The stock market's nose dive last week portends a tough period ahead for equity managers.
But some institutional investors hope the decline will send a clear message to the Federal Reserve Board to put the brakes on future interest rate hikes.
On Nov. 23, the Dow Jones Industrial Average closed at 3674.63, down 3.36 points. The day before, it plunged 91.53 points - or 2.4% - to 3677.99 in one of the heaviest trading days of 1994. The Standard & Poor's 500 Stock Index dropped 1.8% on the same day, and the NASDAQ fell 2.2%. The previous day, the Dow fell more than 45 points.
While stock indexes plunged, prices of Treasury bonds surged. The yield on 30-year T-bonds was pushed to a three-year low of 7.81% by Nov. 22.
"My opinion is there are a lot of fundamental similarities with October 1987," when the stock market crashed, said Laird Landmann, a bond manager for Hotchkis & Wiley, Los Angeles. He cited the weak dollar, an expanding U.S. trade deficit and a rise in interest rates that was similar in magnitude and speed to the 300 basis-point hike in 10-year T-bond rates in 1987.
Donald G.M. Coxe, chief investment officer, Harris Investment Management Inc., Chicago, said: "We're in the major stages of a major global liquidity crisis. Real liquidity problems occur when the economy is strong and it doesn't have enough liquidity to finance the demand for credit. There is a huge loan demand and huge credit demand from consumers.
"The only way to offset this is to pull in money from abroad," Mr. Coxe said. "If we would have had a rally in the dollar, it would have worked. My fear is that the dollar is breaking down.
"A strong dollar would have attracted foreign money and make up for what the Fed is doing (tightening liquidity). But because of the weak dollar it didn't happen.
Harris "turned negative in its balanced portfolios in the second quarter," Mr. Coxe said. "That was too early, and a lot of clients complained. But we aren't getting any complaints now. All the balanced accounts are within two percentage points of the lowest equity allocation permitted. For fully discretionary accounts, that 27%."
Stock market investors seemed to be digesting the events in the bond market of the last few weeks. A yield of 7.3% yield on two-year Treasury notes in an environment of 3% to 4% inflation makes for stiff competition for stocks. "It's is a pretty good investment for a pension fund," Mr. Landmann said.
Mr. Landmann said the drop puts the Fed in "a bit of a box." Corporate earnings are better than they were in October 1987, but that could change if interest rates keep climbing.
"This kind of stock market is kind of an accident, caused by a tremendous amount of money trying to chase or anticipate short-term trends," said Malcolm Clarke, partner at Brundage, Story & Rose in New York, which runs $4.4 billion in stocks and bonds.
"October 1987 was a colossal pile-up .*.*. on the New Jersey Turnpike. (Nov. 22) was kind of a fender bender," Mr. Clarke said.
Although there's always the fear that one of these accidents could inflict some economic damage, currently the firm sees some good stock values in the market.
Edgar E. Peters, director-asset allocation, PanAgora Asset Management, Boston, said of the Nov. 22 fall in the stock market: "It's what we were expecting. The fundamental factors for a bull market aren't there. There's a tightening environment as far as monetary policy.
"The Fed slowdown has to affect corporate earnings. The rise in real (interest) rates is the main reason stocks are going down. .*.*. "We're not in that kind of environment (as the 1987 crash)," Mr. Peters said. "But we're in a bear environment. We haven't had a bear market for 14 years. A bear market is when prices continue to go down for a year. This is like nothing we've experienced since the early 1980s."
In mid-October, Mr. Peters said PanAgora shifted is balanced portfolios to 40% equities and 60% fixed income; the benchmark is the reverse.
William Brennan, director of client services of Avatar Associates, New York, which runs $5 billion in tactical asset allocation strategies, said it's been 10 years since there's been consecutive down quarters in the S&P 500.
"As tactical asset allocation managers it's been difficult to shine because there were not a lot of opportunities to protect capital in down markets," he said.
"We think given the continued strength of the economy and pressure on the Fed to raise rates, it's a very risky environment for stocks and bonds - particularly stocks as higher interest rates compete for investors dollars." Since the Fed began tightening in February, Avatar has been defensive. It has a 50% to 70% allocation to cash and cash equivalents in portfolios.
Said Seth Glickenhaus, senior partner of Glickenhaus & Co., New York, which runs $2.8 billion: "We think this could be a very significant change in the market; at best a careful watching, at worst a very big correction. We've had a field day here in the Dow averages for many years."
But now he sees a disinflationary trend in spending and investments by the federal government, states, cities and corporations.
"You're going to have to be an excellent stock picker in the world of tomorrow. It's no longer a stock market but a market of stocks," Mr. Glickenhaus said.