When Bulls and Bears Act Unruly on a Seesaw

When Bulls and Bears Act Unruly on a Seesaw


By FLOYD NORRIS

Published: September 1, 2007

Does it make sense for stock prices to
plunge one day and soar the next, with little in the way of new
information to explain either move? Skip to next paragraph


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Maybe not, but it happened
this week, just as it did earlier in August. It was the first time in
more than four years that the American stock market experienced such
wild swings, and could be a harbinger of a reversal of direction in
either the stock market or the economy, or both.Or it could just show that changes in the financial system have left many investors confused about what is going on. In
the past, such wild swings have sometimes indicated that markets were
turning in a new direction. In retrospect, there seem to be good
reasons for the turnaround. But at the time, there were also plenty of
investors who believed that the prevailing trend was sure to continue
and jumped in to drive prices in the old direction.In September
1974, with the economy in a severe recession and the stock market in
the worst bear market since the Depression, there was a string of
sharp, contradictory moves. Share prices hit bottom in early October,
and a strong recovery followed.In 2000, the bull market was
going strong, led by the technology stocks that had soared and made
many traders feel rich. The first big reversal came in January, with
prices plunging one day and recovering the next. It happened again in
April, and again in October. The Internet bubble was finally deflating,
and a prolonged bear market was beginning.By 2002, investors
were as depressed as they had been in a generation. The 2001 recession
was over, but that was not clear. A series of summer reversals signaled
that a bottom was near, and was followed by more reversals in October,
November and the following March. The bull market had revived.But
while such reversals can signal major market moves, they can also occur
when markets are stirred by changes that leave many investors simply
perplexed. The 1987 crash, which seemed at the time to warn of
impending recession, now appears to have been caused by a new
investment strategy involving stock index futures that led to major
selling after the first decline. The strategy, called portfolio
insurance, decimated portfolios, but it did not reflect what was going
on in the economy. Aided by quick action on the part of the Federal
Reserve, the next recession was still three years away.Similarly,
reversals in 1997 and 1998 came amid an Asian credit crisis, a Russian
default on debt and problems with a hedge fund, Long-Term Capital
Management, whose strategies were not as brilliant as its founders had
believed. But they did not presage an end to the 1990s bull market.This
year’s sharp moves have come as investors vacillated over how extensive
the effects of the subprime mortgage problems will be. Those problems
have led to a sharp contraction of credit markets and to difficulties
for a number of hedge funds, but it is unclear if the crisis will also
bring on a recession and end a bull market that has sent most stocks
well above the highs they reached in 2000.To some traders, it is
ridiculous to expect the entire economy to falter because of problems
in the subprime mortgage market. That market is, as President Bush put
it yesterday, “modest in relation to the size of our economy,” and the
world economy remains strong. Others are convinced that tighter
credit standards will force American consumers to curtail spending,
slowing the economy and damaging corporate profits. It is from such
contradictory beliefs that the wild days of August sprang.