The 27th of February was a difficult, down day on Wall Street. A record 4.31 billion shares changed hands on the New York Stock Exchange, and the Nasdaq set a record also, at 3.13 billion shares. Each component of the Dow Jones Industrial Average (DJIA) was down, and at 3:19 PM the losers outnumbered the gainers by 50 to 1. The 416-point drop was the seventh worst in history for the DJIA, bringing the index back to 2006 levels. In percentage terms, however, the 3.29% loss can’t compare to the historic 22.61% crash of October 19, 1987. Still, it was the worst one-day percentage drop since March 24, 2003.
One week later, on March 7, stocks had their biggest one-day gain of the year up to then. What is going on?
Proximate causes
The most prominent factor credited with triggering the decline was a nearly 9% drop in China’s Shanghai Composite Index, a one-day loss to investors of some $100 billion. That seemed to have a domino effect on stock markets worldwide. Why the drop in the Chinese index? The day before, the index had closed above 3000 for the first time, capping a remarkable rise that included a 130% surge during 2006. Evidently, some investors decided to take some profits off the table, and there may have been political concerns lurking in the background as well.
Another factor identified by some was a comment made by former Fed Chairman Alan Greenspan to an audience in Hong Kong. He dropped the r-word: recession. Greenspan did not predict a recession, as some headline writers had it, but he appeared to suggest that a recession later this year could not be ruled out. The Wall Street Journal reported that Greenspan’s actual words were these: “We do not and cannot look into history without being very concerned when you see the absence of awareness and concern about risk that we see today.” That was just the selling signal that some investors needed.
The balm of Bernanke
The markets were calmed by soothing words from the current Chairman of the Federal Reserve Board, Ben Bernanke. Speaking before the House Budget Committee, Bernanke said that the U.S. financial markets were functioning well. “My view is that . . . there is really no
material change in our expectations for the economy.” In fact, the Fed’s worries about inflation haven’t been eliminated entirely as yet. As the first quarter closed, Bernanke cautioned the Joint Economic Committee that “Although core inflation seems likely to moderate gradually over time, the risks to this forecast are to the upside.”
The economy is not growing as fast as previously thought, the Commerce Department reported in March. Growth in the final quarter of 2006 was 2.5%, not the 3.5% earlier forecast (or the 2.2% of the preliminary estimate). New home sales fell 17% in January, and there was a 7.8% drop in durable goods orders. U.S. automakers continue to struggle. On the other hand, growth in consumer spending was a strong 4.2% in the fourth quarter. Unemployment remains at 4.6%, with new jobless claims falling to lower levels. The Federal Reserve reported in March that economic growth remained steady through most of the U.S. These are not indicators of a near-term recession and were cited by Bernanke as sources of inflationary pressure.
A question
Why were so many investors so ready to jump ship at the first sign of trouble? Some argue that investors need to rein in their risks. Others, citing the still reasonably strong economic data, have suggested that these market lows represent a great buying opportunity. Though there may be some “froth” in some market segments, looking at the market as a whole, stocks are not overvalued by historical standards.
© 2007 M.A. Co. All rights reserved.
