In the most volatile day in history for U.S. stocks, the Dow Jones industrial average and the technology-laden Nasdaq composite index both plunged more than 500 points before recovering during the last two hours of trading.
At midday, the Nasdaq sank 574 points, or nearly 14 percent, leading the blue-chip Dow stocks down with it in a frightening rout that, to some, was reminiscent of 1987’s “Black Monday” stock market crash.
But just as quickly, the Nasdaq market staged a remarkable recovery, surging on waves of computerized and other buying to finish at 4148.89, down only 74.79 on the day. The Dow, which had plunged a dizzying 700.46 points from its morning high, rallied back along with the Nasdaq, closing at 11,164.84, down 57.09.
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As dramatic as the ride down appeared, the ride up was more so. Shortly after noon CDT, computerized trading programs, which buy and sell automatically at certain prespecified levels, kicked out massive purchase orders. Individual investors also came back in force, combing over the depressed market for bargains.
In the space of two days, the markets covered more ground than they typically would in two or three weeks, said Bill Hummer, a principal at Chicago’s Wayne Hummer & Co. investment firm.
“It’s been like a thunderstorm. It has happened very rapidly,” Hummer said.
By the end of the day, weary traders leaned against the walls of the New York Stock Exchange, smoking cigarettes and spouting superlatives in a drizzling rain.
“It was absolute madness,” said Robert E. Lee, a commission broker with M&J Securities. “It’s because of all the day traders”–the computer-assisted amateurs who try to make a fast buck dodging in and out of stocks.
Alan Skrainka, chief investment strategist with St. Louis-based Edward D. Jones & Co., said his firm has been warning of a 1000-point drop in the Nasdaq index for weeks.
“We’ve said all along that this may be a new economy but the old rules apply. If you play with hot stocks, you are going to get your fingers burned,” he said.
Many felt the heat as margin calls went out throughout the day, telling investors to repay money they had borrowed to trade stocks.
Typically investors have three days to pony up the additional funds to cover a shortfall. But brokerages will liquidate an investor’s portfolio immediately if its value drops below zero, putting the broker’s own money at risk.
“This is the beginning of the end of the Wild, Wild West style of investing. In some cases this is going to be a serious problem and it will drive people away from the market permanently,” Skrainka said.
Fueling the margin calls has been an unprecedented increase in investor borrowing to buy stocks. Typically, investors can borrow up to 50 percent of the value of their portfolios from brokerage firms; they do so, paying their brokerage firms interest on the loans, to maximize their leverage in a rising stock market. But as many are learning now, they can be harshly punished in the event of sudden stock drops.
Investor borrowing has skyrocketed in the past six months–the same time period during which the Nasdaq index doubled in value.
In September, $179 billion in margin debt was owed by investors. But by the end of February, margin debt had exploded nearly 50 percent to $265 billion.
That borrowing led Federal Reserve Chairman Alan Greenspan earlier this year to begin lecturing brokers about tightening their borrowing rules.
Some, such as Charles Schwab & Co., have. Since the beginning of the year, the San Francisco-based brokerage has raised the margin limits on 250 technology stocks as values have soared for many companies that have yet to make a profit.
The rout in Nasdaq stocks began in earnest last week. A succession of 100-point-plus daily drops dragged the index down about 12 percent from its March 10 record high of 5048.62. And Monday the Nasdaq market plunged nearly 350 points in anticipation of Federal District Court Judge Thomas Penfield Jackson’s ruling that Microsoft Corp. was a monopoly.
John Markese, president of the Chicago-based American Association of Individual Investors, said the margin paper held by the nation’s brokerage houses “is just the tip of the iceberg.”
“Rather than paying down the mortgage or paying off the credit cards, people have been taking that money and investing it. It is a form of homemade leverage. And they don’t get a call in the middle of the day to put up more money,” said Markese, adding that this is far more common than individual investors borrowing money from their brokers.
Some said the correction that began last week was a long time coming.
“What you saw today was long overdue. A lot of momentum players and day traders are getting burned today. It doesn’t appear the public is panicking,” said Mike Cassidy, independent floor broker and semiretired New York Stock Exchange member. “We’ve been in a permanent drop for a while with the Dow and the Nasdaq rotating, one up and one down. Now they’re both getting hit.”
Skrainka said a lack of earnings finally caught up to technology companies such as Allscripts Inc., a Libertyville-based company that produces a prescription writing device for doctors, and Sycamore Networks Inc., a Chelmsford, Mass.-based company that is making the next generation of networking systems. Neither has posted any earnings.
Allscripts’ shares closed at $41, down $9 a share and down 55 percent from their high of $89.62. Sycamore’s shares closed $98, down $3.06. Its shares are down 51 percent from their high of $199.50.
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“Traders don’t think the downward movement is over yet,” Cassidy said. “The volatility you have been seeing over the last six months is going to continue and get worse.”