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Analysis : Seen as a Turning Point : Stock Sell-Off Represents Release of Market Tension

October 20, 1987|JAMES FLANIGAN | Times Staff Writer

Why did it happen? What does it mean? Yes, it is true that the stock market's record decline on Monday was caused by panic selling.

Investors in record numbers sold stocks or mutual funds out of simple fear that the value of their investments would decline. And their very selling caused further declines in those values. Selling of U.S. stocks began in foreign markets before most Americans were awake and continued throughout the trading day in the United States.

But though emotion ruled the decline, it didn't create it. The market's spectacular sell-off on Monday can most accurately be seen as a release of tension, in the way that a volcanic eruption or an earthquake releases tensions that have built up over time.

Tension has been building in the U.S. economy as interest rates have risen in the last two months, making it harder for people to buy homes, harder for business to continue expanding. And one reason U.S. interest rates have risen is that foreign investors have been pulling money back from investments in U.S. government bonds and common stocks, because they feared a decline in the U.S. dollar. Yet their very retreat forced the Federal Reserve Board to lift interest rates in hopes of keeping foreign money here to finance the government's budget deficit.

It's a vicious circle, and international conferences pledging to coordinate economic policy have done little. Confidence began to slip--as evidenced by sharp declines in U.S. stock markets last week--that the world's major nations could work things out and keep economic prosperity growing.

And when U.S. Treasury Secretary James A. Baker III publicly criticized West German economic policy, in television appearances over the weekend, investor confidence vanished. The result on Monday was a steep decline on every stock market in the world and the largest drop in history on the New York Stock Exchange.

Where does that leave us on the morning after? Speaking in terms of the economy as a whole, we're only a little worse off than we were Monday morning, said investment managers. The 1987 decline in the stock market was in no sense as devastating to the overall economy as was that of 1929, when stocks were bought with borrowed money and supported by far less economic strength in corporate profits.

But the stock market does not suffer a record decline--from over 2700 on the Dow-Jones industrial average to less than 1740--in isolation. "Money has been lost, wealth that was there when the market was at 2700, is not there now," said Charles Clough, chief investment strategist for Merrill Lynch Inc.

The result will be a slowing of economic activity, says Clough, meaning fewer buyers out there for anything you want to sell, whether it's a business or a house. Borrowers will be pinched as interest rates stay high, so companies that went through leveraged buyouts in the five-year stock market boom may run into difficulty.

The stock market boom itself? Perhaps surprisingly, many investment professionals regarded Monday's decline dispassionately, saying the sell-off is "over done" and won't last. And most agreed that small investors, who haven't bailed out, would be unwise to unload their shares now at what many regard as the bottom of a too-rapid decline.

Firm 'Nibbling Away'

David Dreman, the head of Dreman Value Management and author of "Contrarian Investment Strategy," said that Monday's decline might well frighten the small investor and chill the mutual fund business for six months to a year. But his firm, said Dreman about two hours before the market closed, was "nibbling away" at stocks that he regarded as newly minted bargains. He named Ford Motor Co. among them.

And investment banker George Needham, the head of Needham & Co.--an underwriter and market maker for the stocks of smaller, high technology companies--saw investment money flowing to his kind of companies. "I was out in Boulder, Colo., and in California," said Needham. "Companies in electronics and computer equipment are looking at good business." Other investment managers agreed with Needham that the outlook is best for manufacturing companies.

Yet, Monday's severe decline marked a turning point. "The bear market has begun," said San Francisco investment manager Kenneth Fisher, of Fisher Investments. Fisher said bear market matter of factly, almost as an afterthought. His own firm was buying some stocks on Monday--notably General Motors.

But Fisher cautioned that buying stock now was a risky proposition, as he gave the following outlook for the weeks and perhaps months ahead: "There will be a powerful bounce back, perhaps to levels around 2400 on the Dow. But that bounce back, too, will be unsustainable, and stocks will decline again."

Note: Optimism for the stock market, and perhaps for the economy, is fading. And that's one big meaning of Monday's dramatic sell-off.

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