Nightmare on Wall Street

By MARK FRYER

Day in, day out it's the same story - "Stocks dive" scream the headlines, "Fear stalks Wall St", "Buyers flee tumbling market".

As US share prices fall, the damage rubs off on the rest of the world. The New Zealand sharemarket has escaped with less damage than most of its counterparts, but that won't provide much comfort for many local investors; almost anyone with money in overseas shares has seen those investments going backwards lately.

Too much of this and you could be forgiven for thinking that the end is nigh.

But how bad is it?

In a word - very.

To put things in perspective, take a look at the table below, which shows the biggest falls in US share prices since the great crash of 1929, as measured by the S&P-500 index, which averages out the prices of shares in 500 companies covering all sectors of the US economy.

So far - as of Thursday US time - share prices have fallen by 45 per cent from their peak in March 2000. That makes this one of the five worst falls the market has suffered since the great crash.

Until share prices rebounded sharply on Wednesday, the market was down even further - 48 per cent lower than its peak.

That easily qualifies as a bear market - usually defined as one where share prices have fallen at least 20 per cent.

The only comparable event in recent history was the bear market of 1973-74, which knocked about 48 per cent off the value of US shares.

How about the crash of 1987 - the one that many New Zealand investors are likely to remember? The current bear market has already left 1987 in its dust; at that time US share prices fell about 34 per cent and the damage, while severe, was at least short-lived, with prices reaching bottom only four months after the fall began.

And, as pessimists will have noted, there is no proof that US share prices have hit bottom yet. Wednesday's rebound may have been the event investors were waiting for, but it may also prove to be just a blip in the long downhill slide. If the S&P-500 index falls another 150 points - at this point it's down 690 points - the percentage decline will be even greater than it was in 1937-38, when prices fell by 54 per cent, and second only to the cataclysm of 1929-32.

Slumping share prices are not limited to the US; shares in the United Kingdom, for example, are down 45 per cent from their peak in 1999, as measured by the FTSE-100 index. For the entire world, as measured by the MSCI World index, the damage is about 48 per cent.

Things look even worse viewed from New Zealand, since the rise in the value of the kiwi dollar has further dented the value of overseas shareholdings.

To some extent, the size of the bear market depends on your measuring stick. Things don't look so depressing if you employ the frequently quoted Dow-Jones index, in which case the US market has declined by "only" 30 per cent from its peak and has a way to go before it matches several past bear markets.

However, the S&P-500 is a much wider gauge of the market than the Dow, which includes only 30 shares.

As if the size of the decline wasn't dramatic enough, it looks even more so in contrast to what went before. When the markets changed course in 2000, it came after 10 years of strongly rising share prices.

In fact, US share prices began rising strongly back in 1982 and, while there were sharp downturns in 1987 and 1990, the worst was over in a few months. Between 1982 and the market's peak in 2000, prices rose 12-fold.

But if there is one lesson to be learned from delving into market history, it is that prices don't go up forever. Again, it depends how you do the counting, but writer Peter Rothchild, author of The Bear Book, says investors should expect to see a bear market once every four years or so.

History also tells us that bear markets can last a long time. When US share prices fell in 1973, for example, they took until 1980 to get back to where they were before the bear set in.

But while history helps to put things in perspective, it doesn't tell us what happens next.

Every bear market comes with its own unique circumstances: in 1929 the world was wracked by depression; in 1973 there was an oil crisis and rampant inflation.

By contrast, this bear market is happening at a time when the US economy, while not rampant, is a long way from depression, and American consumers are continuing to consume, encouraged by low interest rates.

While concern about a slower-than-expected economic recovery was one of the reasons for the current bear market, the fall in share prices also resulted from the parade of corporate accounting scandals, a general feeling that share prices had risen too far too fast, and a fear of further terrorist attacks.

There is at least one way in which this bear market is worse than those of the past. These days share prices affect more people directly than they ever did before.

Encouraged by the bull market of the 1980s and 1990s, and the message that everyone had to save for their retirement, millions of people all over the world invested in shares, and are now anxiously watching those investments shrink.

Since the market's peak in early 2000, investors in US shares alone have seen their wealth decline by US$8 trillion, according to the Wilshire 5000 index, which covers all US stocks. In New Zealand dollars that's - wait for it - $17,060,000,000,000.

It may have been only paper wealth, but it was wealth that people were counting on for their retirement, which will now have to be delayed or more frugal.

The cover story on the latest issue of Time magazine sums up the question facing millions of US investors: "Will you ever be able to retire," it asks.

Some bear markets end quickly, as in 1990, when US share prices were back to their pre-crash levels in just seven months. Others took much longer, as in 1973-74 or, if you're really pessimistic, 1929, when US share prices didn't regain their pre-crash peak until the mid-1950s.

In attempting to divine signs of a turnaround, many market watchers appear to have given up on the financial ratios which they normally use to explain the market's gyrations, resorting instead to mass psychology.

One theory has it that the market will hit bottom only when there are no optimists left, or, as they say in the jargon, there are signs of "capitulation". According to that approach, bad news is good news; the gloomier everyone is, the closer the market is to turning around.

According to a UBS/Gallup survey of investor optimism out this week, confidence is at its lowest point since the survey began in 1996.

But investors don't give up easily; more than half of those polled expect the market to be back at its peak within two years.

When optimism is bad news, that may be a sign that we haven't seen the last of this bear yet.

* To contact Personal Finance Editor Mark Fryer write to: Weekend Herald, PO Box 32, Auckland.

mark_fryer@nzherald.co.nz
Ph: (09) 373-6400 ext 8833

Fax: (09) 373-6423.