Why the floor fell out from under stock prices on Wall Street. Market watchers say latest `correction' may continue for several weeks
The four-year-old bull market on Wall Street -- which has enjoyed a 20 percent rise so far this year alone -- is taking a battering. On Monday, the Dow Jones index of 30 leading industrial stocks had an unnerving 61.87-point tumble. That was its biggest one-day drop ever. The market was headed lower at midafternoon Tuesday as well.
Most of the investment community appears to be taking the slide in stride, however. Since the Dow index is as high as it is (around 1,800), a big point drop does not mean that much on a percentage basis.
``The market needed a rest,'' says Thom R. Brown, chairman of the investment policy committee at Butcher & Singer, a Philadelphia-based brokerage firm. This is not the forerunner of a collapse, he says; the market ``will go higher before you see something like this again.''
Mr. Brown is encouraged by expectations that the Federal Reserve will lower interest rates to spur the economy, by the sharp drop in oil prices, and by an unusually high percentage of investible cash now held by mutual funds.
Brown says the bull market is fundamentally intact. But he sees more big swings -- both up and down -- in the months ahead. This volatility is tied to the rise in speculative investing that accompanies a long-running bull market and to futures-related ``program trading'' by wealthy institutional investors.
Brown also contends that if the Senate version of tax reform passes and the six-month holding period for stocks is eliminated, ``that's going to have a real impact on volatility. People are not going to sit and wait six months to take their profits.''
Brown compares the current market volatility to that during the bull market of 1928. ``Over the next 12 months, we will occasionally see swings in the DJIA of 60 to 80 points. . . . We are in for some wild times before this bull market ends,'' Brown predicted in a report he issued on June 18.
What set this record plunge in motion?
Two key market analysts issued sell signals to their followers. These were accompanied by investor worries over bulging federal deficits in the wake of Monday's Supreme Court declaration that parts of the Gramm-Rudman balanced-budget law are unconstitutional.
One of those analysts, John Mendelson, who is Dean Witter Reynolds's chief market strategist, issued a sell order Monday. His call coincided with Robert R. Prechter's sell signal, which arrived in the mailboxes of subscribers to his weekly Elliott Wave Theorist Newsletter.
Not unlike market maven Joe Granville in the early '80s, the Gainesville, Ga.-based Prechter has gained a huge following. One extremely bullish prediction after another has come true over the past several years. His sell signal was the first in 2 years.
Both Mr. Prechter and Peter Eliades, the top two ``market timers,'' according to Robert E. James, publisher of Timer Digest in Fort Lauderdale, Fla., turned bearish last week. ``Now the majority of the top 10 timers are bearish over the intermediate term,'' Mr. James says.
How long is the intermediate term?
In normal times, says James, that means stocks could slide for one to three months. But he adds that ``there's been such a compression of the market action, we're seeing moves in a week or two that used to take months.''
Mr. Eliades predicted in his Los Angeles-based Stock Market Cycles newsletter several months ago that the market would top at around 1,920 in June. Now he boldly pegs July 25 as the low.
Agreeing with Eliades, James says the market should head lower for ``a couple of weeks at minimum. . . . The market needs a little less bullishness on the part of the public before we go higher.''
Both Eliades and Prechter have compiled their records based on a branch of chart reading known as cycle theory. Prechter forecasts using the theories devised by R. N. Elliott. These hold that changes in stock prices are the result of mass swings in investor moods, which follow a sequence, creating predictable patterns. Eliades also tracks price movements and sees numerous cyclical patterns from which he makes predictions about future price changes.
Cycle reading, like chart reading, is considered highly subjective. ``Over the years, some of the most consistent market timers are good cycle theorists,'' says James. But ``those cycles are subject to a great deal of differing interpretation.''
The interpretations by Elaides and Prechter are that after a lull the market is headed for new highs before year-end.