Wall Street’s High Anxiety Stems From Many Sources

Wall Street opens trading today with extraordinarily high anxiety after last week’s plunge--and with few ideas about how the market’s woes can be overcome any time soon.

Overnight in Asia most stock markets initially fell on the heels of Friday’s U.S. decline, which saw the Dow Jones industrials slump 266.90 points, or 2.6%, to 10,019.71 amid soaring inflation worries.

In Tokyo, the Nikkei 225 stock index slid 288.01 points, or 1.6%, to 17,313 by midday. Hong Kong shares dropped 1.5% by midday, while South Korean shares slid 2.9% and Singapore tumbled 3.5%.

The dollar, meanwhile, rallied modestly against the yen early today, to about 105.5 yen, after a renewed slide Friday that could compound the struggles of U.S. stocks and bonds if it continues.

Last week’s dive on Wall Street, which cost the Dow 5.9%--the biggest one-week decline in 10 years--was largely fueled by the growing belief that Federal Reserve policymakers will soon have to tighten credit further to restrain inflation in the booming U.S. economy.

Those fears were magnified Friday after the government said prices at the wholesale level in September posted the biggest one-month gain in a decade.

But many analysts say stocks’ current troubles run deeper than interest-rate concerns. For one thing, the dollar’s weakness is refocusing attention on the U.S. economy’s still-huge need for foreign financing.

What’s more, Fed Chairman Alan Greenspan once again appears to be going out of his way to admonish investors about the dangers inherent in what are still historically high stock prices relative to corporate earnings and other classic valuation barometers. He used a speech last Thursday to give that warning again.

With interest rates rising, the dollar weak and the Fed chairman seemingly anti-stocks, analysts say it’s hardly surprising that the market has slumped--despite stellar third-quarter earnings reports from many companies.

Overlaying all of this, meanwhile, are worries about the year 2000 computer bug and investors’ memories of panic selling in Octobers past--including 1987, 1989 and 1998.

It was 12 years ago today that the Dow collapsed, falling 22.6% in one day, also amid rising interest rates and inflation fears.

Many Wall Street veterans, of course, say history is highly unlikely to repeat. In any case, panic selling today would trigger a series of trading halts to give investors time to regroup. Trading would be suspended for one hour if the Dow fell 10%, and another trading halt would kick in if the market reopened the same day and the Dow fell another 10%.

However stocks fare today, many investors will be holding their breath ahead of the September consumer-price inflation data to be released Tuesday morning. A larger-than-expected jump could turn up the heat on the Fed to raise its benchmark short-term interest rate, now 5.25%, even before the Nov. 16 board meeting.

“The bond market is screaming for a Fed tightening,” said Stephen Roach, economist at Morgan Stanley Dean Witter, noting the jump in long-term Treasury bond yields to two-year highs last week.

The yield on the benchmark 30-year T-bond ended at 6.26% on Friday, down from Thursday’s two-year high of 6.32%, but only because bonds benefited temporarily from a “flight to safety” as stocks were plummeting, traders said.

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Roach is most concerned about the potential actions of foreign investors, who he says are increasingly worried about the massive U.S. trade deficit.

Foreign investors fear that the dollar’s weakness this year could foreshadow a much deeper slide ahead, which would devalue U.S. assets held by foreigners--not unlike the deficit-spurred currency devaluations that ravaged Asia in 1997.

“Foreign investors have had it with the safe-haven play on dollar-denominated assets,” Roach said. Asian governments, in particular, are more inclined to consider shifting some of their dollar currency reserves into euros, he said.

“These guys are overweight dollars, and believe me, they’re all thinking about reducing their exposure to the world’s largest international debtor,” Roach said.

But if they precipitate a dollar plunge by selling U.S. securities, Asian and other foreign investors also run the risk that a market-driven slowdown in the U.S. economy, and higher bond yields, could hurt Asia’s own recovery.

Higher U.S. interest rates over a sustained period threaten to deal the sharpest blow to economies whose currencies are most closely linked to the dollar, including Hong Kong, Singapore and Taiwan.

On the flip side of the U.S. trade deficit are surpluses for many Asian nations. East Asia is in fact more dependent on the U.S. economy than it was even a few years ago given Japan’s continued weakness, so a sharp drop in U.S. import demand would hit it hard.

The U.S. now buys 20% of exports produced by non-Japan Asia. Japan buys 10%.

Still, economists say it may be possible that the region is far enough along in its own recovery to power ahead, even if U.S. demand for imports were to tank.

Given the risks not only to the U.S. economy but also to the world economy, the stakes are extremely high for the Federal Reserve.

Some experts believe that Greenspan--who speaks publicly again Tuesday, in Atlanta--is happy to see the U.S. stock market slowly deflate. That could make many U.S. consumers feel poorer and spend less, thus slowing the economy enough to erase inflation worries--potentially eliminating the need for the Fed to raise rates much more.

What the Fed doesn’t want is a U.S. market crash. But with major stock indexes down 10% to 15% from their 1999 peaks, it isn’t clear how much more will be “enough” of a decline for the Fed--or what the central bank could do if selling snowballed.