Stock-Market Tumult
Economists, pundits, politicians, and investment gurus have had almost two
weeks to explain the Oct. 27 stock-market dive. There are plenty of theories.
Here is the assortment in descending order of optimism.
1 Irrelevant Blip: The most bullish of the bulls tout
the "New Paradigm." Old laws of economics have been eclipsed by recent
breakthroughs in technology and productivity. Now there is no limit to upward
growth, only momentary breaks for the market to catch its breath. The bulls
cite evidence of the economy's continued strength--the low budget deficit ($22
billion), steady GDP growth (2.5 percent projected for next year), and strong
third-quarter earnings reports. As of this writing, the Dow Jones industrial
average is still up more than 15 percent for the year.
2 Necessary Correction: Most observers agree with
Federal Reserve Board Chairman Alan Greenspan that the dive was a healthy
reaction to overvalued stock prices. Pre-dive, the 500 stocks tracked by
Standard & Poor's index sold at nearly 20 times the next year's anticipated
earnings. Post-dive stock values, the Greenspan caucus predicts, will be closer
to traditional multiples of 12 to 15. Greenspan also predicts the crashlet will
have a "salutary effect" of reducing consumer confidence, which in turn will
cause the economy to grow at a slower, more sustainable rate with little
inflation.
3 Irrational Traders: The crash reflects the anxieties
of Wall Street traders, not the economy's weakness. Reams of studies by
psychologists show that emotions, not economic calculations, determine investor
behavior in a volatile market. The cliché is that traders and investors move as
a "herd"--once the bears reach a critical mass, the entire market panics.
4 Myopic Managers vs. Shrewd Small Investors: Most
pundits blame the crash on panicky mutual-fund managers, who unloaded massive
amounts of stock Oct. 27. Most credit small investors, who bought more stock
during the week after the crash, with fueling the recovery. The typical
American investor has "guts of steel," declared the Washington Post .
5 Hyperbolic Media: Journalists created bad vibes with
their wave of stories about a) how the market had topped and b) the
10 th anniversary of the 1987 crash. (See the Economist 's Oct.
18 cover story, "Crash, Dammit.") Television heightened the panic by
interrupting broadcasts to update "Market Mayhem" (ABC). Critics especially
point to the widespread publication of remarks by Morgan Stanley analyst Barton
Briggs that the market had gone bearish. Flip side: The media gets credit for
giving a platform to bulls like Goldman Sachs market strategist Abby Joseph
Cohen, "our spiritual guide," whose recommendations "helped the market change
direction" ( U.S. News & World Report ).
6 Options: The downward acceleration produced by
option-linked selling (the current substitute for the "portfolio insurance"
that was a prominent factor in the 1987 crash) is blamed by some analysts for
as much as 30 percent of last month's slide.
7 October: No serious market analyst believes that
there is something about October that tends to spook financial markets. But the
fact that so many past market mishaps have happened during October (some
famous, like the 1929 and 1987 crashes, others familiar only to insiders) makes
traders jittery because they're afraid that everybody else is
superstitious.
8 Circuit Breakers: What would have been a minor dip in
the market became a major one when automatic trading halts--"circuit
breakers"--were invoked at the depth of the dive. (See last week's "Gist" on
"Stock-Market Circuit
Breakers.") Instead of calming jittery investors, the two mandated breaks
induced more panic, and were portrayed by the electronic press as evidence of a
major crash. Traders unloaded stock for whatever they could get between the
breaks, fearing a shutdown would prevent them from executing sell orders. Under
current rules, the first circuit breaker kicks in when the Dow falls 350
points. That yardstick is too conservative, say critics, because it was
instituted when the Dow stood at about 2,300, compared with today's 7,600. The
New York Stock Exchange may raise the circuit-breaker threshold.
9 Alan Greenspan: The market tumbled in anticipation
of an economy-cooling rise in interest rates at the Fed's upcoming meeting.
Rumors about the Fed's intentions swept Wall Street the week prior to the drop.
Greenspan is also faulted for not
reducing interest rates to spur
growth as inflation has slowed: Adjusted for inflation, rates stand at 3.3
percent today, compared with 1.98 percent last December. After the dive,
Greenspan was universally lauded for putting a happy face on the market in
congressional testimony. Greenspan's performance was likened to his calm
approach in 1987, which some say halted the market slide.
10 Obsession With Profits: The stock market's
unhealthy fixation on expected earnings led many executives to exaggerate
balance sheets through accounting tricks, distorting true stock worth. The
market recognized this and adjusted. Also, disappointing earnings reports from
Intel and other blue-chip companies in the two weeks leading up to the crash
caused investors to question the value of entire portfolios.
11 East Asian Trade: Many trace the dive to economic
slumps in Malaysia, Thailand, the Philippines, and Indonesia--which together
buy 4 percent of all American exports. Dependent on a steady stream of foreign
investment to finance their large trade deficits, the Thai and Malaysian
governments were forced to devalue their currencies, making their exports
cheaper in foreign markets. In the short term, U.S. consumers will benefit from
cheap imports (as will U.S. multinationals that use parts made in East Asian
factories). On the other hand, American companies may have to lower their own
prices to compete with Asian products. Such deflationary pressures, pessimists
note, set off the Great Depression.
12 Robert Rubin and the International Monetary Fund:
Blame goes to Treasury Secretary Robert Rubin and the IMF for not helping the
East Asian nations stabilize their currency the way the United States and the
IMF came to Mexico's aid during the 1994 peso crisis. In response to criticism,
last week the U.S. government guaranteed a $3-billion loan to Indonesia.
13 U.S. Recession: Some argue the crash
was the announcement of a long-overdue U.S. recession. An especially ominous
sign is the lower-than-expected earnings of supposedly booming companies like
Intel, Boeing, and Sun Microsystems. There are also new reports of increased
bankruptcy filings--up 5 percent this year--and predictions that growth will
slow to 2.5 percent, down one percentage point from the previous year.
Conditions are said to resemble those in the months prior to the early '90s
recession. This theory for the stock plunge of Monday would not, of course,
explain why stocks soared back Tuesday.
