Ripple effect sends stocks into tailspin
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Wall Street's bulls took a Greek holiday Thursday, as a wave of apparent computer-generated selling triggered by that nation's debt crisis sent stocks into a sudden tailspin that saw the Dow Jones Industrial Average plummet in a matter of minutes before paring its losses in late trading.
Some investment managers said the crush of mid-day selling was reminiscent of Oct. 19, 1987, when computer programs designed to protect investors from losses provoked a crush of sell orders that sent the Dow down 508 points, or a record 23 percent.
"It feels a lot like '87, when the machines took over," said Charlie Smith, chief investment officer for Fort Pitt Capital in Green Tree.
Mr. Smith said some investors use software that automatically initiates sell orders once the Dow Jones Industrials, S&P 500 or other index falls below a prescribed level. He described the steep descent that sent the widely watched Dow Industrials down hundreds of points in a matter of minutes as "machine-driven panic."
"It was a straight line, and human beings don't work that way," Mr. Smith said.
Rumors of erroneous trades added to the sharp swoon, said David B. Root Jr., CEO of D.B Root & Co., Downtown.
"It all circles back to fear induced from the debt panic in Europe and Greece," he said.
Violent protests continued in Greece on Thursday, as the government passed a $40 billion austerity measure in order to win support from the European Union and the International Monetary fund for a bailout. Analysts fear that the debt crisis will spread to Spain, Portugal, Ireland and other European nations before washing ashore here.
"Your reactionaries are going to think the world is coming to an end, and it's not," said Malcolm Polley, chief investment officer for Stewart Capital Advisors in Indiana, Pa.
Bank stocks were among the hardest hit Thursday, as investors speculated that U.S. banks will have exposure to Greece's debt problems. "The reaction to the problem has generally been 'ready, shoot, aim,' " Mr. Polley said.
Rumors about the cause of the chaos were rampant on Wall Street and in Washington. Some traders speculated about human error, such as an electronic trade of stocks entered with the wrong amount. Regulators offered little clarity, saying they would investigate what had happened.
The confusion also highlighted the evolution of stock trading, which some market officials say has happened too fast without adequate safeguards. The NYSE has "circuit breakers" in place to pause the trading of stocks during a panic. But investors also can trade stocks on 10 different electronic platforms that have sprung up in the shadows of the NYSE in recent years, and generally have no way of stopping unrestrained selling.
Senior NYSE executives said the Securities and Exchange Commission has given too much freedom to its competitors, not ensuring that the smaller trading platforms have needed protections. Lou Pastina, the NYSE's executive vice president of operations, said the SEC system exacerbated problems Thursday.
At least part of the sell-off appeared to be linked to trader error, perhaps an incorrect order routed through one of the nation's exchanges. Many trades may be reversed so investors do not lose money on questionable transactions.
As of about 6 p.m., all the officials knew was that there was what one official called "a huge, anomalous, unexplained surge in selling, it looks like in Chicago, at about 2:45." The source remained unknown, but it apparently triggered algorithmic trading strategies, which rippled across everything, pushing trading out of whack and feeding on itself -- until it started to reverse.
Federal officials fielded rumors that the culprit was a single stock, a single institution or execution system, a $16 billion trade that should have been $16 million. But they did not know the truth.
What happens to the day's market losers will depend on what the cause was, whether it can be identified. That's a question for the SEC.
The SEC said in a statement that it would "review the unusual trading activity that took place briefly this afternoon. We are also working with the exchanges to take appropriate steps to protect investors pursuant to market rules," it said.
In 2007, the SEC put in place new rules for how stocks are traded, led by then-Chairman William Donaldson. The goal was to give investors more control over how their trades were executed and to guarantee the best price when they buy stocks.
The new SEC rules toppled the dominance of NYSE, said James Angel, a professor at Georgetown University's McDonough School of Business. As a result, a single entity can no longer put a stop to panicked selling.
Yesterday's paroxysm of selling is the most serious challenge to the robust market recovery that began when the market bottomed in March 2009. Major market indexes have risen 60 percent or more since then.
Thursday, the Dow, S&P 500 and Nasdaq all declined 3 percent. The Dow, down nearly 1,000 points at one point, finished down 347.8 at 10,520.32. The S&P 500 fell 37.75 to close at 1,128.15 while Nasdaq closed at 2,319.64, down 82.65.
The Post-Gazette/Bloomberg Index fell 2.5 percent, with only eight of the 59 stocks in the regional index registering gains. They were led by Koppers Holdings, which finished at $30.38, up $3.07 and L.B. Foster, which advanced 68 cents, closing at $29.47.
The biggest losers were grocer Supervalu, off $1.01 to $13.99, and Comcast, which closed at $18.51, down $1.23. PNC Financial Services Group fell nearly 5 percent to $64.41, down $3.18, while Bank of New York Mellon retreated 96 cents to finish at $30.22.
While Mr. Polley does not downplay concern over the Greek contagion, he believes that the magnitude of credit-related problems has diminished since residential mortgage defaults helped trigger the recession and problems on Wall Street in the fall of 2008. So does Federated Investors' Carol R. Miller.
"We're in better shape today than we were five years ago, when the markets had no recognition of this and we continued to pile on the debt," said Ms. Miller, a senior portfolio manager.
While computer-related trading based on technical details can cause outbursts like the one that occurred Thursday, "at the end of the day, the markets trade on fundamentals," Ms. Miller said. She said those are improving, citing the improving economic data and the tremendous amount of liquidity that is fueling a recovery.
Mr. Root is concerned that Thursday's activity could indicate that Wall Street is going to be troubled for a significant period of time. While he's not looking for a crash, Mr. Root would not be surprised to see a drop of 10 to 15 percent.
"A correction would be normal from here, but it may be signalling the beginning of a sideways, grinding market for a longer period of time that's measured in years, not months," he said.
First Published May 7, 2010 12:00 am