October 27, 1997
A major sell-off on Wall Street resulted in the Dow Jones Industrial Average's greatest single-day point loss in history, 554 points. Economics correspondent Paul Solman of WGBH Boston talks with Michael Goldstein of the University of Colorado, and Mary Farrell, Senior Strategist at PaineWebber, about today's record drop.
A RealAudio version of this segment is available.
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New York Stock Exchange
PAUL SOLMAN: Today's market drop was very steady, very wide, and very deep. When trading was halted for the second time this afternoon in accordance with breathing room mechanisms on the stock market known as circuit breakers, the Dow Jones Industrial Average had dropped more than 554 points, and that's more than seven percent of its opening value. The broader Standard & Poor's 500 Index dropped 64 points or 6.8 percent, and the NASDAQ market made up of newer companies, many of them technology-based, dropped 115 points or 6.8 percent of its total.
For more, we're joined from New York by Finance Professor Michael Goldstein of the University of Colorado, currently doing research at the New York Stock Exchange, and Mary Farrell, senior strategist with PaineWebber. Welcome to you both.
Ms. Farrell, what explanations for this were being offered on Wall Street today?
A Global Economy.
MARY FARRELL, PaineWebber: I think the major explanation is the U.S. was reacting to the turmoil in Asia, which has affected the Asian markets, Europe, Latin America, virtually all the world markets. We did not go unscathed. It's a global economy.
PAUL SOLMAN: Yes. But I mean we dropped more than Hong Kong dropped today, and when Hong Kong went up on Friday, we also dropped. So how could it just be the Asian markets, or Hong Kong?
MARY FARRELL: Well, that precipitated this initial decline but I would put this in perspective. We are still ahead 17 percent this year. Remember, this is--if you want to call this a correction, obviously an extreme one happening in such a short time frame, a day, but this is within the context of a market that is up significantly this year, almost twice the average gain, even including today's down trend, so--and we're still--we're off the high, but we're off the high by a little over 10 percent for the year. So I wouldn't-- I want to put that into perspective; that this is not necessarily a bear market here. I think quite the contrary.
PAUL SOLMAN: Well, I'm just looking for explanations at the moment. Professor Goldstein, other explanations besides Hong Kong or Asian markets?
MICHAEL GOLDSTEIN, University of Colorado: Well, sometimes people look for an excuse the same way sometimes people look for an excuse to buy. And a lot of people today and the previous days--if you felt the market was overvalued, then today the Asian markets were your excuse. On the other hand, I suppose if you felt that the market was valued fairly before, tomorrow morning is your excuse to buy.
PAUL SOLMAN: So are you skeptical when you hear things like the Hong Kong market is the reason that this is happening?
MICHAEL GOLDSTEIN: Well, I'm skeptical in a small way in that people need excuses. There is some inter-linkage between the global markets, but in terms of affecting the profits of Coca-Cola or McDonald's I highly doubt that the drop in Asia is going to affect the overall profits of Coca-Cola to the extent of seven percent or 13 percent from the high.
PAUL SOLMAN: So what does explain that? Why would--what was Coca-Cola--was Coca-Cola simply very overvalued at point?
MICHAEL GOLDSTEIN: Well, I don't want to necessarily think Coca-Cola or any other stock is particularly overvalued.
PAUL SOLMAN: Was as of this morning. I mean--
MICHAEL GOLDSTEIN: But obviously some people today felt that it was time to sell; that maybe they'd been planning on selling and looking for an excuse or looking for something that said okay, now is the time, and now--and maybe they felt now is the time, especially if they're managing funds, and they're worried about the end of the year coming up and how they're going to look. They may have felt a need to sell. But I don't want to come out and say that Coca-Cola or McDonald's or any other fine companies are--
PAUL SOLMAN: Are overvalued. No. I meant if they dropped by the end of the day they must have been overvalued at the beginning of the day. No or--
What goes up...
MICHAEL GOLDSTEIN: By some people's standards. That's the important point to remember, is that some people felt that there was a reason to sell today, and they sold. And apparently other people today didn't feel that there was a reason to buy. But tomorrow it very well could be that all the people who were at, you know, the regular people who were not watching the market today and didn't have time to call their broker today may decide this is a great deal, and they're going to buy tomorrow. It's--that's the way markets are. They go up and they go down. In fact, the best thing that happened in terms of today is it reminds people markets go down, as well as up periodically. And that's why you get 18, 20 percent returns at times.
