Stocks dive: Snowballing fears on Street set us up for a fall
— -- Another day of huge losses on Wall Street caused fear to spike and prompted investors to flee risk and plow their money into super-safe U.S. government debt that basically offer a zero rate of return.
Risk aversion skyrocketed Wednesday as investors still shaken by Monday's 500-point Dow plunge were rocked with another 450-point decline, one that wiped out another $700 billion in shareholder wealth and tested the nerves of even the most committed long-term investors.
The tumultuous session sparked a massive flight to safety that drives home just how fearful investors have become as the credit crunch intensifies.
There was an abundance of signs showing just how worried investors are getting. The biggest, perhaps, was the dive in the yield of the 3-month U.S. Treasury bill, considered one of the safest investments on the planet. It closed at 0.05%, down from 1.47% on Sept. 12 and its lowest since 1941, says Bryan Taylor of Global Financial Data. That means that people are willing to park money despite getting virtually no return.
"People only want to own what is the ultimate in safety and liquidity," says Bill Hornbarger, bond strategist at A.G. Edwards. "They want to know that if they put a dollar in today, they can get a dollar out tomorrow."
Other signs of rising panic were evident. A widely watched Wall Street "fear gauge" jumped 20% Wednesday, to levels not seen since the scary moments at the bottom of the last bear market in October 2002. Investors also piled into hard assets viewed as havens, such as gold. An ounce of gold shot up $70.10 to $846.60, its biggest one-day price gain ever. Even crude oil regained its stature as a place to park cash in a crisis. A barrel of crude rose $6.01 to $97.16.
Startling events on Wall Street since the weekend have pushed investors into fight-or-flight mode as they see news events shred their portfolios. Sunday kicked off on an ugly note as investment bank Lehman Bros., a major Wall Street player for 150 years, prepared to file for bankruptcy protection. Then came equally shocking news that storied brokerage Merrill Lynch was pushed into a late Sunday marriage with Bank of America. Then Tuesday, the government announced a bailout for failing insurer American International Group, including an $85 billion loan.
Mom-and-pop investors who own mutual funds are starting to rethink their stock exposure. Monday, when the Dow tumbled 504 points, investors yanked $11 billion out of stock funds, according to TrimTabs Investment Research. Less than $2 billion came back in Tuesday when the Dow rebounded. But when data for Wednesday become available Thursday, more major outflows are expected, says TrimTabs CEO Charles Biderman: "Assets are being thrown out the window."
More signs of stress surfaced in the money market. The $260 million Colorado Diversified Trust saw its share price fall below $1 a share Wednesday because of losses on Lehman Bros. debt. Money funds strive to keep their share prices at $1 a share so investors won't lose money. Tuesday, the Reserve Prime money market fund said its shares had fallen to 97 cents, the first retail money fund ever to "break a buck."
Confidence, the bedrock of efficiently working markets, is in short supply. "This is pure and simple a crisis of confidence," says Bob Barbera, chief economist at ITG.
The market gave a clear no-confidence vote Wednesday to the financial sector, which is struggling to survive after losing more than $350 billion on souring real estate-based assets.
Investment banks take a hit
Fears over whether the last independent investment banks can survive the credit crunch and avoid failing or losing their independence caused their stocks to get hammered. Shares of No. 1 Goldman Sachs and No. 2 Morgan Stanley were decimated. Goldman plunged $18.51, or 14%, to $114.50 — down from $154.71 Friday and far from its 52-week high of $250.70. Morgan skidded $6.95, or 24%, to $21.75. It has fallen 42% since Friday.
Many analysts blamed the assault on the two stocks on so-called short sellers, who profit when stocks fall. In a short sale, investors sell borrowed shares with the hope of buying them back later at a lower price. Lately, shorts have been going on so-called bear attacks, ripping the stocks to shreds, putting the firms in an even more vulnerable position.
"It's when a bunch of people just sort of gang up and sell the stock," says Stephen Coleman, chief investment officer at Daedalus Capital, adding that the shares succumb to a flood of sellers far exceeding buyers. "There comes a tipping point when there is a loss of confidence in the stock, and buyers just step aside."
John Mack, Morgan Stanley CEO, in a memo to employees Wednesday, blamed short sellers for his stock's steep decline, Reuters reported. He said the drop was not "rational" and that the market is being controlled by "fear and rumors."
(Wednesday, the search was on for who might be the next to fail or be forced to find a buyer. Morgan Stanley is in the preliminary stages of exploring a possible merger with Wachovia or other institutions, says a person familiar with the matter who didn't want to be identified because the person is not cleared to speak publicly. Both companies declined to comment.)
It is that kind of abusive trading that the Securities and Exchange Commission is cracking down on on Thursday. It added rules to stop the illegal practice called "naked" short selling, or selling shares without actually borrowing them. The new rules include all stocks, not just major financial stocks, as was the case during the summer when a similar ban was temporarily installed.
In another sign that investors want nothing to do with troubled banks, bank-to-bank lending basically froze up Wednesday, says Joe Balestrino, a senior fixed-income portfolio manager at Federated Investors. That caused the Libor rate that banks charge each other for short-term loans to jump from 2.87% to 3.06%, Bloomberg News reported, its biggest jump since Sept. 29, 1999. Millions of adjustable-rate mortgages and other types of loans are pegged to that rate.
"How frozen was it? Anyone would be hard-pressed to trade a bond without a U.S. government label," Balestrino says.
Not only did the stocks of Morgan Stanley and Goldman Sachs get creamed, the firms' cost of borrowing skyrocketed. In a environment where raising capital is key, that was also a negative drag on the stock.
In addition, the cost of insuring against a potential default of each firm's debt also jumped sharply, yet another sign that confidence is low. Jeff Houston, who runs a diversified bond fund for American Century Investments, said part of that phenomenon was caused by the fallout from Lehman's collapse and the government having to bail out AIG.
Some encouragement
The market has undergone similar crises before, including the scare over Long-Term Capital Management, the Enron scandal and the S&L crisis. So far, the market's direction is a "standard correction in a bear market," he says, with stocks falling 26% in this bear. "With all the body blows, the fact the market has done as well as it has is encouraging," says Ken Winans of money management firm Winans International.
Quincy Krosby, chief investment strategist at The Hartford, says a big investor with a big-time reputation must swoop in and buy. "We are watching to see if any of the Warren Buffets, the Carl Icahns and the Kirk Kerkorians of the world start picking away. That will give confidence."
Contributing: Kathy Chu, wire services.