508…an eerily familiar number

In my office, I have a photo of an old Quotron machine from the eighties. On it, the following jumps out at the trained eye: DJIA -508. The photo was taken on Monday, October 19th, the day that the Dow Jones Industrial Average fell 22.6%. Yesterday, it was déjà vu---another 508 point drop, but this time the point total did not amount to 22%, but 5.1% was plenty, thank you very much!

The selling was not prompted by anything new—same old credit crisis which has now morphed into blind fear. After gains at the start of the session, stocks turned down steadily and the losses accelerated, leaving the Dow down 508.39 points, or 5.1%, at 9447.11, its lowest close since Sept. 30, 2003. The Dow shed nearly 13% in the past 5 trading sessions, the largest drop since September 2001. The 1403.55-point decline was the Dow's biggest 5-day drop ever, and that doesn't include a 778-point drop on Sept. 29. The Dow is now down 33% from its record high reached almost exactly a year ago.

The damage was worse for the S&P 500, which closed yesterday below the psychologically important 1000 level for the first time since Sept. 30, 2003. The S&P fell 60.66 points, or 5.7%, to 996.23. Its 14.6% five-day decline is the biggest since the five days that included the October 1987 stock-market crash and the index stands 21% lower than it was just one month ago. The S&P 500 is now down 36% from its peak a year ago, almost to the day, on October 9, 2007. The NASDAQ fell 108 points or 4.3% to 1862.

If you woke up early this morning, the news did not seem much better. But then at 7:00 am, history was made: in a coordinated global effort, the world’s central banks announced cuts in target interest rates. The US Fed, the European Central Bank (ECB), the Bank of England, the Bank of Canada, Sveriges Riksbank and the Swiss National Bank all reduced their respective policy interest rates by 50 basis points or a half of a percentage point. The Fed's open market committee voted unanimously to cut its target to 1.5%, the ECB to 3.75%, the Bank of England to 4.50% and the Swiss to 2.5%. The dramatic action was intended to help stem a growing global financial crisis. The Fed noted that “The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability."

The unprecedented action is a good step forward, leading me back to October, 1987. At that time, fear gripped investors and everyone bailed out simultaneously. While our crash was not as dramatic because it took place over the course of weeks, not in a single day, this period will likely be seen as what academic Charles Kindleberger called the “revulsion stage” of a crisis---the indiscriminate and contagious selling of distressed assets that leads “banks to stop lending on the collateral of such assets.” When such fear grips the markets, investors (and speculators) are quick to generalize-punishing many for the sins of the few. That’s the most dangerous phase of any crisis—when market implosions start to take on a self-reinforcing life of their own. It is worth noting that sometimes the painful “revulsion” stage sets up the next phase of the process, where investors and markets remember how to breathe.

In 1987, the stock market regained its footing after October 19th and the crash marked the low point for stocks in 1987 and by year-end, the Dow actually showed a gain for the year! Within nine months, stocks recovered all of the losses incurred on October 19th and the US economy never went into a recession as a result of the crash. Given the unwinding that is occurring, it is doubtful that we will avoid recession this time around, but sometimes it is helpful to return to other turbulent periods to help us put our current situation in context a bit more.