Inflation Signs Drive Dow Into 148-Point Skid
Fresh economic data pointing to continuing vigor in the American economy--and perhaps higher inflation--sent interest rates surging Friday and stock prices plummeting, deepening Wall Street’s woes.
The Dow Jones industrial average tumbled 148.36 points, or 2.3%, to 6,391.69, the fourth 100-point-or-greater decline since mid-March and enough to wipe out the last of the closely watched index’s year-to-date gains.
More important, stocks’ latest slide leaves the Dow off nearly 9.8% from its record high of 7,085.16 set on March 11, and is fueling increasing talk that the 6 1/2-year-old bull market may be on its last legs.
“Goldilocks is dead,” said Gail Dudack, market analyst at UBS Securities in New York, referring to the “Goldilocks economy” of the last two years--growth that was neither too fast nor too slow, but just right to keep corporate earnings advancing and inflation subdued.
The Federal Reserve Board’s decision to raise short-term interest rates by a quarter of a point on March 25, the first such credit-tightening move in more than two years, was a wake-up call for investors who believed that the economy’s moderate pace could continue indefinitely, Dudack said.
Since then, stock investors have focused not only on the negative effects of higher interest costs on businesses, but on the chance that the Fed will have to raise rates much more than was expected to slow the economy again.
Friday’s economic data reinforced those concerns, analysts said. In one report, the government said retail sales rose 0.2% in March, slower than expected.
But in the same report the February retail sales gain was revised upward to 1.5% from an initial estimate of 0.8%. Sales had jumped 1.7% in January.
Combined, the data pointed to much more robust consumer spending in the first quarter than most economists had anticipated.
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“The consumer looks so darn strong,” said James Glassman, economist at Chase Securities in New York. Moreover, he said, consumer spending is merely tracking healthy gains in personal income, as wage gains have improved during the past year thanks to the tight labor market in many parts of the country.
While economic growth and meaningful wage increases naturally are good news for workers, Federal Reserve Chairman Alan Greenspan has warned that the central bank is concerned about the potential for higher price inflation fueled by strong wage gains and higher consumer spending.
The Fed’s primary job is to keep inflation subdued, because an upward spiral in wages and prices can feed on itself and severely undermine the economy’s long-term health.
With that in mind, the second economic report Friday was exactly the kind of bad news Wall Street fears most: a sign that inflation might be picking up.
The government said the “core” rate of inflation in March at the wholesale level--excluding volatile food and energy prices--rose 0.4%, well above expectations.
Although some experts said the number was skewed by higher tobacco prices, that did not mollify bond investors: The yield on the 30-year Treasury bond, a benchmark for long-term rates in the economy, jumped to a nine-month high of 7.16%, up from 7.10% on Thursday.
Investors push bond yields up when they fear higher inflation because inflation erodes the value of fixed-return investments like bonds.
Investors also assume that if inflation is accelerating, the Fed might tighten credit substantially to brake the economy--meaning that short-term interest rates could rise much more, in turn pushing up longer-term rates.
Meanwhile, higher interest rates have historically been the stock market’s worst enemy. Hence, the Dow index has fallen 514 points just since the Fed began raising rates on March 25.
Still, analysts note that the stock market’s slide thus far has shown no indication of panicked selling by either institutional investors or individual investors in mutual funds.
Even in Friday’s market plunge, trading volume on the New York Stock Exchange was a modest 442 million shares.
Many economists believe that first-quarter economic activity won’t be sustained. The economy’s pattern in recent years has been to grow in fits and starts, with sharp bursts of activity followed by relatively slow growth.
“Economic growth undoubtedly will slow in coming months from the first quarter’s unsustainable 3.5% to 4.5% [annualized] pace,” said Gary Schlossberg, economist at Wells Capital Management in San Francisco.
But he said the odds still favor additional Fed rate hikes, perhaps as much as half a percentage point in total. That would raise the Fed’s benchmark short-term interest rate to 6% from 5.5% now.
How the stock market might respond to still-higher interest rates isn’t clear. But the lack of heavy selling in the market’s latest decline, with the Dow index down nearly 10% from its peak, is worrying rather than comforting some veteran analysts.
Because the Dow also dropped about 10% last summer, then quickly rebounded, investors may be assuming the same pattern will hold this time.
That may mean that investors will be psychologically unprepared if stock prices continue to slide from here, even if slowly, said Arnold Kaufman, editor of Standard & Poor’s Outlook investment newsletter in New York.
“As long as trading activity remains light you have to assume that this decline will go on,” he said, as marginal sellers continue to chip away at stocks after racking up stunning gains over the past 6 1/2 years, while buyers remain hesitant in the face of higher interest rates.
Analysts also warn that the stock market faces a challenge now that it has not faced in three years: the likelihood that corporate earnings growth will continue to slow.
Robust earnings were a key prop for the market from 1993 through 1996, as many companies reaped the benefits of extensive restructurings and efficiency gains.
But this year, even with the economy’s strength, earnings gains are expected to be fairly modest for many major companies.
For one, the dollar’s recent strength against key currencies such as the Japanese yen and German mark is crimping sales and earnings of U.S. multinational companies, while giving their foreign competitors a pricing edge in the United States.
Kaufman, noting that the Dow rocketed 85% between Jan. 1, 1995, and its March record high, said he believes that stock prices simply got far ahead of underlying earnings growth during the past two years, and that investors are just now coming to grips with that realization.
“This is not an earnings-supported market anymore,” he said.
The major question now is whether stocks are merely in a “correction” phase, wherein key indexes could drop another 5% or so, then stabilize; or whether this is the start of a true bear market, in which the Dow and other indexes would be expected to lose at least 20% from their peaks before bottoming.
“Is this the start of something bigger? The verdict is still out on that,” said Philip Roth, an analyst at brokerage Dean Witter Reynolds in New York.
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What is untested, analysts note, is the willingness of millions of small investors who entered the market via mutual funds in recent years to stay put if their funds begin to rack up substantial, if temporary, losses.
In March, as the market dropped, fund investors reduced their net purchases of stock funds to an estimated $8.5 billion, the lowest monthly total since last summer, according to the Investment Company Institute, the mutual fund trade group.
Still, that represents an inflow of cash, not an outflow.
But because most stock fund investors have only been in the market since 1990, they have never experienced even a 15% decline in major stock indexes.
That worries some analysts, who say investor psychology never changes in the long run--and that at some level of decline, many people will be frightened into bailing out.
Fund investors “are not going to be very happy if this market drops 15%,” predicted Glen King Parker, editor of Market Logic newsletter in Deerfield Beach, Fla.
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Interest rate increases seen slowing soon. D1
