214-Point Gain Carries the Dow to a Record High
Flush with cash and newfound confidence, investors Monday slammed the door on the shortest bear market in history, driving the Dow Jones industrial average to an all-time high.
With a dramatic 70-point surge in the last 15 minutes of trading--as though Wall Street wanted to watch itself make history--the blue-chip Dow leaped 214.72 points, or 2.3%, to 9,374.27, crashing through the previous peak of 9,337.97 set on July 17.
The Standard & Poor’s 500 index, a broader blue-chip stock gauge, also set a new high.
The broad market also rose, but the gains were concentrated in groups that have led the surge of recent weeks--especially Internet issues.
The stock market has made an astonishing turnaround--both in share prices and investor psychology--since the nightmare of August and September, when markets worldwide were hit by fears of a global economic meltdown.
The Dow plummeted nearly 20% between July 17 and Aug. 31, its worst decline since the market plunge of 1990 after Iraq invaded Kuwait.
After threatening to fall to new lows for the year on Oct. 8, the Dow has rocketed, with the index gaining 21.3% since that date.
And the rebound has occurred for all the right reasons, many analysts note: Takeover mania has resurged, President Clinton’s future now seems safe, Japan has taken surprising steps to right itself, Asian stock markets have bounced back from their worst levels amid hopes that the situation there is stabilizing, and Brazil was rescued by a new international aid package.
Most important, the Federal Reserve came to stocks’ rescue with three interest rate cuts in eight weeks, the latest coming last Tuesday when the Fed trimmed its benchmark short-term interest rate to a four-year low of 4.75%.
The Fed’s rate cuts, as well as cuts by other world central banks, were aimed at halting the panic that had gripped markets in late summer and early fall in the wake of Russia’s ruble devaluation, fears that Japan’s banking system would collapse and the spread of the Asian economic crisis to Latin America.
In recent decades, falling interest rates have been one of the most powerful catalysts for higher stock prices by stoking the economy and making competing returns on bonds and bank CDs look inferior to holding stocks.
Yet for the Fed, in large part the architect of stocks’ resurgence, the new ebullience on Wall Street is something of a mixed blessing, many experts say.
Investors Brush Warnings Aside
Next week marks the second anniversary of Fed Chairman Alan Greenspan’s famous “irrational exuberance” speech--on Dec. 5, 1996--in which he questioned whether soaring stock valuations could create a bubble that would burst in investors’ faces.
Since then, the Dow has climbed an additional 2,937 points, or 46%.
More ominously, the S&P; 500 blue-chip stocks are now selling at an average of 24.5 times next year’s estimated earnings per share--the highest price relative to estimated earnings in the 31 years that market-watching firm First Call Corp. has kept such records, and perhaps the highest ever.
“If you’re rooted in valuations, this market is fundamentally riskier than it was in mid-July,” said Richard Cripps, chief strategist for Legg Mason & Co.
Do the economic and interest rate fundamentals justify stocks at these levels? Many experts say they don’t. But they also concede that the thing this market has done best in the 1990s is defy history.
The summer bear market, as measured from July 17 to the Dow’s low on Aug. 31, lasted just 45 days--the shortest ever, according to Ned Davis Research.
With stocks’ rebound, perhaps nothing better represents the “exuberance” that Greenspan warned of than what’s happened with Internet stocks--a corner of the market that is dominated by individual investors.
Yahoo Inc., the popular Internet search service, for example, gained an additional $30.44 to a record $221.44 on Monday in Nasdaq trading. It’s up nearly $200 a share from this time last year and now has a total market valuation of $21.8 billion--more than 105-year-old Sears, Roebuck & Co.
The Internet mania, in fact, illustrates an overlooked theme of this stock market rebound: Most individual investors never lost their nerve.
Small investors by and large stayed in the market, as was demonstrated by the lack of significant outflows from mutual funds even after the Dow dropped 512 points on Aug. 31.
It was the big institutions that showed the greatest fear when the market was rocked by Asian financial turmoil, the ruble devaluation and worries that scandal might drive Clinton from office.
Indeed, the near-collapse of Long-Term Capital Management, a so-called hedge fund, on Sept. 24 focused Wall Street and the Fed on the mounting reluctance of many large investors to put their money to work in higher-risk securities that they had been snapping up with abandon just months before.
The Fed, in making its first rate cut Sept. 29, indicated great concern about big investors’ sudden risk aversion, and the chance that it could snowball into a massive global credit crunch, choking off business and government access to capital and triggering recession.
Those worries were also cited when the Fed made its second cut, on Oct. 15, a move that took the markets by surprise.
Last week, when it cut rates a third time, the Fed again cited concern about risk perception among investors and the need to protect the financial markets from further “unusual strains.”
But as the Fed has pushed rates down, some critics have charged that it is feeding a stock market that has become addicted to lower rates--and which expects to be rescued from any and all troubles by the central bank.
Those critics contend that the U.S. economy has remained healthy all along and that the market crisis of late summer was a Wall Street problem more than a Main Street problem.
“I don’t think the Fed’s reason for existence is to take care of the market’s expectations,” said Anna J. Schwartz, an economist at the National Bureau of Research and a member of the Fed-watching Shadow Open Market Committee.
She and other critics say the Fed should focus on price stability and the “real” economy and let the markets take care of themselves.
If Wall Street starts expecting a bailout whenever stock prices start to flag, these analysts say, it increases the pressure on the Fed to appease the markets and pulls the central bank further away from its basic mission.
Many analysts, however, don’t see it quite that way.
The reason the market has rebounded so smartly is that political and fiscal authorities worldwide--including the Fed--have finally started to show some leadership, said Jack Shaughnessy, investment strategist at Advest Group.
He said it makes sense that investors are “much more brave” now that the Fed and other central banks have cut rates, Congress has funded the International Monetary Fund, Japan has advanced a plan to solve its banking problems and U.S. voters have apparently eased the pressure on Clinton.
Purely from an economic view, the Fed’s latest cut was a “flu shot against recession” in 1999, said Christine Callies, chief investment strategist at CS First Boston.
If there was any lingering fear that the economy would turn down sharply next year, the Fed’s cuts, by keeping money and credit flowing in the economy, should erase that worry, she said--barring another major shock from abroad.
And for many investors, the most important lesson of the 1990s has been that as long as the economy continues to grow, and interest rates remain tame, U.S. stock prices don’t stay down for very long.
* MERGER MANIA: Nine $1-billion-plus corporate marriages are proposed. C1
* STREET SMART: Investors should ask themselves why before buying. C1
