"Wild Day Leaves Dow Under 8000"
Losses Raise Fear of Damage to Economy
By Steven Pearlstein
Washington Post Staff Writer
Tuesday, July 23, 2002; Page A01
Another roller-coaster day on global stock markets yesterday left the Dow Jones industrial average below the 8000 mark and economists wondering aloud if the plunge in share prices will bring the real economy down with it.
After a day of heavy trading that saw the blue-chip index swing nearly 400 points during the lunch hour alone, the Dow finished the day off another 234 points, or nearly 3 percent, at 7784.58. Other broad indexes fell to a similar degree, extending a sell-off that has trimmed $1.5 trillion from the value of publicly traded stocks in just the last two weeks, and $7 trillion since stock prices peaked more than two years ago.
The selling yesterday was broad and, at times, indiscriminate, reflecting a massive retreat from stock ownership by individual investors, who have withdrawn more than $30 billion out of stock mutual funds over the past nine weeks, according to AMG Data Services, which tracks fund flows.
The Gallup Organization, meanwhile, said investor optimism has plunged in July to an all-time low.
Pessimism has also spread to European markets, where a broad sell-off has already put major insurance companies on the brink of technical insolvency and threatens to snuff out what was the beginning of a stock-owning culture among the middle class. Leading indexes fell by nearly 5 percent yesterday in London and more than that in Paris and in Frankfurt, Germany.
"Investors are unwilling to try to catch the falling knife," said Thomas Galvin, chief investment officer for Credit Suisse First Boston, reaching into the bag of familiar Wall Street metaphors.
Sunday's announcement by WorldCom Inc. of the biggest corporate bankruptcy filing in U.S. history no doubt contributed to yesterday's sour mood by reminding investors and traders that the fallout from accounting scandals is far from over, with more revelations, indictments and bankruptcies almost sure to follow.
Just yesterday, for example, stock in BellSouth Corp. fell 18 percent after the regional phone monopoly announced that its second-quarter earnings had fallen 67 percent because so many customers are disconnecting their second phone lines and businesses are cutting spending on data transmission. BellSouth is also owed millions of dollars by WorldCom for using its local network to complete long-distance calls. The news dragged down other phone stocks as well.
Investors also hammered the stocks of two of Wall Street's leading investment banks, Citigroup Inc. and J.P. Morgan Chase & Co., on the eve of Senate hearings into the firms' role in helping Enron Corp. hide its deteriorating financial condition from investors and rating agencies.
Market analysts yesterday were careful not to make any predictions on when the bear market might reach bottom.
The throw-in-the-towel sentiment voiced by growing numbers of individual investors sounds to many like the kind of capitulation that is considered necessary before a new bull market can begin.
But analysts warn that just as momentum was able to carry the markets upward for months at the end of the 1990s even after it was clear to many that stocks were grossly overpriced, the same kind of effect can be expected as stock prices fall.
Others, such as Richard Bernstein of Merrill Lynch & Co., also argue that, even at these levels, stocks remain overpriced when measured against historic averages and the level of current corporate profits.
Among economists, there is also a debate raging over what effect the economy is having on the stock market, and the market on the economy.
The optimists argue that the market and the economy have essentially disconnected from one another in the wake of corporate scandals that have focused investor attention on the reliability of financial statements and the ethics of corporate officials rather than the unmistakable rebound in corporate profits this year. As a result, the stock market, for now, cannot be counted on as a reliable predictor of economic activity.
"The market's performance is no reflection of the economy," declared Merrill Lynch's bullish forecaster, Bruce Steinberg, who predicted that the economy would grow at a robust 4 percent annual rate during the second half of the year.
Steinberg and others acknowledged late last week that the plunge in equity prices would dampen consumer spending and discourage businesses from hiring more workers and making investments in new equipment.
But Steinberg argues that most of those drags on the economy will be offset by the salutary effect of rising home prices and the drop in interest rates that has resulted as stock-weary investors move their money to the relative safety of the bond market. Because rates fall as bond prices rise, the yield on the benchmark 10-year Treasury bond has dropped by nearly three-quarters of a percentage point over the last two months, to below 4.5 percent.
A similarly upbeat outlook was provided last week by Federal Reserve Chairman Alan Greenspan in his semi-annual economic report to Congress.
A growing cadre of pessimists, however, now argue that the stock market is sending an important and credible signal that the economic recovery that began in January has stalled, and the economy could dip back into recession.
"The market is sending a very clear signal that the economy in the second half of this year will be very bad," said James Paulson, economist and chief investment officer at Wells Capital Management.
In Paulson's view, its not just U.S. investors who are capitulating but also U.S. consumers, who have become increasingly unable and unwilling to continue spending beyond their means, particularly as their stock wealth melts before their eyes.
Paulson noted that the growth in demand by consumers and businesses for goods and services is already beginning to decelerate markedly, resulting in a slowdown in economic growth from a 6 percent annual rate in the first quarter of this year to an estimated 2.5 percent rate in the second. And he predicted the annual growth rate would fall to 1 percent or less for the balance of the year.
John Makin, an economist at the American Enterprise Institute, is even more pessimistic.
"Growth in demand is very weak right now," said Makin. "The only way companies are going to be able to deal with that and make any money is to cut costs even further and lay off more workers. And that is only going to reduce demand even further. That's the cycle we're about to enter -- and that is what the stock market is telling us."
Makin says it is now more likely than not that the economy will not only slow, but fall back into recession by the end of the year.
"The economy can't continue to glide along on the cushion of rising house prices and consumer spending," said Robert Dugger, a former Fed economist who is now a partner at Tudor Investment Corp. in Washington. "There will be no sustained recovery until we move away from debt- and consumption-led growth and toward growth that is fueled by savings and investment. We can't get rich by getting any deeper in debt."
Straddling the two camps, economist Robert Barbera at Heonig & Co. said yesterday that the U.S. economy could probably avoid sinking back into recession -- but not if the stock prices fall another 10 or 15 percent.
"I was one of those who said that, because of the accounting problems and corporate scandals, the market would continue to struggle while the economy would do okay," said Barbera. "But if the next 90 days [on the market] are like the last 90, it becomes a self-fulfilling prophecy. At that point, all bets are off."
According to Yale economics professor Robert Shiller, an expert on market volatility, more chaotic days like today are to be expected, particularly in a bear market environment where investors are paying rapt attention.
"Time is sped up when people are paying this kind of attention," he said. "Humans are naturally social animals and have a hard-wired tendency to sense alarm among others and drop everything they are doing and deal with it."
Staff writer Ben White contributed to this report from New York.
© 2002 The Washington Post Company
washingtonpost.com |