PAUL SOLMAN: There's something that I think a lot of people don't understand, Mary Farrell, which is there is a buyer for every seller, right? So I mean there were as many people buying as actually selling today. They just had a different notion of what things were worth.
MARY FARRELL: Exactly. So I think you're looking for some very rational explanations, and even though the market moves towards efficiency it tends to overshoot on the upside or overshoot on the downside and isn't necessarily a rational entity when it comes to buying and selling. But today there were certainly a lot more people interested in selling but they matched those buyers and sellers.
PAUL SOLMAN: Professor Goldstein, what was it like? You were on the floor today?
MICHAEL GOLDSTEIN: Yes, I was.
PAUL SOLMAN: So what was it actually like out there? You seem so calm and debonair even.
MICHAEL GOLDSTEIN: As an outsider coming in from Colorado and watching the exchange today it was amazing. They were so calm on the floor. The people that--I've been there for a while, and I've been visiting people on the floor. And today, for a large part, was like any other day. There were only a couple of times where it was a little bit busy. In fact, myself and a few other people were amazed at how calm and orderly everything was. And that was partly a function of the way the orders came in, I think.
Some orders come in electronically over the computer, and some orders come in via the floor traders. And there were not a huge number of orders coming in over the floor traders. Specialists who make markets in the stock had time to talk to me today and talk to me orderly. You know, again, it was only seven percent. And so it wasn't the same feeling, and all the people on the floor were saying it's not the same thing as October 1987, where it was 23 percent.
PAUL SOLMAN: Wait a second. Mary Farrell, is this not a panic? I mean, when a market goes down seven percent, I would think that in the textbooks and in the common parlance that would be called a panic, though.
"Seven percent is really not overwhelming."
MARY FARRELL: I don't think this really would qualify for a panic. Seven percent is certainly a lot more than we see on a normal day, but with a market between the seven and 8,000 level, you know, I think that--well, the point number appears shocking. Seven percent is really not overwhelming. I think they key thing--
PAUL SOLMAN: Wait for a second. I was looking at a list of all-time stock market declines, and I think seven percent is now running third all time.
MARY FARRELL: But you forget a lot of those other declines didn't happen in an era of technology and telecommunications. We have instantaneous information available globally. You have a lot more people trading a lot faster, and I think that's why you tend to get much more concentrated movements today, so I wouldn't compare the seven percent today to a seven percent that occurred in an era where it took the rest of the globe quite a long time to get information.
PAUL SOLMAN: But I thought there were these things called circuit breakers that we've been hearing about, even reported a little on, that were supposed to let everybody take a breather, get a cup of coffee, Paul Erdman said on our show a week ago or so. So that--and then you don't panic. You don't keep selling with selling momentum once you take that kind of break. The circuit breakers went into effect today and Prof. Goldstein, nothing happened. I mean, people just kept selling.
MICHAEL GOLDSTEIN: Well, that's true, but actually it's not completely true. It's going to take some while to look at the data and look at the research to really figure out if the circuit breakers slowed up the selling. You know, circuit breakers aren't there as a guarantee. This isn't insurance. It is just taking some time and figuring out what's going on. While I was down on the floor today, it got to negative 347, and it was supposed to kick in at 350. And then it bounced back up to--it went back up about 100 points. So in analyzing what the circuit breaker does we have to look at both after the circuit breaker got triggered but also just before it to act like a floor. And that's going to take a certain amount of time with a lot of research. We have bumpers on our cars. And that's supposed to help--prevent us from getting hurt in accidents. But there's not--that doesn't mean you can drive like a thousand miles an hour into a brick wall and expect to look at her.
PAUL SOLMAN: You were not surprised by what happened today? You were not surprised by the fact that after the circuit breaker kicked in and trading resumed the market went down even more precipitously or as it had been?
MICHAEL GOLDSTEIN: I wasn't--I had a little bit of better information because while I was on the floor like I was able to watch the orders coming in and whether they were going to be on the buy side or the sell side, so by the time it came I was not surprised.
