Wall Street's October Massacre

By Gordon Bock

"It's extremely emotional. People are dumping stocks with reckless abandon. As trite as it may sound, the market is going down because it's going down."

-- Newton Zinder, analyst for E.F. Hutton

The process is called a "correction," which makes it sound like a painless, orderly affair. But last week's bloodbath on Wall Street was more aptly dubbed an "October massacre." Turmoil and outright fear shook the financial markets as stampeding hordes of investors got caught up in a mood that had been almost absent during the go-go 1980s: bearishness. Over the course of less than two months, in the worst setback since the bull market began five years ago, the value of U.S. stocks has plunged by nearly half a trillion dollars.

The market's rapid conversion from boom to gloom may well signal a fade-out of confidence in America's long-running economic good times. Despite reassuring words from the White House and Treasury Secretary James Baker, the unruly mob on Wall Street saw only the threat of rising interest rates and faltering economic growth. "I fear we will have the worst of possible worlds, with high interest rates and a recession," said Rudy Oswald, chief economist for the AFL-CIO.

Stock-market investors were the first to feel the pain. Records fell to the stock-market floor last week like so much scrap paper. On Friday the Dow Jones industrial average plummeted more than 100 points for the first time in history, dropping 108.36. In just one day, the value of 5,000 common U.S. stocks slid $145 billion, or 4.9%. "We're all stunned. Everything happened so fast," declared Byron Wien, portfolio strategist for the Morgan Stanley investment firm. Wall Street's computer-trading mechanisms, which brought so much efficiency to a rising market, were working just as efficiently in reverse. During the week the Dow fell 235.48 points, a record for a single week, closing at 2246.73. Since Aug. 25, when the Dow peaked at an all-time high of 2722.42, it has given up 475.69 points.

Investors were already poised at the brink of panic, looking for reassurance, when the announcement of a key statistic set them running. The Commerce Department said on Wednesday that the U.S. trade deficit, the closely watched barometer of America's competitive woes, failed to improve as much as investors had hoped: the imbalance between imports and exports fell from the record $16.5 billion in July, but only to $15.7 billion in August. Investors concluded that if a 30% drop in the dollar over the past two years has failed to help cure U.S. trade problems, then perhaps the currency would have to fall further. And any greater drop, they reasoned, would surely aggravate U.S. inflation and interest rates.

As feared, the disappointing trade figures inspired global money traders to send the dollar sliding against the yen, deutsche mark and other currencies. On the bond market, interest rates on 30-year U.S. Treasury securities topped 10% for the first time in nearly two years. Wall Streeters responded by pushing the Dow down 95.46 points on Wednesday. That prompted Treasury Secretary Baker to try to soothe the roiling financial markets on Thursday. Baker described fears of rekindled inflation as "overblown." Though "we recognize of course some market nervousness," he added, "conditions do not warrant Apocalypse Now worries or scenarios." Just before he spoke, however, Manhattan's Chemical Bank raised its prime lending rate for the second time this month, from 9.25% to 9.75%. That day the Dow dropped an additional 57.61 points.

The real rout came Friday. Bent on selling, stockholders brushed off any signs of reassurance, like the Labor Department's announcement that wholesale prices had risen only .3% during September. That normally would be seen as a sign that inflation remained in check. Instead, investors showed concern about a Baker remark from the previous day. Railing against West Germany's central bank for raising its interest rates, the Treasury Secretary led many listeners to believe that the German action might cause the dollar to move lower.

On top of that, another new anxiety developed when the attack on a U.S.-registered tanker in the Persian Gulf pushed crude-oil prices above $20 a bbl. for the first time in six weeks, increasing inflation fears.

Before long the Dow went into a virtual free fall. At one point the stock index was down a breathtaking 131 points. Selling was so furious that the New York Stock Exchange set a one-day record for volume, 338.48 million shares, shattering the old mark of 302.39 million set in January. Nearly all stocks got caught in the downdraft: 1,749 fell, and only 111 managed to rise.

The steepness of the plunge sent market watchers to the history books for some perspective. The drop in the Dow since August represents a decline of 17.5%, but that is still far behind the 35.9% correction in 1968-70 and the 80% wipeout during the Great Depression. Still, the paper losses are staggering. The stocks that comprise the Wilshire 5000, which includes most U.S. issues, have fallen $486 billion in market value. But they are still $379 billion ahead of their value at the beginning of the year, and the Dow industrials remain up 350.78 points, or 18.5% from the Jan. 1 mark.

