Dow drop may keep Fed from raising interest rates
The stock market has been falling for more than a month - which could
The stock market, one of the pillars of the economy, has a few hairline cracks. Not real fissures, just yet, but a few spider-web lines, the type that show up on a pillar when it's in need of paint.Skip to next paragraph
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Since mid-August, the Dow Jones Industrial Average has lost 1,000 points, and last week it dropped 524.30 points - the worst numerical loss in history.
There are plenty of reasons to think that the blemishes don't have any deeper meaning than a bad month on Wall Street. After all, economists are not predicting a recession because gravity is pulling the Internet stocks back to earth. And it's still too early to say retailers might see slightly dimmer holiday shopping because a mutual fund is up only 9 percent instead of 20 percent.
Yet the downturn may have other ramifications for the US and its economic policy - such as a sigh of relief from the Federal Reserve Board, which meets Oct. 5 to look at interest rate policy.
In a recent speech, Fed chairman Alan Greenspan said the Fed might have to factor in the stock market when setting monetary policy. In the past, Greenspan has worried that the market might be getting out of hand and then crash, requiring the Fed to bail out the investment community.
"I think Greenspan would love it if we let a little bit of air out of the balloon," says Charles Pradilla, chief investment strategist at SG Cowen, a brokerage house in New York.
Indeed, a market cool-off could actually be beneficial, since it "could have one more moderating effect on consumption," adds Gerald Cohen, an economist with Merrill Lynch & Co. in New York.
Besides, Mr. Cohen adds, the stock market's rise has created enormous investor confidence, and last week's drop will not shake that. "We have taken away so little of what we have gained that it's not as if the US consumer has to scrap all their plans because of a 1,000-point drop in the Dow," says Cohen.
Even after early trading Sept. 28 - when the Dow Jones average was down some 120 points from the previous day - the market was still up about 12 percent for the year. A broader market index, the Standard & Poor's 500, is up only about 4 percent. But, those indexes don't tell the whole story.
"The average stock on the New York Stock Exchange is down 20 percent since April of 1998 and many are down even more," says Duncan Richardson, the Boston-based portfolio manager of Eaton Vance's Information Age Fund, a $100 million mutual fund. For example, America Online has lost 55 percent of its value this year, Coca-Cola is down 33 percent, and Eli Lilly is down 40 percent.
The one area that has remained buoyant is high-tech stocks. Although they were hammered recently when the president of Microsoft suggested that they were overvalued, some of the high flying Internet stocks continue to do well
The average high-tech stock sports a price-to-earnings ratio of 40, compared with 24 for the average S&P 500 stock. Sam Stovall, a market strategist at Standard & Poor's, calls the high-tech ratio "historically rich."
Market watchers would not be surprised to see stocks spin their wheels for a while. Many companies are now in the process of confessing that they will not meet their earnings goals. On Wall Street this is known as a "pre-announcement," designed to keep stocks from getting slammed when the earnings are actually reported. Given the uncertainties, Mr. Pradilla says it would not be surprising to see the Dow close the year at around 10,000.
Some investors, though, are watching October, when there has been at least two major market slides. The most notable came in 1929 when the market crash was followed by the Great Depression. Then, in October 1987, the market swooned again, but quick action by the Fed prevented a recession. "There has been some sense that October is seasonally a bad month," says Pradilla.
In the past, investors have rushed back into the stock market after sharp loses. Eighteen months after the stock market crash of 1987 - when the Dow lost more than 500 points in one day - the market had recovered.
"Most investors have been conditioned to buy on the dips and that has not changed," says Mr. Stovall. "If we had another 1987 again, people would see it as a good buying opportunity and not a time to panic."
(c) Copyright 1999. The Christian Science Publishing Society