Stocks plummet to 6-month low

April 05, 1994|By Ian Johnson | Ian Johnson,Sun Staff Writer

U.S. stock prices plunged to the lowest point in six months yesterday as a near-panic sell-off in bonds sent long-term interest rates to their highest level since January 1993.

Even without any clear signs that i2nflation was on the rebound or that the economy was overheating, the bond market continued its sharp decline, with the yield on the 30-year Treasury bond closing at 7.41 percent yesterday -- just six months after reaching a record low of 5.78 percent.

The higher rates, in turn, pushed stocks down sharply. The Dow Jones industrial average skidded 42.61 points, or 1.17 percent, to 3,593.35, and the Nasdaq combined composite index of smaller stocks took a 2.16 percent hit, falling to 727.41.

It was the fifth time in the last seven trading days that the Dow has lost more than 40 points, as the stock market's first serious downdraft in 3 1/2 years continued into its third week. As the Dow has fallen 9.7 percent from its all-time closing high Jan. 31, billions of dollars in gains made by small investors in mutual funds have been wiped out.

Market analysts said that if the market pushes much lower, most investors who joined the rush to mutual funds over the past four years may see all their gains wiped out. If this takes place, many small investors could pull out of the stock market and accelerate the downturn.

"It's hard to predict mass psychology, but when investors see that they're losing their principal they react two ways: They bail out immediately or they ride it out all the way. Typically, they bail out," said James Bianco, research director of Arbor Trading Group in Chicago.

About 75 percent of the $793.8 billion held in stock mutual funds has been invested over the past 3 1/2 years, Mr. Bianco said, and the average price paid works out to 3,446 points on the Dow. This means that if the Dow falls an additional 150 points, these recent investors will see all their gains since 1990 wiped out and their principal threatened.

While the reaction of small, individual investors during previous bear markets was largely irrelevant, they now control 15 percent of the market -- twice the amount they did during the 1987 and 1990 crashes and seven times the amount at the start of the 1980s.

Worsening the market's downturn, and investors' worries, has been the plight of speculative "hedge" funds. Yesterday, rumors permeated many trading rooms that the rise in interest rates and the parallel fall in bond prices are forcing more and more of the funds, which had bought huge amounts of government bonds with borrowed money, to pay back the money to their antsy creditors. The hedge funds have been raising money by selling stocks and bonds, helping to further drive down both markets.

At least three big hedge funds that once controlled $2 billion in assets have not been able to make the payments and have been liquidated in recent days. The funds had correctly gambled early last year that low inflation would cause interest rates to fall -- and that the price of government bonds would rise. But when that trend reversed last fall, the three funds starting racking up huge losses.

The back-breaker for many who had invested in bonds has taken place over the past two trading days, as the yield on the 30-year government bond has risen from 7.08 percent on Thursday to yesterday's close of 7.41 percent.

Besides representing a blowoff of speculative pressures, many believe that the slide in stock and bond prices has been fueled by legitimate economic concerns.

Richard Fontaine, a Towson-based money manager who has been bearish on the stock market for several months, said that inflationary pressures clearly are on the rise and that higher interest rates, which help combat inflation, are overdue.

"It's not just hedge funds, it's also fundamentals. Rates will continue to rise, and that is taking the floor out from under the bull market. The Dow is vulnerable of hitting 3,200 in the near future," Mr. Fontaine said.

The Federal Reserve Board has raised short-term interest rates twice since Feb. 4, in an effort to stifle inflation. The federal funds rate, which banks charge each other for overnight loans, was raised to 3.5 percent on March 22 after being boosted to 3.25 percent on Feb. 4.

Higher interest rates hurt the stock market for two main reasons: They can slow the economy, and they provide a more attractive alternative to investors. Higher rates on certificates of deposit, for example, could lure investors away from stocks.

Alan Snyder, a San Francisco-based money manager, said he worries that despite the sell-off, many investors are still complacent, heeding the advice in finance columns and on TV talk shows to "sit tight."

Yesterday, President Clinton urged Americans to stay calm, predicting that interest rates are "too high. I think they'll come back down."

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