Stocks Dive as Investor Fear Sparks Widespread Sell-Off

Stocks plummeted Friday in record trading as more investors shifted to panic mode after two years of losses.

Wall Street suffered one of its biggest one-day declines, driving the Dow Jones industrials down 390.23 points, or 4.6%, to 8,019.26, the lowest level since 1998.

Analysts said more investors reached their threshold of pain after nine weeks of almost unrelenting price declines that have driven many well-known stocks to five-year lows.

Shaken by the wave of corporate financial scandals this year, the threat of more terrorist attacks and uncertainty over the strength of the economic recovery, institutional and individual investors alike have been abandoning stocks for the safety of Treasury bonds, bank savings accounts and gold.

“It’s just indiscriminate selling,” said Liz Ann Sonders, portfolio manager at New York-based money manager Campbell Cowperthwait.

The severity of Friday’s decline raised concerns that Monday could bring a fresh torrent of selling, after investors have had the weekend to ponder their losses.

In Washington, President Bush made no mention of the market’s plunge Friday during a visit with U.S. soldiers at Ft. Drum, N.Y., but White House officials said he would address concerns about the economy in his radio address to the nation this morning.

Reacting to Friday’s sell-off, the White House said Bush still believes the fundamentals of the U.S. economy remain solid.

“We are working with Congress to enact policies to strengthen the economy, but the fundamentals are strong,” White House spokeswoman Claire Buchan said.

Meanwhile, House and Senate negotiators signaled that they would send a major accounting and finance reform bill to Bush by the end of next week, moving with urgency to stiffen penalties for corporate crimes and increase oversight of accountants.

But none of that appeared to cheer investors Friday.

Wall Street pros have argued repeatedly in recent weeks that the market was reaching a “capitulation” phase as stocks plunged, and that a bottom was likely soon, as investor gloom deepened.

“If we can find a glimmer of hope, it’s that this is usually how bear markets finally end,” Sonders said.

But many more investors stepped up to sell Friday, raising new fears that a bottom could be far off.

Analysts said the market is being hit from all sides: Foreigners are selling as the weak dollar devastates their U.S. holdings; hedge funds and other active traders increasingly are “shorting” the market, betting on lower prices; individual investors are selling out of mutual funds; and fund managers are selling, trying to raise cash in case redemptions accelerate.

Losses have been most pronounced in the biggest blue-chip stocks this week--a sign that many investors, professional and individual alike, are getting rid of the last of their favorites.

Though some say the pattern of dumping the strongest names may indicate that selling is close to exhausting itself, investors have grown weary of hearing analysts say in recent weeks that the decline is almost over, only to see share prices fall further.

Friday’s slide was triggered in part by reports that drug giant Johnson & Johnson is facing a federal investigation of record-keeping at a manufacturing plant in Puerto Rico. The news added to the cloud over many big-name U.S. companies.

As trading swelled, more than 3 billion shares changed hands on the New York Stock Exchange and regional exchanges Friday, eclipsing the previous peaks set in the aftermath of the September terrorist attacks.

For the Dow, Friday’s decline was the seventh-biggest in terms of points, though it did not rank among the top 10 declines by percentage.

The broader Standard & Poor’s 500 sank 3.8% to 847.75 and the tech-heavy Nasdaq index slumped 2.8% to 1,319.15, both reaching new five-year lows.

The S&P; index now is down 44% from its peak in March 2000. The Nasdaq index is down 74%.

The focus now shifts to Monday, and whether more investors will decide over the weekend that they can’t bear any more pain.

“The Dow breaking through its September lows is going to cause a lot of people to say, ‘That’s frightening. I’m out of here,’ ” said Chip Hanlon, editor of investing newsletter Unfundamentals.com in Huntington Beach.

A huge wave of selling Monday could trigger trading halts on the New York Stock Exchange for the first time, if the Dow falls as much as 950 points.

Regardless of what happens Monday, Hanlon said, several “classic contrarian signals” suggest the market is reaching at least a near-term bottom.

Professional investors’ sentiment has gotten extremely bearish, he said. For instance, the latest Investors Intelligence survey of market newsletter editors, issued this week, showed 39.6% were bears and 35.4% were bulls, an unusual occurrence. The last time bears outnumbered bulls was in September, preceding the powerful fourth-quarter rally. The last time before that was in late 1998, also around a market low.

The current mood among average investors is bleak as well. Stock mutual funds were hit with an $11.4-billion net outflow in the week ended Wednesday, the heaviest this year, according to AMG Data Services of Arcata, Calif.

“Our call volumes are high and the reaction is one of losing patience with this market,” Steve Norwitz, spokesman for mutual fund company T. Rowe Price Group in Baltimore, said Friday.

“People are expressing shock, dismay and distrust, especially over the larger companies.”

Norwitz said redemptions at the firm this month have been only “moderately negative” because investors are reluctant to take losses in what might turn out to be a bottoming phase. “But if the market continues to slide, I expect some acceleration of the redemptions,” he added.

Philip Dow, director of equity strategy at brokerage RBC Dain Rauscher in Minneapolis, said he is reminded of the 1973-74 downturn, the worst postwar bear market, when “a lot of people gave up and never came back. This is similar the way it’s scaring the heck out of everybody.” The S&P; 500 fell 48% in that bear market.

As prices continue to fall, part of the blame is put on professional “short sellers”--traders who borrow stock and sell it, hoping to buy it back on the cheap if the price goes down. A record 7.55 billion NYSE shares were sold short as of mid-July, up 5% from a month earlier, the NYSE said Friday.

Some of the biggest short sellers are hedge funds, freewheeling investment vehicles that often chase high returns by placing momentum bets on the direction of the market.

Strategists who focus on fundamentals and long-term investing say the momentum approach exaggerates market swings in either direction.

“Hedge funds helped drive the market to an irrationally exuberant extreme” in the late 1990s, said Paul McCulley, chief economist for Pacific Investment Management Co., a Newport Beach bond specialist with $274 billion in assets under management. “And now, because of their shorting abilities, they are driving it to an irrationally pessimist extreme.”

McCulley is hardly alone in believing the market has been driven to extremes.

“I’m bullish short-term. But I have been for two weeks, and of course we’re down even further,” said James W. Paulsen, chief investment officer of Wells Capital Management in Minneapolis. Paulsen said he thinks individual investors have been behind the latest slide, either directly by selling in their brokerage accounts, or indirectly by rebalancing their retirement accounts so that stock mutual funds have been forced to sell large holdings.

Despite signs of a “washout,” Sonders warned that it can be hazardous tp try to pinpoint the market’s bottom.

Dow agreed, saying, “The challenge is that this kind of a psychological trend can be slow to change. Remember that on the upside a few years ago, when all these young people were making millions of dollars, it went on two years longer than expected.”

Psychology isn’t the only hurdle facing the market, investment pros say. Dow noted that dozens of companies have been lowering revenue and profit guidance for the year’s second half. And many stocks remain highly valued, relative to earnings, even though share prices have plummeted, experts warn.