Dow under 10,000: Signs of a growing crisis

NEW YORK -- Stocks worldwide plunged Monday on growing signs that the credit crisis is spreading to banks and economies outside the USA, sparking a sharp selling spree on Wall Street that drove the Dow Jones industrials below 10,000 for the first time in four years.

Stocks in London fell almost 8%. The Paris market slid 9%, its steepest retreat since 1987. Big drops in Russia and Brazil led to trading halts in their markets. Russian shares fell 19.1%; those in Brazil dropped 4.4% after falling as much as 15%. Tokyo shares fell 5% to a five-year low.

Panic selling spread to Wall Street, where the Dow tumbled 800 points, briefly topping its record 778-point plunge on Sept. 29. A late rally cut the day's loss to 369.88 points, or 3.6%, to 9955.50. It was the Dow's lowest close since Oct. 26, 2004.

Amid a crisis fueled by a meltdown in the mortgage industry, the Dow has lost nearly 30% since Oct. 9, 2007, a fall that has gashed Americans' investment and retirement accounts, raised fears of a prolonged recession and made the economy the top issue in the presidential campaign.

Hopes that Friday's passage of the U.S. government's $700 billion rescue plan for the financial industry would restore investor confidence already are fading, as the worldwide reach of the credit crisis becomes more clear. Many investors fear the plan lacks the punch needed to quickly thaw frozen credit markets and avert a global economic slowdown.

"It's a lethal one-two punch: A global credit crunch equals a global recession," says Nicholas Sargen, chief investment officer at Fort Washington Investment Advisors.

Monday's tumult and volatility were historic. A closely watched Wall Street "fear gauge" skyrocketed to levels not seen since the October 1987 stock market crash, when the market fell 22% in a single day.

Individual investors dialed in to their fund companies for advice and reassurance — and to dump stocks. Traders and money managers gritted their teeth as the value of their stock holdings tumbled $500 billion, extending the market's 2008 loss to $5 trillion and a staggering $6.4 trillion since last October's high, according to Dow Jones Indexes.

"I'm under my desk," said Jeffrey Saut, chief investment strategist at Raymond James. "Brokers are getting calls to just sell everything."

At the peak of the selling, Todd Leone, a trader at Cowen & Co., said, "They are just selling everything. They just want to get out."

Wall Street's red ink has its origins in a housing market gone bust. Like a domino effect, the troubles started on Main Street. A sharp drop in housing prices after a multiyear boom caused millions of Americans to fall behind on mortgages, which led to a surge in foreclosures, which caused massive losses at banks that lent the money.

To make matters worse, Wall Street packaged the bad mortgages into risky, hard-to-understand securities and peddled them around the globe to investors in search of higher returns. The value of the securities plunged along with home prices, making it impossible to price or sell them. Financial institutions were saddled with hundreds of billions of dollars in losses. Many have failed, and the ones still standing are too fearful to lend money to other banks. That's resulted in a severe credit crunch that has shut down the world's economic engine.

"The credit crisis is evolving into a full-blown credit squeeze," says Alan Skrainka, chief market strategist at Edward Jones.

That squeeze hit Europe in a big way last week. The global sell-off came after European governments rushed to prop up failing banks, while the governments of Germany, Ireland and Greece also said they would guarantee bank deposits.

Many Wall Street traders say the government's poor handling of the economic rescue bill caused the stock rout.

Lawmakers' initial rejection of the $700 billion plan to rid banks of toxic real estate assets hurt investor confidence, cost the government valuable time in implementing fixes and created intense uncertainty that sparked selling, says Don Luskin, investment strategist at TrendMacro.

"Why is it that Treasury is not there immediately to implement the authority that it said it needed immediately" in the rescue plan? Luskin asks. "That failure to act once the authority was granted is the reason why the market is selling off today."

President Bush said Monday that "it's going to take awhile" for the Treasury's plan to work.

The Federal Reserve and Treasury Department announced separate moves Monday to try to calm spooked financial markets.

The Fed said it's doubling to $900 billion the amount of cash it lends to banks under a special program. The Fed also will start paying interest on bank reserves, making it easier to manage its interest rate policy. A key interest rate in recent days has dipped well below the Fed's 2% target because of extraordinary funding demands.

Meanwhile, the Treasury Department appointed Neel Kashkari, a Treasury official and former Goldman Sachs executive, to oversee the bailout program.

Hedge funds to blame?

Many investment strategists blamed the steep sell-off on forced selling by hedge funds that need to raise cash to meet redemption requests from investors. The average hedge fund fell 5% to 10% in value in September, the worst month in over a decade, says Hennessee Group.

"The way you get these types of waterfall declines is due to forced liquidations," says Bruce Bittles, chief investment strategist at R.W. Baird.

Market sectors such as basic materials and energy are suffering as these former favorite bets by hedge funds are getting hit with an avalanche of selling. The iShares Dow Jones U.S. Basic Materials Sector exchange traded fund dropped 3.9% Monday, and the Vanguard Energy ETF lost 4.5%.