PAUL SOLMAN: You were the only person in America--
MICHAEL GOLDSTEIN: But--
PAUL SOLMAN: You would not have been surprised had you not had that information?
MICHAEL GOLDSTEIN: No. I think--no, I probably wouldn't have been surprised. I think that I was kind of expecting that it would continue to go down because first off half an hour is not an extremely long time for brokers to get on the phone and call me or you or anyone else and say, hey, look, prices are down, it's time to buy. And that's what a circuit breaker is supposed to do. It gives you some time to stop and think about what's going on. But if you were in the mood to sell, you're still in the mood to sell half an hour from now. The question is: Were they able to find enough buyers to offset you?
PAUL SOLMAN: Mary Farrell, you weren't surprised by what happened today? You weren't surprised that circuit breakers didn't give people pause so that they then resumed their normal activities, as opposed to selling, selling, selling?
MARY FARRELL: I do think the circuit breakers give them pause, but I don't think it turns sellers into buyers. And I think that's the fallacy of these circuit breakers. I have never been a fan of them. I think when you have free markets, you have to allow free trading, so it doesn't--I don't think you're ever going to change the trend of the market. You can only hope to slow things down, and perhaps that's what happened today. But, as we saw, circuit breakers don't change trends.
PAUL SOLMAN: What about changing the economy? Does this kind of a drop have a real effect or impact on the economy, and, if so, what would it be?
Panic or Correction?
MARY FARRELL: I'm glad you asked that because I think that's a crucial issue for investors today. U.S. stocks are priced on two things: earnings and interest rates. Nothing that we've seen happening in Asia is going to have anything but a minimal impact on earnings. On interest rates you could even argue to the extent that we import goods that cost less from over there interest rates will come even lower. We had a big rally in the bond market this morning. For U.S. investors rates are still coming down. That's positive for stocks. Earnings are still going up. That's positive for stocks. And that's why I think this correction--and I'm--you called it a panic--I call it a correction--will turn right back into a bull market once rationality returns, and we examine what does this mean to the bottom line of corporate America--frankly, not too much in terms of earnings.
PAUL SOLMAN: Prof. Goldstein, I keep hearing about and reading about something called the wealth effect, and I take it that that means that I'm poorer, I know I'm poorer today in my pension fund than I was this morning--you're presumably somewhat poorer. Mary Farrell may even be poorer. Doesn't that have some effect on what we're going to do in the future?
MICHAEL GOLDSTEIN: Well, I don't know about you, Paul, but I wasn't ready to retire tomorrow, so given that I'm a little bit--I'm seven percent poorer in my retirement account at my age there's still quite a while till I'm really going to worry about that and start spending more money or less money now. I think that's one of the things that people need to remember too. We're down seven percent from where we were this morning, but that doesn't necessarily mean--unless I was planning on spending that money today, I'm not going to buy any less. Really, if you think about a lot of the money that people have in their retirement accounts and to the extent that you're 45 and you're worried about something that's happening from 65 to 80, this is not a major deal for you. The wealth effect occurs as you generally get wealthier, you generally increase the amount that you're spending, but basically unless you've--for the average American ask yourself, are you spending more money--were you spending more money yesterday than you were spending in March because the amount that your stock went up? If you weren't, then when this came back down a little bit, that shouldn't affect you either.
PAUL SOLMAN: And you don't think for most people that that was true?
MICHAEL GOLDSTEIN: I certainly didn't spend any more money. No one that I knew was spending more money between say June or May and now because of the amount the stock market went up.
PAUL SOLMAN: And Mary Farrell, last question to you, you weren't spending any more money because the stock market was booming? You were doing well at PaineWebber--nothing now?
MARY FARRELL: I think people are much more conservative in the 90's than they were in the 80's. The savings rate is going up. Those baby boomers--the notorious debt people of the 70's and 80's are saving--so I don't think this is--we haven't really seen a huge boom in consumer spending, despite a boom in the economy, so I really don't think we're going to see this have a big impact either on consumer spending.
PAUL SOLMAN: Okay. Well, thanks both of you very much.