Quality highlighted in stumble

SO FAR this year we have seen share prices on Wall Street tumble, particularly in the technology sector.

But what are the reasons for this fall?

The analysts at Bankers Trust have looked back at the fall over the first week of trading and provide some ideas for the downturn.

It seems the prospect of rising interest rates has given investors a reason to sell shares and capture gains from last year’s spectacular performances.

The Nasdaq composite index, the best performer in 1999, suffered its worst point loss in history.

According to preliminary calculations, the Dow Jones industrial average fell 359.58 over one day of trade to close at 10,997.93, its fourth-worst decline ever.

The blue-chip index dipped as much as 380 points earlier in the day’s trade.

Broader stock indicators also sustained sharp losses.

According to preliminary calculations, the Standard & Poor’s 500 fell 55.80 to 1,399.42 and the Nasdaq composite index plunged 229.99 to 3,901.16.

Investors continued a wave of selling that began on Monday as the market balanced good news about a smooth conversion to the year 2000 with growing fears that runaway economic growth would prompt the Federal Reserve to raise interest rates.

“The toggle switch moved from ‘off’ to ‘on’ regarding interest-rate worries,” Waddell & Reed chief investment officer Hank Herrman said.

Herrmann said investors were able to brush off concerns about rising rates while Y2K loomed as a threat to the economy.

With worries about computer troubles now mostly alleviated, interest rates are once again rattling investors.

The Federal Reserve left rates unchanged at its last meeting, hoping to ensure monetary stability while Y2K concerns played out around the world.

Now, central bankers are likely to focus on continued signs of economic growth and a stock market that defied rising rates to set a string of new records at the close of 1999.

Rising interest rates typically hurt stocks by cutting into corporate profits as it becomes more expensive to borrow money.

Higher rates can be especially devastating to high-growth stocks, whose promise of future earnings growth may be threatened.

Ironically, a decline in US equities now could help assuage the Federal Reserve, which has made no secret of its concern over stocks’ lofty valuations, analysts said.

Still, most analysts believe the sell-off was a temporary drop in a market that is still

feeding on strong corporate profits and a robust economy.

The steep decline in stocks was to be expected, and could leave the market in better shape for another advance according to Legg Mason chief market strategist Richard E Cripps.

Technology stocks struggled as investors collected profits from a stellar year in 1999.

Traders said many investors who held on to shares of top-performing companies last year are now selling because the taxes on their gains won’t be due until 2001.

US markets also took little notice of President Clinton’s renomination of Alan Greenspan for another term as chairman of the Federal Reserve System.

The announcement was widely expected, but traders said the market would probably have fared worse without it.

Distilling all this information about the market leaves us with the distinct impression that, despite the fact that the sell-off was probably unexpected, it is still one that is welcomed by analysts.

We had been so consumed by the Y2K bug that reports everything had been successful left us feeling elated and certainly not expecting a sell-off of technology stocks.

The reason for analysts welcoming the sell-off is that it was generally accepted that in 1999 the market in the technology sector had been too strong and that the rises in the Nasdaq index were without justification.

The recent decline is seen as a reality check bringing stocks to more fundamental and, perhaps, realistic valuation.

The implications for Australia are not too hard to assess.

Essentially, all the arbitrage and exorbitant profits in technology and communications sectors could be returned to the market as a similar process occurs here.

Certainly, the realistic valuations suggest that investors are becoming more discerning in their assessment of the quality of some of the floats of recent times.

That is a comforting sign.

The recent merger of America Online and TimeWarner is an indication the quality end of the market perceives potential growth to be still available.

• Economist Suresh Rajan is a director and proper authority holder with Smith Martis Cork and Rajan – financial planners.

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