Dow’s 96-Point Plunge Raises Selloff Fears

Investors reacted with surprising dismay to the Federal Reserve’s interest-rate increase on Friday, dumping stocks and bonds in a flurry of anxious trading that led to the biggest decline in the Dow Jones industrial average in more than two years.

The widely watched Dow average plummeted 96.24 points to close at 3,871.42, the eighth-biggest one-day point loss ever. Declining stocks outnumbered advancing ones on the New York Stock Exchange by nearly a 7-1 ratio.

Some analysts expressed fear that the Fed’s move will dramatically depress what has been an upbeat mood among investors, possibly leading to further selloffs. Others, however, suggested that stocks--which have risen to record heights in recent days--were ripe for a temporary pullback, and that demand for stocks will resume as long as interest rates don’t rise much more.

Still, many Wall Street analysts were stunned by the selloff, because the Fed has virtually been telegraphing the inevitability of a rate increase for months. It was believed that most investors had expected a small boost in the cost of credit as a natural side effect of a growing economy.

Instead, sellers took early control of the stock market Friday, and relatively few buyers materialized as prices slid. The Dow, down 50 points near midday, continued to drop steadily all afternoon.

By the market close, experts were looking warily toward Monday’s trading, wondering how the huge wave of novice investors who purchased stocks and stock mutual funds in 1992 and 1993 will respond to Friday’s tumble.

“This is likely to dent confidence a bit,” warned Alan Ackerman, analyst at the investment firm of Reich & Co. in New York. “I think this is going to cause investors to want to take some chips off the table.”

Other analysts, however, noted that the market appeared ripe for a pullback even before the Fed move, given stocks’ surge in January. Indeed, the Dow had rocketed 6% in January, or 224 points, and reached a record high of 3,978.36 on Monday amid burgeoning optimism about the economy.

In effect, stocks may have been victimized by their own recent success, experts said, as the urge to jump into the market in January quickly became an urge to exit on Friday with a fast profit.

“The market was ahead of itself,” said Allen Sinai, economist at the Boston Co. in Boston. The Fed’s rate hike “was just an excuse for a correction (in stock prices), for a market that was looking for any excuse to sell.”

Fundamentally, Sinai and others said, the Fed’s rate hike should have comparatively little effect on the economy’s advance or on rising corporate earnings, which have underpinned the latest phase of the three-year-old bull market’s advance.

Indeed, Fed officials painted this slight tightening of credit as a move aimed at prolonging the current economic expansion--and, by proxy, the bull market. By ensuring that business activity doesn’t overheat, the Fed hopes to dampen inflationary pressures that could ultimately be a far bigger concern for stock and bond investors than a small rise in interest rates.

Signs of nascent inflation have been apparent recently in rising prices of key commodities, including gold, silver, lumber and sugar.

Though some investors may fear that the Fed is acting too quickly to curb brisk economic growth, a preemptive strike “is better than the old game of fighting inflation once it starts,” Sinai said.

Nonetheless, analysts admit that this first official interest-rate hike since 1989, however logical, may not play that way with investors in the short run.

The fear is that the Fed’s move will dramatically change the psychology on Wall Street, where for the last three years investors have been conditioned to believe that interest rates only went in one direction: down.

As the economy sputtered in 1992 and 1993, the decline in short-term rates to their lowest level in 30 years encouraged millions of Americans to pull money from bank savings accounts and invest it in stocks and bonds, in search of higher returns. And stocks generally have increased steadily during the last two years, with few major selloffs; Friday’s fall was the biggest for the Dow average since it dropped 120 points on Nov. 15, 1991, when disappointment over biotechnology stocks triggered a broader decline.

With the Fed’s rate boost on Friday, short-term Treasury bill yields rose to 3.28% from 3.0% a week ago. Most economists believe that short-term rates now are likely to hold at current levels, because the Fed isn’t expected to make another move unless it sees new signs that the economy is picking up substantial steam.

For the stock market, however, the worry is that many small investors will curtail their stock and bond investing and instead begin to favor money-market accounts and other short-term investments again, expecting further Fed rate hikes to boost money-market returns as the year wears on.

Because the bull market has depended so heavily on individuals’ dollars in recent years, especially via mutual funds, any drop-off in investment--or a rise in redemptions of fund shares by nervous investors--could lead to a sharp decline in stock prices.

“A lot of how this plays out will depend on how the individual investor reacts,” concedes Jay Mueller, manager of the Strong Investment mutual fund in Milwaukee. “It all comes down to market psychology: Are we at an inflection point?”

Still, bullish analysts scoff at the idea that most investors will see disaster in Friday’s rate rise or in the Dow’s big drop.

Instead, with the economy booming and short-term interest rates still historically low, many Wall Streeters suggest that investors will respond the way they have continually in recent years: by buying on any slump in stock prices. That strategy has worked every time since the 1987 market crash.

“Most of the public has been conditioned to buy on dips, and that goes for professionals too,” noted Ralph Wanger, who heads the $4-billion Acorn Funds investment company in Chicago.

On Friday, major mutual fund companies reported relatively little activity from small investors, indicating that most of the day’s selling was the work of professionals and speculators, analysts said.

But the fund companies said they were preparing for a deluge of calls over the weekend to their toll-free information lines, as many Americans discuss the Fed rate increase and the market’s plunge, and decide whether to act on them.

Whether more individuals will be buyers, or sellers, come Monday is the question likely to keep Wall Street pros awake for the next 48 hours. “The worrywarts will be working overtime this weekend,” said analyst Ackerman.

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