The Slate Gist

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 10th 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.

9Alan 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 notreducing 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.

10Obsession 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.