Stocks fall to lowest level since 1997 as Dow drops below 6,800

NEW YORK -- If there ever was a symbol of investors' lack of confidence in the government's ability to stem the financial crisis, it was the Dow Jones industrials plunging below 7000 Monday and closing at levels not seen since April 1997.

Stocks are in free fall. Investors are in panic mode. The government's numerous bailout attempts — including its latest gambit to prop up insurer American International Group — have failed to restore hope.

And how low stocks must go before bottoming out is anyone's guess.

"It's a bloodbath, pure and simple," says Scott Black, president and portfolio manager at Delphi Management. "This is a vote of no confidence in the Obama administration. It doesn't matter what you own, everything is going down. It is a total capitulation. People are just terrorized and are throwing in the towel."

Wealth is being destroyed on Wall Street at a rate not seen since the 1930s. The gains from the 2002-07 bull market are gone. A big chunk of the huge profits from the 1990s dot-com stock boom have been wiped out. In all, after Monday's 300-point drop to 6763, more than 7,400 Dow points, or 52.3%, have disappeared since the October 2007 peak, the biggest-ever point drop.

Of all the bear markets in Dow's long history, only the 89.2% drop during the Great Depression was worse.

All that pain is calling into question the buy-and-hold strategy that once was sacred on Wall Street. And it's leading analysts to wonder if a generation of investors, many of whom have seen their retirement nest eggs lose more than half their value, will bail out of stocks for good. Some analysts say stocks, which posted zero gains for the 10-year period ended in October, are setting up for a second "lost decade."

"The danger is, you risk developing a generational divesture out of the stock market," says John Bollinger, president and founder of Bollinger Capital Management. "You could have an entire generation say, 'I don't care, get me out of the stock market.' Investors could flee stocks in 401(k)s, IRAs, trust accounts and their personal accounts. I think that is what is going on now."

Adds Frank Cappiello, chairman of Montgomery Bros. Cappiello in Baltimore:

"This is frightful — I've never seen a bear market without a rally. No one wants to step up to the plate. We're going to have a whole generation without enough to retire on."

A sudden fall

The rise and fall of the stock market has been sudden and swift. The peak of the market was hit in October 2007, when stocks were flying high amid record corporate earnings fueled by cheap money and massive risk-taking by investors who thought home prices and stock prices would keep going up forever.

But that investment thesis came tumbling down last spring, when the bursting of the housing bubble started to add up to massive losses for Wall Street banks and other financial services firms tied to bad mortgages. The near failure of Wall Street investment bank Bear Stearns in March 2008 and its subsequent purchase by JPMorgan Chase at a fire sale price was a key turning point, because it illustrated just how profound and dangerous the brewing financial crisis and credit crunch was to banks and the health of the economy.

The stock market has deteriorated sharply in 2009, as investors' hopes for a comprehensive government solution to the banking crisis and deepening recession have been dashed amid growing concerns that the plans and programs implemented by President Obama and his economic team might not be the right prescription for what ails banks and the economy.

"The problem," says Andy Brooks, head trader at mutual fund giant T. Rowe Price, "is that people want to see solutions; they want answers, and they want a sense of timing" as to when the government programs will be announced and when they will start to take effect.

"But we don't have any of that yet," he says. "The solutions are still being developed, the answers are being worked out, and the timing is unclear."

The latest government intervention that failed to boost investor confidence involves AIG. On Monday, the insurer posted a $61.7 billion quarterly loss, the biggest in U.S. history. staggering $61.7 billion in quarterly losses In an effort to boost AIG's financial position and protect the broader economy from so-called systemic risk of an AIG failure, the government provided AIG with an additional $30 billion in capital. The government, which already has a nearly 80% stake in AIG, has committed $150 billion to the giant insurer. AIG shares, which have been virtually wiped out, finished flat Monday at 42 cents a share.

AIG's latest bailout follows last week's move by the government to help shore up the sagging finances of Citigroup. Citi shares Monday fell 30 cents to $1.20.

'I am beyond fear'

The inability of any of the government's moves to gain traction or get buy-in from Wall Street is causing uncertainty to jump and stocks to fall.

"The market is telling me that it doesn't like the direction that policy is taking us in the nation's capital," says Doreen Mogavero, an independent floor broker at the New York Stock Exchange. "I know it needs time to see if it works. But it seems we have thrown everything but the kitchen sink at our problems, and I think investors are afraid if this doesn't work — and there are no signs that it has even made a dent — that we are all out of ammo."