There is also a major lack of confidence now haunting financial markets. "This is a confidence game," Saut says. "And we have suffered a loss of confidence in financial institutions, in the economy, and the straw that broke the camel's back was a loss of confidence in our elected officials."

The massive stock market declines of the past week make the current bear market the fourth-worst since World War II. At Monday's low point, the Standard & Poor's 500 index was down 35.6% from its October 2007 high. That loss tops the average postwar loss of 31.5% but is a far cry from the 49.1% loss in the 2000-02 downturn sparked by the tech-stock bust. It is also well shy of the 48.2% decline in the 1973-74 bear market, which occurred amid a backdrop of double-digit inflation, the Arab oil embargo and a lengthy recession.

Even so, the ongoing bear market has wiped out all of the market gains during Bush's second term. Investors are dealing with the distinct possibility that they might, for the first time, end a decade with less money than they started with. After Monday's close, the Standard & Poor's 500 index is 20% below its 1320.28 close on Dec. 29, 2000. The worst decade for stocks was the 1930s, when the S&P 500 generated 0% returns on average for the decade, according to Vanguard.

Even longtime market cheerleaders are losing faith. Jim Cramer, the hyperkinetic host of CNBC's Mad Money show, who treated investing like a sporting event during the run to the peak, told investors to "take it out" if they needed money within five years. "I can't have you at risk in the stock market," the former hedge fund manager told viewers Monday on NBC's Today show.

Capitulating?

Monday's roller-coaster-like trading action had many of the elements that normally appear when scared investors finally get spooked enough to throw in the towel and sell whatever stocks they have no matter what the price.

That kind of panicky behavior often occurs when markets are in the latter stages of a bottoming process. Nearly 1,700 stocks hit new lows on the New York Stock Exchange. There is so much negativity priced into the market that just a glimmer of good news could lift stocks.

"Very few people are talking about anything positive," says Ken Winans of money manager Winans International. "Bear markets end with capitulation. Bull markets don't start when the headlines are favorable."

"We are approaching the capitulation we've been anticipating," notes Randy Frederick, director of derivatives at Charles Schwab. "It is safe to say the uncertainty now exceeds all times in recent history, except for the stock market crash of 1987."

Some Wall Street pros aren't sure stocks have stopped falling. Says Gary Kaltbaum, president of Kaltbaum & Associates, "You have to get calls of the 'end of the world.' You need front covers of every magazine reporting doom and gloom. We are getting there."

There is more pain to come, says Robert Dugger, managing director of Tudor Investment, speaking at a conference of the National Association for Business Economics in Washington, D.C. "The asset price destruction and uncertainty that we are seeing still has a number of years to run," he says.

If there is a silver lining in the carnage, it is that stocks are becoming increasingly cheap relative to their expected earnings.

The price-earnings ratio, or P-E, for stocks in the S&P 500 has fallen to less than 13 based on 2008 profit estimates. (P-E is the price of a company's stock divided by its earnings per share. It gives investors a gauge of how much they are paying for a company's earnings power.) The S&P 500's P-E for next year has dipped to 10.3. Those P-E ratios compare with a 30-plus P-E at the height of the dot-com tech bubble in early 2000.

Individual investors frightened by the sharp drop in the values of their stock holdings in brokerage, 401(k) and college-savings accounts, swamped mutual fund companies with calls Monday.

At fund giant Vanguard, call volume was busy Monday, "but manageable," spokesman John Woerth said. "The general sense from investors is concern but calm. Most investors are sticking to their long-term investment plans."

Woerth added, "We don't comment on daily cash flows. That said, on days like today, you typically see a mixed bag of transactions — some seeing the stock market decline as a buying opportunity and others looking to safer havens like money market funds. Most investors stick to their long-term plans."

Charles Schwab spokeswoman Sarah Bulgatz also reported "very high" call volume from account holders: "I can tell you that people are obviously very concerned."

She said some people need reassurance that they have the right investment strategy. But some still opted to lighten up on holdings deemed too risky, although Schwab doesn't disclose daily outflows from stock funds. "In some cases," she said, "they've decided to make changes that reflect their feelings that their investments just aren't right for the time."

Despite the steep losses, Katherine Berke, a financial planner based in Parker, Colo., advises most investors to stay calm. "There is a lot of uncertainty. But what happens any one day doesn't make a 10- or 20-year strategy," Berke says. "There should be no knee-jerk reaction to the market. But people tend to sell when the market is low and buy when it's high. That is counterintuitive, but it is typical."

While admitting that they were frightened by the declines, some individual investors were selectively bargain hunting Monday. "I am buying," says David Leon, a 42-year-old attorney from Winter Garden, Fla. "There are some great bargains out there right now."

Contributing: Christine Dugas, Barbara Hagenbaugh, Del Jones and Sue Kirchhoff