Bruised and battered Wall Street faces another test in the coming week with more data to highlight dire economic conditions and a US Federal Reserve meeting expected to offer a fresh rate cut.
A major question for investors is whether the horrific market action of recent weeks reflects worries of tougher economic conditions ahead or is the result of hedge funds and portfolio managers pulling out cash at any cost to meet redemptions.
In the week to Friday, the Dow Jones Industrial Average slid 5.35 percent to 8,378.95 and has plummeted 37 percent so far this year.
The broad-market Standard & Poor’s 500 index retreated 6.78 percent to 876.77 and the technology-heavy NASDAQ composite plunged 9.3 percent on the week to 1,552.03.
In the coming week, the market will see a grim reminder of the economic woes with the first estimate of US GDP for the third quarter and reports on durable goods orders and consumer confidence.
The Federal Reserve is widely expected to cut key interest rates further at its upcoming two-day meeting, hoping to offer a psychological boost to panic-stricken markets.
Joseph LaVorgna, economist at Deutsche Bank, said he expected a half-point cut that “should embolden some investors to take risk” that would help ailing markets.
“Hopefully, the combination of excess liquidity and government guarantees will encourage investors to extend further out on the money market curve,” he said.
Some analysts argue that the stock market is being punished by portfolio managers forced to sell to pay clients pulling out their cash.
Liz Ann Sonders, chief investment strategist at Charles Schwab & Co, said as many as 10,000 hedge funds with US$2 trillion in assets had been in the markets at their peak. But the size is magnified because many use borrowed funds to increase their assets by up to 30 to 40 times.
“Due to forced deleveraging, partly triggered by record-breaking redemption requests, hundreds of hedge funds are selling, sparking a fire sale on all sorts of investments,” Sonders said.
John Wilson, equity strategist at Morgan Keegan, said he was advising clients to stay in the market.
“If you sell into this air pocket, I believe you run the risk of being the last seller,” he said.
Gina Martin at Wachovia Securities argues the markets are being paralyzed by fear and reflecting the economic turmoil.
“We are starting to acknowledge that we are probably going to have the worst recession in the United States in decades, and that is being acknowledged in equity prices,” she said.
Nouriel Roubini, a New York University economist who has been warning for years of a deep crisis, said that “we have now reached a point where fundamentals and long-term valuation considerations do not matter any more for financial markets.”
“What matters now is only flows — rather than stocks and fundamentals — and flows are unidirectional as everyone is selling and no one is buying as trying to buy equities is like catching a falling knife,” Roubini said.
Gregory Drahuschak at Janney Montgomery Scott said that the markets may be glad to see an end to this month, and that it could mean an end to the “forced selling that has ravaged equities for months.”
Drahuschak said many portfolio managers faced a trading deadline for liquidating shares and that this was driving the panic trades.
“The key date is Oct. 28, which is the last regular settlement date that allows trades to be booked as October business,” he said.
“In past years there has been a strong relationship between this time and the market moving up. This in part probably contributes to the seasonal effect that provides the market with a strong November and December,” Drahuschak said.
Bonds rallied amid the renewed equity market turmoil in the week. The yield on the 10-year Treasury bond slumped to 3.697 percent from 3.938 percent a week earlier, and that on the 30-year bond eased to 4.087 percent against 4.137 percent. Bond yields and prices move in opposite directions.
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