Mogavero says the biggest cause of the intensifying selling is "lots and lots of fear."

Bob Martin, a retiree from Palestine, Texas, is having a tough time putting the market's losses into perspective. "I am beyond fear," he says. "I am numb."

The inability of the Dow and other major stock market indexes to stay above their prior lows last November has increased anxiety, mainly because few analysts are confident they can predict the ultimate bottom for stocks.

Mogavero says there is a lot of talk on the floor of the NYSE that the Standard & Poor's 500, a broad market gauge, may find some buying support at the 600 level, almost 15% lower than Monday's close of 700.82.

Questioning Obama

The lack of stock market support so far coincides with Wall Street's dwindling support and confidence in Obama's economic recovery plan, his just-released budget and the inability of the president's team at the Treasury Department to provide the market with a clear road map on how it plans to repair the broken banking system, says Pat Adams, a hedge fund manager at Choice Investment Management.

"The market has lost confidence in Obama awfully fast," Adams says. The Dow is down 30% since Election Day and 15% since Obama took office.

Wall Street typically takes a dim view of regulation or government involvement in business — and continues to do so even at a time when key parts of the financial industry have sought government help to stay alive. Now, Adams says, Wall Street generally believes the president's budget relies too much on government spending and too little on tax cuts and other incentives for businesses. Big investors also are complaining that Obama's policies are more anti-business than they believed initially. "The market thought it was getting a Bill Clinton-type Democrat that would move toward the political center," he says. "But we got a guy way off to the left."

Gary Kaltbaum, president of money management firm Kaltbaum & Associates, says Obama's plans to tax the wealthy and take aim at big business will have an adverse affect on the ability of companies, big and small, to generate the types of profits needed to reignite growth.

"When all is said and done, it is profits that drive stocks," Kaltbaum stressed in a note to clients Monday. "When profits expand, the markets expand. When profits contract, the markets contract. Most of the time, profits are based on the talent and wisdom of Corporate America, and then there are times when profits are based on policy. I believe we are now in a period of a war on profits, a war on success."

More room to fall?

Profits are down sharply and in danger of falling further if the economy doesn't get healthy soon. That's driving stock prices down sharply. Earnings of S&P 500 companies peaked in 2006. Analysts expect that this year, profits will be down nearly 30% from the peak, according to Thomson Reuters.

Since the start of the year, analysts have slashed their profit expectations sharply, signaling more potential downside for stocks. A 31.4% decline in profits is now estimated for the S&P 500 for the first quarter of 2009, down from a Jan. 1 estimate of a drop of 12.5%. All 10 sectors in the index are now showing profit declines, the first time that's happened since Thomson Reuters began tracking such data in 1998.

That sharp drop in earnings — and the inability of corporate CEOs, analysts and investors to get a good handle on what future profits will be — makes it tough for investors to gauge exactly how much they should be paying for stocks, says Charles Biderman, president of TrimTabs.com.

"At the start of the year, most analysts and brokerage firms said the worst was over and that stocks were cheap," says Biderman. "But they are cheaper now."

At Monday's close, the S&P 500 was trading at roughly 11 times expected profits of $63.14 for 2009. And while that is far below the 30-plus price-to-earnings ratio, or P-E, at the height of the tech stock bubble in 2000 and below the long-term average of 15, there is still a risk that stocks might not be as cheap as they appear if profits keep falling, says Delphi's Black. If the S&P 500 earn only $40 a share in 2009, the P-E would be above 17.

What could reverse the stock market's free fall?

A bank fix plan from the Treasury Department that Wall Street thought would work would be near the top of the list, says hedge fund manager Adams. "I kinda gave up on it and stopped looking for it," he says. If a plan with teeth was released, it could erase a lot of the uncertainty facing investors and give stocks a huge boost, he believes.

The mere sign of the economy not getting worse and stabilizing could be enough to lift investors' spirits and propel money managers to use some of the nearly $4 trillion in cash in money market funds to buy stocks, says David Chalupnik, chief equity officer at First American Funds.

The current market decline reminds Lewis Altfest, who runs a wealth management firm in New York, of the dark days of the 1973-74 bear market, when the market fell 48.2% and anything appeared possible in terms of more downside. But a mad rush to the exits if the S&P 500 index nears a selling climax at, say, the 600 level could signify that the final capitulation is in, he says.

"If investors could just be Rip van Winkle and close their eyes, it could be a great buying opportunity," he says. "Some people think the market is going to zero. That is not going to happen."

Contributing: John Waggoner in McLean, Va.