Stock market's rollercoaster ride

A look at the major stock indexes for the past two days. From the New York Times.

It is time now to look at the roller coaster ride over the past two days. Let's look at this ABC News story of the Dow's 416-point drop on Tuesday:

NEW YORK Feb 28, 2007 (AP)— Stocks had their worst day of trading since the Sept. 11, 2001, terrorist attacks Tuesday, hurtling the Dow Jones industrials down more than 400 points on a worldwide tide of concern that the U.S. and Chinese economies are stumbling and that share prices have become overinflated.

The steepness of the market's drop, as well as its global breadth, signaled a possible correction after a long period of stable and steadily rising stock markets that had not been shaken by such a volatile day of trading in several years.

It began with a 9 percent slide in Chinese stocks Tuesday, which came a day after investors sent Shanghai's benchmark index to a record high close, setting the tone for U.S. trading. The Dow began the day falling sharply, and the decline accelerated throughout the course of the session before stocks took a huge plunge in late afternoon as computer-driven sell programs kicked in, and also as a computer glitch caused a delay in the recording of a large number of trades.

The Dow fell 546.20, or 4.3 percent, to 12,086.06 before recovering some ground in the last hour of trading to close down 416.02, or 3.29 percent, at 12,216.24, leaving it in negative territory for the year. Because the worst of the plunge took place after 2:30 p.m., the New York Stock Exchange's trading limits, designed to halt such precipitous moves, were not activated.

A display board at the New York Stock Exchange shows the Dow Jones Industrial Average down more than 415 points during the closing moments of the trading session in New York February 27, 2007. (Mike Segar/Reuters)

It was the Dow's worst point decline since Sept. 17, 2001, the first trading day after the terror attacks, when the blue chips fell 684.81, or 7.13 percent. In percentage terms, it was the biggest decline since March 24, 2003, when the index fell 3.6 percent as investors started getting rattled as U.S. casualties mounted in the early days after the invasion of Iraq.

The broader Standard & Poor's 500 index fell 50.33, or 3.47 percent, Tuesday to 1,399.04, and the tech-dominated Nasdaq composite index was off 96.66, or 3.86 percent, at 2,407.86. Both indexes have also turned negative for the year.

The Russell 2000 index of smaller companies dropped 31.03, or 3.77 percent, to 792.66.

And today, the market's rebounded somewhat after yesterdays big sell-off. This is off Businessweek:

Stocks were modestly higher in heavy trading Wednesday afternoon, though well off their best levels of the session, after Tuesday's plunge in China's stock market sent U.S. indexes to their worst day in years. Shanghai rebounded overnight, but European bourses were lower and most Asian markets took a second straight tumble.

In afternoon trading Wednesday, the Dow Jones industrial average rose 35.49 points, or 0.29%, to 12,251.73. The broader Standard & Poor's 500 index added 6.67 points, or 0.48%, to 1,405.71. The tech-heavy Nasdaq composite gained 9.04 points, or 0.38%, to 2,416.9.

Market breadth was positive, with 21 stocks advancing for each 11 declining on the NYSE. Nasdaq breadth was 17-12 positive. Trading was heavy amid margin calls, notes Standard & Poor's MarketScope.

[....]

But upside may have been limited by some less-than-encouraging economic reports. U.S. fourth-quarter gross domestic product growth was revised down to 2.2% from the advance reading of 3.5%, for a third straight quarter below 3%. The headline number was "exactly as expected," says Action Economics.

Meanwhile, U.S. new home sales tumbled 16.6% in January to a 937,000 pace, the largest decline since 1994, from an upwardly revised 1.123 million in December.

The Chicago purchasing managers' index, a gauge of factory sentiment in the Midwest, eased to 47.9 in February, weaker than expected, from 48.8 in January.

So what happened here?

From what I can gather, this whole mess started in China where a government crackdown on "illegal share offerings and other banned activities" caused China's stock market to drop the most in 10 years. According to Bloomberg:

The Shanghai and Shenzhen 300 Index slid 250.18, or 9.2 percent, to 2457.49. The measure, which jumped 13 percent in the past six sessions, closed at a record yesterday.

Today's rout wiped out $107.8 billion from a stock market that doubled in the past year as 249 of the key index's 300 shares plunged by the 10 percent limit. The 300 index is valued at 38 times earnings, compared with 16 times for the Morgan Stanley Capital International Emerging Markets Index.

The State Council, China's highest ruling body, has approved a special task force to clamp down on illegal share offerings and other banned activities in the market, the government said. The group will provide advice on regulations and policy explanations of the securities market, according to a statement published Feb. 25 on the central government's Web site.

Banks in China are banned from lending money for stock investments. The regulator last month ordered banks to examine personal loans to prevent them being used to buy shares. The central bank carried out similar crackdowns on unauthorized margin trading in 1997 and 2001 after indexes surged.

The government must pay attention to ``bubbles'' in its stock market before they get out of hand, Cheng Siwei, vice chairman of the Nation's People Congress, wrote in a commentary published Feb. 6 in the Chinese-language Financial News. The Congress next convenes for an annual meeting on March 5.

China's economy has been growing spectacularly. The World Bank is estimating that China's growth will fall from 10.7 percent in 2006 to 9.5 percent for 2007. Even a 9.5 percent growth rate is still impressive. A lot of investment money has been flowing into China. According to a January 15, 2007 International Herald Tribune story:

Excluding the financial sector, foreign direct investment in China rebounded last year after a fall in 2005, the Commerce Ministry said Monday.

Not including banks, insurance and securities, foreign direct investment amounted to $63.02 billion in 2006 — a 4.47 percent rise over 2005, the ministry said on its Web site.

Including the financial sector, China drew $69.47 billion in foreign direct investment in 2006, down 4.06 percent from 2005.

But China reported cumulative nonfinancial foreign investment of $54.26 billion in the first 11 months, suggesting a December figure of about $8.76 billion.

China's economy has surged more than tenfold since foreign investments were allowed in 1980, with money pouring into factories on the east coast.

So is it no wonder that the Shanghai and Shenzhen 300 Index was valued at 38 times earnings, as the Bloomberg story reports? There was certainly some speculation going on, as investors were chasing after some big profits in a sizzling Chinese economy here. The China Securities Regulatory Commission decided to issue new regulations in the securities market, perhaps as a means to limit a potential Chinese stock market bubble. We had a little panic start up in the Chinese stock market, as these regulations were announced. The panic reverberated into both the European and U.S. markets.

There is more here to this story than just a Chinese government crackdown on illegal trading causing a world-wide panic. There is also still a weakness in the U.S. economy. U.S. economic growth slowed to a 2.2 percent annual rate during the last three months of 2006.

U.S. real economic growth slowed to 2.2 percent during the fourth quarter of 2006. Graphic by New York Times.

New home sales in the U.S. fell 16.6 percent--the most in 13 years, according to the Commerce Department.

New home sales plunge 16.6 percent. Graphic from New York Times.

And finally, the Commerce Department reported that new orders for durable goods plunged 7.8 percent in January. There is even talk that the U.S. manufacturing is now in a recession.

U.S. manufacturing orders for durable goods dropped by almost 8 percent in January 2007. Graphic by The New York Times.

And I haven't even talked about the problems with the U.S. budget, the rising war costs of Iraq, or the already $8 trillion in U.S. debt. These are all serious problems with the U.S. economy. This U.S. economy is not strong. If a speculative shock Chinese stock market can cause a major drop in stocks on Wall Street, what will happen when a serious economic crisis takes place within China?