Wall Street has long been aware that America's trade and budget deficits could drag down the economy. The trade gap, $156 billion last year, has proved especially slow to remedy. The decline of the dollar was supposed to boost exports by making U.S. products more affordable overseas and to discourage imports by making them more expensive for American consumers. But during August exports dropped 3.7%, to $20.2 billion. One reason for the weak overseas demand for U.S. products is the sluggishness of global economic growth in industrial countries and developing countries alike. While imports in August dropped 4.2%, they persist at a staggering $35.9 billion. The import bill remains high in part because Americans have been reluctant to give up their craving for imported goods, even though the cost has gone up.

The trade gap's crushing impact on the stock market ignited a stormy political exchange about how to solve it. The trade deficit is boosting congressional support for tougher measures that might include sheltering U.S. industries and blocking some imports. But the Reagan Administration and many economists contend that the general trend is toward improvement. Indeed, during the first eight months of 1987, exports have risen 13% over the same period last year. Says U.S. Trade Representative Clayton Yeutter: "It would be a tragic mistake to give in to protectionism at a time when the real trade deficit is declining."

With inflationary pressures (current rate: 5%) mounting and patience running out, Federal Reserve Board Chairman Alan Greenspan tried early last week to assuage inflation fears by saying that the trade deficit is "bottoming out." Not everyone is so sanguine. "Greenspan is wrong. There are plenty of signs of inflation," says Edward Yardeni, chief economist for Prudential-Bache Securities. Right now the most obvious sign is the stubborn trade deficit and fragile dollar. Martin Feldstein, President Reagan's former chief economic adviser, predicted earlier this month that the dollar will have to fall another 10% to 15% soon.

Rising prices and interest rates would be sure to act as a damper on the economy, which is still expanding at a healthy 3% pace. In corporate America, higher interest rates could force many companies to delay capital expansion projects. Steeper rates already seem to be throttling one of the economy's driving forces, consumer spending. The increases hit consumers faster than ever because of the growth in home-equity loans and adjustable-rate mortgages. The average conventional mortgage rate, one survey says, is now more than 11.4%, up from 9.1% in March. Gripes a Chicago real estate agent: "This is a dead market, deader than when we were in a real slump in 1981 and '82. I have listings that haven't been shown in a month."

But no one was hit harder by the market's fall than Wall Street's investment houses, for whom the fat-and-happy days of the long bull season may be over. "If you look at the bond market, the crash has already occurred," says a discouraged investor. As bond prices plunged, several Wall Street firms that had beefed up their bond staffs in recent years began to cut back. Salomon Brothers laid off 12% of its estimated 6,500 employees. The 800 furloughed workers earned an average annual income of $125,000, which Salomon was ill able to afford after losing $100 million in its municipal-bond unit so far this year. Kidder Peabody laid off 100 of its 280 municipal-bond traders. Said Analyst Perrin Long, who covers the investment community for Lipper Analytical Services: "This could be the beginning of the long-awaited retrenchment on Wall Street."

And this week? Many investors saw a hopeful sign in the waning minutes of Friday's bloodbath, when the market rallied and stopped what looked like a slide toward a 150-point loss. Some experts see the fall as a long-needed comedown, which took the Dow to a more rational level after an unrealistically fast climb. They believe that after a rest, Wall Street will rally again. Says Robert Prechter, the Georgia-based stock guru: "The bull market remains intact."

Yet after last week's spectacle, a growing number of investors are likely to put their money elsewhere. Rising interest rates on bonds are starting to siphon some big-time investors' funds away from the stock market. Many individuals are taking their market profits and putting them in banks. Says Charles Allman, editor of the Growth Stock Outlook newsletter: "I'm neither a bear nor a bull. Right now I'm just chicken." Along with a lot of others.

CHART: TEXT NOT AVAILABLE

CREDIT: NO CREDIT

CAPTION: Dow Jones industrials, daily closings.

DESCRIPTION: Figures from August 17, 1987, through October 16, 1987.

With reporting by Rosemary Byrnes/Washington and Frederick Ungeheuer/New York