Wall Street: One Hectic Week

• Share

(5 of 8)

The Crucial Questions. Toward the end of the '50s came a turning point in the economy: consumer demand began to be satisfied, and industry found itself nagged by excess capacity. This, coupled with mounting competition from the Europeans and Japanese, enforced a new price discipline on U.S. business. In 1957 wholesale prices leveled off. And in 1961 the U.S. enjoyed economic expansion with only a 1% rise in the cost of living.

"How can you have inflation," asks Partner Armand Erpf of New York's Carl M.

Loeb, Rhoades & Co., "when there are no shortages and when the whole world has adequate capacity?" Carried away by the paper gains of a decade during which it took real talent to lose money on the market, most small investors failed to consider the consequences of an end to inflation. When the stock market hit its December peak, stocks in the Dow-Jones index (a relatively stable, conservative group) were selling at a precariously high 23 times earnings. As prices rose, dividend yields on common stocks fell from their long-term average of 4.9% to less than 3%—well below the average 4.3% yield on high-grade bonds, which, being less speculative, traditionally pay less income. Only four times in the past 80 years had common stock yields been so low—and each time this happened, stock prices had fallen sharply within 13 months thereafter.

There were other early warning signals: last summer, many of the high-riding glamour stocks went into a tailspin, and by last autumn a few Wall Street professionals anxiously noted that, although the Dow-Jones average was still going up, there were many days when more stocks were falling than rising on the New York Stock Exchange.

The Loaded Gun. As 1962 began, the early warning signals began to be borne out. In January, to help prevent short-term investment funds from fleeing to foreign countries with higher interest rates, the Federal Reserve Board permitted U.S. commercial banks to raise their maximum rates on long-term savings deposits from 3% to 4%. The sharply competitive savings-and-loan associations countered by pushing their own rates as high as 4.8%, and as these figures loomed big in hard-sell bank advertising, many small investors obviously concluded that they could make as much money, and more safely, in savings accounts as in stocks. As the market declined, this became a more powerful appeal. "People invest for growth when the market is going up," Wall Streeters say, "but when it goes down they invest for yields." Result: the Dow-Jones index fell 25 points between New Year's Day and April 1.

Then came the dramatic showdown between the President and U.S. Steel. It is a Wall Street axiom that the market always finds a ready reason for a selling wave—and this time the accepted one is Kennedy's offensive against steel. Says U.C.L.A. Economist Theodore Andersen: "Kennedy's criticism of steel triggered the market decline, but the gun had to be loaded—poor yields, better returns elsewhere, the lack of a need of a hedge against price inflation."