Beating The Second Scare

The market came down as surely as the Twin Towers did, touching Americans with another kind of dread. In its first wave, terrorism leaves you in fear for your life. In its second wave, you fear for your livelihood and your future.

Most investors sleepwalked though last week's calamitous drop in stocks, hearing the bad news through the same veil of shock they've carried since Sept. 11. Few individuals dumped and ran. The selling came almost entirely from professionals (read: the people who run your pension funds and mutual funds).

By Friday's close, we had seen Wall Street's worst week in memory. The tech-heavy Nasdaq fell 16 percent, for a total loss of 72 percent since its March 2000 peak. The S&P index of 500 leading stocks fell 12 percent, for a bear-market slide (so far) of 37 percent. The Dow Jones industrial average closed at 8236 (the worst point drop ever--down 14 percent for the week, 29 percent from the peak). Under the week's rubble, you'll find airlines, hotels, casinos, travel and recreation. This bear has turned into one of classic proportions--yet individuals still haven't caved.

Nevertheless, I can feel discomfort bubbling up. During most of this bear market, holders of 401(k) plans pretty much let their money ride, reports the consulting firm Hewitt Associates, which tracks $71 billion in 401(k) assets. But last Monday, when the markets reopened, accounts suddenly switched into conservative, "stable-value" investments earning around 6.4 percent. Stocks now make up 61 percent of these employee plans, compared with a peak of 75 percent in September 2000, Hewitt says.

Money flowed out of equity mutual funds last week, although not in record amounts, says Charles Biderman of, a financial-information firm. Some investors rediscovered the comfort of bond funds and even insured bank accounts. Huge sums are sitting in money-market mutual funds at 3.5 percent. But all told, folks haven't really been selling stocks. They've just failed to buy.

Or rather, they failed to buy seriously. Thousands of people put in small "patriotic" buy orders when stocks first reopened for trading last week. You might as well have fed that money to the birds. Markets are neither caring nor moral. They don't give a hoot about sending anyone a message. In my office, I have the front page of a New York Times for Oct. 29, 1929. A prominent headline reads BANKERS MOBILIZE FOR BUYING TODAY. Their moneybags were expected to put prices up. Fat chance. The 29th became the stock market's blackest day.

But when investors place buy orders based on stocks' basic values--that's when prices rise. From a historical perspective, plenty of stocks look attractive today--including some from the "worst performers" group. And they'll look even better if money-fund earnings drop to the 2 percent range. Stock prices have always rebounded from big sell-offs like the one last week, says Irwin Kellner, chief economist for You never know when the bounce will come. But at this point, boomers should think about gradually moving 401(k) money into stocks, not out of them.

How long it will take for stocks to recover depends on how bad business gets, says economist Mark Zandi of In turn, that depends on how Americans perceive the effectiveness of President George W. Bush's call to arms against terror. We're waiting to see what happens next.

While we wait, business sinks. Prior to the terrorist attack, it was possible to believe that the country could successfully skirt an actual recession. Now we're in for it. Spending will slow. Home prices won't increase so fast (making it risky to take large home-equity loans). Unemployment will rise higher than we'd thought.

The government has been fighting this sudden turndown with every weapon it has. The Federal Reserve cut interest rates and made more than $80 billion available to the financial system. That money ensures that--despite the disruptions--transactions can close, says economist Frederic Mishkin of Columbia University. Adding liquidity also encourages new transactions, new business investment and fresh credit to investors.

Meanwhile, Congress has promised a $40 billion rebuilding fund. The airlines may get $15 billion. Talk of more tax cuts is in the air. In what I'd call war profiteering, the rich are using this opportunity to seek a cut in the tax on capital gains. (In case you'd forgotten, almost half of all capital gains are held by households earning $250,000 or more, says economist Edward Wolff of New York University.)

But then there's the war. Investors can't get a grip on the level of uncertainty they face. Consumer and business spending may remain depressed until the country sees our military act. The longer that takes, the longer business will slide.

Stocks could turn around fast if we see an early success. After American troops landed in Kuwait in January 1991, the market jumped 18 percent in four weeks. And that could be chicken feed. Bin Laden--"dead or alive," as the president says--is worth 2,000 points on the Dow. Maybe 2,500.

The professionals selling stocks last week were the same people going to memorial services and staring at the sky where friends' offices used to be. The extraordinary disruption caused by this terror attack raises questions about whether such a mighty financial center should still exist. Why concentrate top money minds in a single district? Why does the all-important New York Stock Exchange have a "floor" where specialists in company stocks are required to congregate? "This is an opportunity for all companies to rethink the way they do business," says former Securities and Exchange Commission chair Arthur Levitt. Dispersal, electronic markets, secure communications. Like bin Laden. Modern caves.