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THERE'S NO REASON THIS MARKET WON'T BE FALLING A LOT FURTHER
By JOHN CRUDELE
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IT ain't just Russia or Clinton anymore.
The troubles that sent the Dow Jones industrial average to its second-worst day ever yesterday go beyond the usual suspects that you've been reading about these past few months.
These things remain a big hurdle. The Russian financial crisis has no quick solution, even if someone could come up with a plan. Japan's economy isn't getting any better. And I've now learned that the impeachment report against Bill Clinton will come within two weeks - not later this month as expected - and may even arrive as early as this week.
With these dour backdrops, the stock market's bubble is already moving through some prickly territory. But, oddly, none of these were investors' biggest enemy yesterday.
That honor went to nothing less than a flaw in the system. A quirk that the growth of exotic mutual funds and ballsy trading strategies has begot. An abnormality that, if not fixed, could lead to Wall Street "s biggest nightmare coming true.
To explain, let's go to the last hour of trading yesterday.
The Dow Jones industrial average was down just 267 points at 3:30 p.m., as part of a slide that began in earnest at around 2 p.m. but accelerated at 3 p.m.
Over the last-half hour of trading the Dow fell another 245 points for a total loss of nearly 513 points. What happened in the last half hour that made the situation look like a panic?
The blame can be placed on index funds, which apparently had been getting a lot of redemption orders throughout the day. These funds aim to mimic the gains of various indices. They are billed as the most passive of stock investments.
But because of a quirk in how these funds operate, sources say they are required to the give sellers the closing price on the day.
That means index fund managers will try to sell shares from their fund as near to the day's closing prices as possible. The same goes when the market is rising, which explains some of the remarkable last-minute gains scored during many sessions on the way up.
But yesterday the last-minute activity meant selling - a lot of selling.
That isn't the only problem with the system.
With foreign investments plummeting over the past few weeks, a lot of big institutional sellers are being forced to cash in their more liquid assets to fill in holes overseas. And right now the most liquid of their holdings are in the U.S.
That could have accounted for a lot of yesterday's early selling.
The hedge funds, which are highly leveraged and speculative, have been attempting to hold the market steady. That unusual early morning trading I wrote about in my last two columns looks like it came from hedge funds trying to assure an optimistic mood for stocks early in the day.
And the past few days they have succeeded in those efforts. Yesterday the Dow was actually substantially higher in the first 30 minutes of trading before the bubble again came under attack.
Things that can't be measured yet are the effect of margin calls and the sentiment of small investors. If investors are required to put up more cash against stock in their margin accounts, then the selling pressure could intensify over the next few days.
But small investors hold the key.
Steadfast in their support of the bubble over the past few years, it is still unclear whether the 50 million-plus households that now own stock will stand pat through the latest selloff. So far there doesn't seem to be any panic. Which is, when you think about it, pretty bad news.
If the Dow can suffer a 19 percent decline simply because professional traders are scared, imagine what's going to happen if small investors join in their stampede.
I spoke with Henry Kaufman, the famous Wall Street economist, a few weeks ago and he believed that the retreat from stocks would follow precisely this pattern. First, highly-leveraged professional traders would bolt as their portfolios around the world came under attack. Only after this happened would small investors catch on.
Making matters worse is the absence of leadership in Washington. With Clinton under relentless attack, it is up to Treasury Secretary Robert Rubin and Federal Reserve Chairman Alan Greenspan to provide guidance.
But words will probably not work at this point. And while Greenspan will be very reluctant to cut interest rates as a sign that the stock market's decline must stop, that could be his only option.
It's Russia. It's the economy. It's Rubin. It's Clinton. Where are they?, said Bill King of M. Ramsey King Securities of Burr Ridge, Ill., one of the smartest Wall Street pulse takers I know. If they don't show up tomorrow, this could crash.
The other option, of course, is what I suggested in Friday's column - rigging the stock market
But even the hint of a market rigging might send foreign investors scampering from American markets for a long time.
I hate to be the one to break the news, but unless someone comes up with a remarkably innovative solution this stock market still has a lot of space between it and the bottom. Massive corporate stock buybacks, encouraging words from market gurus and a confident smile from the jet-setting president just aren't going to work.
The many engines that got the market up to its extreme levels just got thrown in reverse.
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