With the successful reopening of the stock market on Sept. 17, Wall Street took a giant and inspiring step toward recovering from the terrorist attack at its heart. While trying to cope with grief, traders, technicians, executives, and regulators worked all hours for six days to get the system running. They met their Monday morning deadline: With only minor glitches, a record 2.4 billion shares traded on the New York Stock Exchange. The loss on the widely watched Dow Jones industrial average, 7.1%, was in line with those registered in Europe while the U.S. market had been closed. And in the next two days the Dow fell another 1.8%, reaching its lowest level since Dec. 14, 1998.
Now, Wall Street faces another arduous task, one that will last for months: adjusting to a world in which the new war with terrorists has dramatically increased the risk of enormous swings in value. "The patriotic response may have slowed some of what is hitting the market, but it can't stop it," says John L. Manley Jr., strategist at Salomon Smith Barney. "Over the next several months you are going to see a very volatile market."
Investors will want higher returns to compensate for the risks of sudden price shocks. So far, Wall Street firms have said they will put extra capital on the line to halt any lurch into panic. But, to protect themselves against sudden drops in prices, they'll be less ready to carry as much inventory as they have in the past, removing a buffer against instability. Much of the extra liquidity that helped smooth the market's reopening could evaporate even as Wall Street rebuilds its physical and human infrastructure.
Big firms took every step to make sure trading was as smooth as possible. Encouraged by the Federal Reserve's promise of liquidity, they called major mutual fund families and assured them that they would have money to buy whatever the funds needed to sell. Liquidity would be no problem, they said. Unlike in the aftermath of the 1998 Long-Term Capital Management debacle, the firms said they would buy stocks themselves, not just act as agents. "Everyone knew there would be selling pressure. Everyone's goal was to put as much liquidity as possible against that trend," says New York Stock Exchange Chairman Richard A. Grasso.
For their part, major money managers hesitated to ask the brokers to commit their capital and buy shares without another buyer on hand. "I was surprised at the lack of requests" for the firms to take in stock as dealers, says Mark Kuzminskas, head equity trader at Boston Partners Asset Management. Hank Herrmann, chief investment officer at Waddell & Reed Inc., had wanted to unload retailing shares but backed off when their prices fell 10% to 15% before he could complete trades. "We just didn't see any wisdom in aggravating the situation," says Herrmann.
Decisions to show support for all markets seemed to be the order of the new day. Goldman, Sachs & Co. (GS
) bought $1 billion of newly issued bonds from Walt Disney Co. (DIS
) It also placed a daily record $33 billion of commercial paper on Sept. 14. And more than 110 companies, including investment bank Morgan Stanley Dean Witter & Co. (MWD
) and coffee chain Starbucks (SBUX
), announced they stood ready to buy back a total of over $10 billion worth of their own shares.
But when Wall Street returns more fully to business as usual, market players may be less protective of each other. "At the end of the day, if you're a money manager you will do what is best for your clients," says Edward P. Hemmelgarn, chief investment officer at Shaker Investments. The same goes for others, from individual investors to the biggest investment banks. And at some point, to avoid pumping up another stock bubble, the Fed will drain the liquidity it poured into markets.
Even so, on Sept. 17, dealers weren't heroically buying stocks when everyone else was selling. They did little but keep order as the Dow dove nearly 600 points in the opening minutes. "No one felt like it was their obligation to put their finger in the dike," says Laszlo Birinyi, president of research and money management firm Birinyi Associates.
Uncertainty over how the U.S. will retaliate for the Sept. 11 attacks--and worries of more terrorist attacks--will keep volatility high. Besides, most analysts are at a loss to gauge the impact on corporate earnings of the shock to the economy. Before the attack, analysts were estimating earnings on companies in Standard & Poor's 500-stock index would fall 10.2% this year and rise 23.5% in 2002; as of Sept. 19, they expected a 10.5% slide this year and a 20% rise next year, according to First Call/Thomson Financial. But analysts haven't yet updated their numbers. The downward revision is likely to become sharper as more factor in a cascade of new earnings warnings and layoff announcements. Eastman Kodak Co. (EK
) said its third-quarter profit will be one-third less than expected. Viacom (VIA
) said earnings will miss forecasts because of lower advertising revenue and higher costs. Says money manager Herrmann: "I feel about as useless as I've ever felt in terms of predicting what 12 months out will look like."
Even so, many investors are encouraged by the support Wall Street and the economy are getting from Washington. They believe the recovery that was pending before the attack is more certain now because of the Fed's rate cuts and new government spending. However, the big question is what will influence stock prices the most, worry over the earnings collapse or enthusiasm over the potential future rebound. The answers may change from day to day. "You'll see sharp breaks on the downside and sharp rallies," says Merrill Lynch & Co. Chairman David H. Komansky.
BOND BLUES. By some measures, the stock market is in much better shape than it might have been. If the attack had occurred in spring 2000 when the Nasdaq peaked, says Hemmelgarn, the market would have dropped much more dramatically than it has. Instead, the market had already eliminated a lot of its excessive valuations. There was also a lot of money on the sidelines, in cash or in money market funds. Individual investors did not rush to redeem mutual fund shares after the attack. History suggests they'll remain passive and not buy or sell, according to Avi Nachmany at consulting firm Strategic Insight Mutual Fund Research. European investors, significant players in the market, are not rushing to sell U.S. shares, either, says Byron Wien, a Morgan Stanley Dean Witter & Co. strategist. He was meeting with clients in Europe at the time of the attack. "They think things will go back to normal relatively quickly," says Wien.
Although the stock market functioned well after reopening, the $18 trillion bond market was operating at way below normal volumes. So great were the difficulties of settling and clearing trades when it reopened two days after the attack, that the market had to extend the time for settling bond trades to five days from the usual one in an attempt to clear up the backlog. Corporate bond trading was only 50% of normal. Spreads between dealers' buying and selling prices widened sharply as did their price differences with benchmark U.S. Treasury bonds. Indeed, Stephen Kane, a portfolio manager at Metropolitan West Asset Management, said the sell-off in corporate bonds was the worst since the 1998 Russian debt default. Trading in junk bonds virtually dried up.
Worse may be to come for bonds. Already, longer-maturity issues are dropping in price as investors demand higher interest rates to compensate for bigger risks. Indeed, bonds are facing their old bugaboo: a return of federal deficit spending that revives fears of inflation and steps up competition for capital.
In this difficult market, underwriters will be called on to raise capital for insurance companies who may have to pay out anywhere from $30 billion to $100 billion on property and life claims. That's going to be tough: since Sept. 11 at least four stock offerings for a total of $1 billion have been shelved.
Merrill's Komansky predicts underwritings will resume by the last week of September, especially in the bond market. His confidence would be unfounded if not for the federal government's steps to save the markets and the economy. If the Fed were not providing capital and Congress were not crafting a bailout to prevent the airline industry from defaulting on more than $35 billion of debt, there would be virtually no way the Street could raise capital.
Wall Street never likes having to count on Washington for help. But for now, there's little choice.
By David Henry, with Mara Der Hovanesian and Susan Scherreik, in New York and bureau reports
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