Greenspan, Gust of Inflation Pummel Stocks, Spiking Fears
Twin jolts from a government inflation report and a speech by Federal Reserve Chairman Alan Greenspan triggered a broad sell-off on Wall Street on Friday, capping the stock market’s worst week in 10 years and perhaps foreshadowing something even uglier next week.
The Dow Jones industrial average dropped 266.90 points, or 2.7%, to close at 10,019.71--barely above the 10,000 mark that was conquered with a ballyhoo on March 29.
The Nasdaq stock market composite index, reflecting many of the technology giants that have carried the stock market all year, also plunged along with other market indexes.
For the week, the Dow lost 630 points, or 5.9%. That was the steepest weekly point drop ever and the worst percentage drop since October 1989. The fall left the Dow 11.5% below its Aug. 25 peak, near the 10% threshold that usually defines a correction.
The question now is whether the correction turns into an outright bear market. Investors have grown skittish this month, not the first time October has delivered punishment on Wall Street. And rather than being comforted that the Dow did not slide even further, some traders felt that the market will need to reach a crescendo of selling and perhaps panic before recovering.
Friday’s downturn was sparked by a worse-than-expected uptick in the producer price index for September and by a Greenspan speech Thursday night in which he warned that banks are vulnerable to severe losses if the financial assets they accept as collateral--stocks and bonds, basically--should suddenly plunge in value.
The hike in producer prices led many analysts to predict an interest rate increase by the Federal Reserve when its policymaking body meets next month.
The not-so-veiled reference to a potential market crash didn’t sit well with traders. They were already nervous about rising interest rates, most visible in the yield of the benchmark 30-year U.S. Treasury bond that hit a two-year high of 6.32% Thursday. That is up a stunning 1 1/2 percentage points from this time last year. A rally Friday sent the rate to 6.26%.
The stock market hates rising interest rates because they slow the economy and choke off corporate profits by raising borrowing costs.
Because Greenspan holds the big stick--the central bank’s ability to increase short-term interest rates--traders are hypersensitive to the economic indicators that they think upset him, especially signs of inflation like those contained in Friday’s producer price index.
The index showed a monthly rise of 1.1%, well above the consensus estimate of 0.5%. A number of economists explained away the increase by pointing to temporary “hiccups” in oil, tobacco and auto-component prices, but the number looked terrible to Wall Street.
“You don’t fight the Fed,” said Charles Pradilla, chief investment strategist at S. G. Cowen in New York. “He [Greenspan] controls the money and he can change the rules.”
In that atmosphere, some experts think the market has farther to fall. Friday’s sell-off was far from cataclysmic, however. Trading on the New York Stock Exchange was heavy, with more than 900 million shares changing hands, but that was well below the volume to be expected in an outright panic.
Perversely, that worried some analysts who thought the market could be floored next week by a rise in fears over the weekend or by more bad news Tuesday, when the government releases its consumer price index of inflation at the household level.
Moreover, although some regard calendar-watching as voodoo, there is no escaping the shadow of previous Octobers.
Consider the Crash of 1987, when the Dow lost a record 23% in a single harrowing day: There was bad economic news on a Friday--a failure of industrialized nations to agree to protect the dollar--and after the weekend came Black Monday.
To be sure, some Wall Streeters are forecasting a “relief rally” early next week if the CPI report is moderate.
Also, corporate earnings are coming in very strong for this quarter, which should help justify some of the high prices of certain stocks.
“We could have a bounce early next week, but if the [inflation] number is lousy, we’re going straight back in the tank,” said Peter J. Anderson, chief investment officer at American Express Financial Services in Minneapolis.
Technically speaking, it would be difficult for even a panic-stricken market to top the 1987 record for a one-day downturn. Since that crash, the New York Stock Exchange has imposed “circuit breakers” that temporarily halt trading after drops of 10% or more in the Dow.
The 10-year bull market has fattened many Americans’ nest eggs and increased their feelings of well being--a rosy glow that economists call the wealth effect--so much that they are emboldened to spend freely on cars, homes, furniture, clothes and other goods.
The spending binge is a big factor in driving the U.S. economy to the point of overheating and spawning destructive inflation--or so Greenspan and fellow central bankers believe.
The Fed chief wants to stamp out investor expectations of a perpetually rising stock market, Pradilla said, and if it takes a year or two of zero or even negative returns, then so be it.
The damage to the market already has been considerable. Because the major averages have buoyed the good performance of a handful of big-name stocks, such as Microsoft Corp., Cisco Systems Inc. and General Electric Co., it is easy to overlook what has happened to the average portfolio.
But the average financial services stock, the average transportation stock and the average small-company stock--to name just three sectors--all are down considerably for the year.
After its 2.7% drop Friday, the Nasdaq index is 6.3% below its all-time record set only Monday. Meanwhile, the Standard & Poor’s 500-stock index fell 2.8% Friday and stands a full 12% below its July 16 peak.
Some analysts expect the Fed to keep raising interest rates, perhaps as much as a full percentage point more. Since high rates on bonds draw investors away from stocks, the result could be a much deeper slide in stock prices.
“You don’t have to be a Calamity Jane--or John--to conjure up a market that goes down another 1,000 points from here and still does not look cheap by historical standards,” Pradilla said.
