Committee Of Correspondence

What is Wall Street Saying?

Herb Stein
12:00 p.m.  Friday  7/19/96
On Monday, July 15, the Dow Jones industrial average fell almost 3 percent. This was not among the biggest drops in history and some of it has since been reversed. But it was enough to remind us that the market will fluctuate and that its fluctuations can include sharp drops as well as prolonged declines. In this week’s discussion we are not asking our experts to tell us whether, when, or by how much the market will crash. If they are inclined to give us the answers to these questions we will be pleased to hear them. And, of course, since this discussion will be going on for a week there is a possibility that we may see the answers while we are online. But I hope that we can talk about some longer-run questions. Why does the market sometimes fall precipitously in the course of a day? If the prices in the market reflect investors’ expectations of corporate earnings and interest rates, what makes these expectations change so radically within a few hours of a trading day? What are the consequences for the economy in general of a sharp crash or a prolonged decline? After the crash in October 1987 a number of changes were made in the trading system in the hope of reducing volatility. What does experience tell us about the effectiveness of these changes? What policies can and should the Federal Reserve and other agencies follow either to stabilize the markets or to keep fluctuations from seriously hurting the economy? Before the experts turn to these and other questions about the market, a few bits of history may help to provide perspective. The largest one-day drop in the Dow Jones industrial average of the past 100 years came only recently. It was a drop of 22.6 percent on October 19, 1987. That was about seven times as large as the drop on last Monday, July 15. The October 1987 crash was not followed by further declines. The market rose from its low of that day and a year later was about 23 percent higher, although it was another year before the pre-crash level was regained. The biggest stock market decline of the post-war period did not include any big one-day crashes. That was the irregular, gradual decline from December 1972 to September 1974, when the market fell by about 40 percent. Since the Consumer Price Index rose by about 20 percent in that period, that was a decline in real terms of about 50 percent. The index did not get back to its December 1972 level for almost 10 years.

In the past 50 years there were eight years when the market was lower than it had been three years earlier (see graph). In two of these years the difference was less than one-half of 1 percent. Five of the other cases occurred in the 1970s. Since 1982 there has been only one year in which the index has not been at least 20 percent higher than it had been three years earlier.

Now we turn to our panel, which consists of:

  • James Cramer, business columnist for New York Magazine.
  • James Glassman, investment columnist for the Washington Post.
  • Robert Litan, director of the economic studies program at the Brookings Institution.
  • Robert Shiller, professor of economics at Yale University.