arbor Trading Group in Barrington, Ill. “The only [players] the bond market has left are the big-money guys who like to swing a lot of money around.”

Even so, the surge in yields is rooted in a fundamental fear, experts note: If the Federal Reserve begins to tighten credit to keep the economy from overheating, or if fast growth were to push inflation up from its long-subdued level of under 3%, the fixed-interest returns on bonds would be eroded.

Political concerns may be another force behind higher bond yields. As Democrats and Republicans alike in Washington have stopped talking about how to achieve a balanced federal budget, the bond market has lost hope that reduced federal borrowing in the years ahead might take pressure off interest rates, some bond market pros say.

Clinton spokesman Mike McCurry, traveling with the president on Friday, contended that there is no reason for markets to panic. Clinton believes “that the fundamentals for steady economic growth, with low interest rates, with low rates of inflation, are in place,” McCurry said. “All the necessary building blocks are there for investor confidence.”

Ripple Effects

In any case, soaring bond yields will have an impact on real people, pushing mortgage and other loan rates higher and potentially acting as a brake on the economy--whether or not the public, the Fed and the government believe such a brake is needed.

Higher rates also affect the stock market, of course. Bonds and other fixed-income securities become more competitive with stocks as yields rise, and could siphon away some of the massive sums that individual investors have been pouring into stock mutual funds over the past year in particular.

Even without significantly higher bond yields, many experts concede that the stock market is ripe for a pullback, given the phenomenal gains of the past year.

A 10% “correction” in key indexes such as the Dow would be entirely normal, and in fact is overdue, many pros say.

A 10% decline in the Dow from its record high of 5,642.42 set on Tuesday would push the index down to 5,078--back to mid-January levels.

When interest rates jumped in 1994 as the Fed tightened credit, the Dow fell nearly 10% that spring before rebounding by year’s end, then soaring in 1995 as rates fell again.

“My feeling is that even if we get a 10% correction, there still should be one more move up after that,” in this bull market, said Richard McCabe, market analyst at Merrill Lynch & Co. in New York.

He noted that for many investors who are optimistic about the economy but have been fearful about buying stocks at recent record levels, “Their initial response to this decline might very well be, ‘It’s time to buy,’ ” McCabe said.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Jobs Jump ...

The U.S. economy grew by 705,000 jobs last month, twice what many economists expected.

Signs of a rebounding economy could lead to higher inflation and rising interest rates, which are bad for stocks.

Dow by the hour

Friday close: 5470.45

Sources: Bureau of Labor Statistics, wire reports. Researched by JENNIFER OLDHAM / Los Angeles Times