Business

Causes of stock drops internal Second-guessing, not outside factors, seems to blame

NEW YORK - Triple-digit swings in the Dow Jones industrials the past two weeks might seem like a painful reminder of the volatility that devastated Wall Street in the early part of the decade. But the turbulence might actually reflect more prudence than panic.

Investors were shell-shocked after the technology bubble burst in 2000 and sent stocks plummeting from record levels - often in 100-point-plus chunks as Wall Street reacted to events that also included the Sept. 11 attacks, recession and a string of corporate scandals. The road back has been slow, a reflection of the market's more conservative stance.

Now, the sort of declines Wall Street has been seeing lately seem to be growing not just out of worries about interest rates or the economy, but out of investors second-guessing themselves.

Fed's effect

The past two weeks, investors sold stocks off when they realized they'd gotten ahead of the Federal Reserve in expecting an interest rate cut this year. Fed Chairman Ben Bernanke helped set off some of the triple-digit selling when he talked of the economy's health - something unlikely to help push the Fed toward a rate drop.

Stocks had surged during the spring on growing expectations that rates would indeed be coming down. But Charles Blood, senior financial market analyst at Brown Brothers Harriman, said the market's growth in April and May was at an "unsustainable pace."

He argued that stocks needed to cool down a bit, and some of the recent drops were "one way to do it."

By the middle of this past week, investors were taking another look, and, aided by better than expected inflation data, realized they had again overdone it, this time on the down side. So stocks regained much of their losses from the previous week.

This kind of back-and-forth motion to the market accomplishes two important things, analysts said. The most important is that it lets some air out of stocks that continue to test new highs, but it also shows investors aren't so exuberant about equities that they aren't afraid of a little consolidation.

Still, it's not to say the market isn't capable of great nervousness.

But investors might also have learned something from that plunge, which now appears more than a little out of proportion because the stock market and the economy are not in the same precarious state they were six and seven years ago. A series of smaller declines might accomplish the same thing as a precipitous drop - bring the market down to earth - without doing so much psychic damage.

"We're nowhere near the situation we were in during 2000," said Scott Wren, senior equity strategist at A.G. Edwards & Sons. "You need to take a look at the fundamentals, weigh the uncertainties, and try to draw a conclusion - and most of all take advantage of these pullbacks."

"We, in a sense, needed to burn up time, otherwise the market would be rising faster than underlying corporate earnings," Blood said. "We all know that the market hasn't had a 10 percent dip since 2002, so for us to have a 3-to-4 day decline is really just a very, very normal stock market fluctuation."

Wren and other investment strategists are advising their clients to take advantage of these kind of swings. This most recent decline actually created an opening for investors to buy into the market - and then better economic news helped feed three straight sessions of big gains.

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