Rollercoaster@stockmarket.com
BY EVA CHENG
After skyrocketing some 260% in 17 months from 1400 points to the
March 10 peak of 5048, Nasdaq -- the United States index which measures
the prices of key hi-tech stocks -- suffered a series of plunges in April
which were interlaced closely by steep rises.
The indexes which reflect the stock prices of conventional blue-chip
firms, such as the Standard and Poor 500 and the Dow Jones Industrial Average,
have also registered big ups and downs.
These dramatic movements prompted many people to wonder whether a major
stock market crash is looming, mindful of its possible devastating consequences
-- via a severe crisis in the banking system -- on jobs and the general
US economy.
Given the US's dominant position in the world economy, especially its
ability to move world interest rates and as a key export market, few people
have illusions that if the US economy went into recession this would remain
a purely US event.
Big-time speculator George Soros was among the first to share a sorry
tale. Two of his key investment funds which bet heavily on Nasdaq stocks
-- the Quantum Fund and Quota Fund -- have lost nearly US$4 billion (A$6.9
billion) in the first half of April, or 24-33% of their market values.
This prompted him in late April to restructure Quantum Fund.
But Soros' star fund manager Stanley Druckenmiller claimed that his
boss's funds had only lost half of their recent profits in high-tech stocks,
with US$2.5 billion of net gain still in the kitty. “That's not bad for
a year's work”, Druckenmiller trumpeted.
Triumphalist claims, such as Druckenmiller's, are common lately among
capitalist managers and their apologists who tirelessly “talked up” the
market. They stressed that the Nasdaq, despite the falls, remains 40% higher
than a year ago.
That may be the case measured by the stock market average index. But
major stock market downturns tend to hit many players hard, including the
latecomers who were tempted by a rising market and who tend to scale up
their bets by heavy borrowing. They can go belly up soonest.
`Margin plays' and high `leverage'
“Margin play”, in which the stockbroker provides the lending, is only one
of many ways to bet in stocks through borrowed funds. The margin requirement
-- the cash deposit required in relation to the current share value --
has risen sharply lately in the US to 50%, but it still allows a $2 bet
with $1 on hand.
Big money is involved. In the US alone, margin debt rose 46% from last
October's US$182 billion (A$314 billion) to US$265 billion at the end of
February, nearly triple what it was three years ago.
Other forms of credit allow stocks punters to make even bigger bets
-- increasing their “leverage” -- such that when prices plunge, they will
lose more than their shirt. Their financial troubles, even bankruptcy,
can spread to the “real” economy in many ways.
Similarly, speculators can complement and reinforce their bets in stocks
with other financial instruments which can greatly increase their leverage
-- the size of their bet in relation to a given amount of cash (and their
chance of financial ruin). They are more likely to sell in panic, therefore
magnifying market volatility.
Stock options are a case in point. A “put option” gives a holder the
right to sell a stock at a predetermined price for a specified period,
protecting the holder from a falling market. A “call option” provides the
reverse function, giving the holder the right to buy, and thus protection
in a rising market.
But option sellers need to hedge their risks by buying or selling the
underlying stocks, which becomes very difficult to do when the market is
moving one way. Yet the option sellers' desperation to cover their positions
in such situations can make things much worse.
The March 18 London Economist reported that when Nasdaq was zooming
fiercely north last year, there was at one point a complete dry up of offers
for Yahoo! shares at any price. “Faced with a shortage of stock, option
sellers panic buy; as they scramble to cover positions, they force prices
-- and volatility -- higher”, the Economist said. The dynamics work
the other way when share prices are sharply falling.
Moreover, the volatility that US publicly traded shares have experienced
in recent weeks has never been greater. Until recently, an occasional intra-day
fall of 3-5% in the share indexes was already a nerve-racking event. But
after having fallen at one point on April 4 by 13.6%, the Nasdaq rose again
the next day. After plunging by more than 25% in the week to April 14,
it climbed 6.6% and 7.2% the following Monday and Tuesday; then it jumped
by another 6.6% on April 25 after four straight losing days.
And the US stock market yo-yo keeps rocking, making its impact quickly
felt in other markets, especially Asia which, among other connections,
relies heavily on the US market. A growing worry is that these much greater
fluctuations might become a norm.
Wilder swings
Many capitalist apologists seized on the quick sharp rises to calm such
concerns. They attributed the recent Nasdaq drops to inflationary pressure
arising from a “booming” US economy, driven by the “prosperity” generated
by the information technology revolution.
The alleged boom officially started in 1992, but it has delivered much
less prosperity than is claimed. Between 1989 and 1997, the average US
GDP grew by only 2.3% per year, or 1.3% per capita.
By 1998, six years into the “boom”, the income inequality among US households
reached its highest since such records were collected in 1947 (Left
Business Observer, February 10). While trumpeting that on an annualised
basis, US real GDP grew by 6.3% in the second half of last year, the Economist
(March 25) admitted that real wages actually fell during the same period.
The 1990s “boom” is also unusually dependent upon the credit-fuelled
expansion of consumer spending. During the first quarter of 1999, US households
recorded their first negative savings rate since the early 1930s, spending
100.5% of their income after taxes (Monthly Review, July-August,
1999). Last year, US consumer debt exceeded US$1.4 trillion (Economist,
April 1).
Though not a unique phenomenon, US capitalists have been increasingly
cautious in investing to create new productive capacities, a development
closely linked to growing overcapacity in the production of material goods.
Between 1990-96, private investment in productive assets grew by an average
of 2.1% per year, declining from 4% during 1960-73, 3.4% during 1973-79
and 3.2% between 1979-90 (New Left Review, May-June 1998).
Only paper loss?
Some commentators argued that the declines in stock prices would only be
paper losses so long as the stocks are held for the long term. But in real
life, this easy option is only available to a small proportion of shareholders.
The option isn't quite there for those with margin loans whose key way
to save their own skins in a falling market is by cutting losses early.
Those who bet on stocks by way of futures contracts could also easily
sustain enormous losses. Those who bet, via futures, that the index would
go up when in fact the actual index was falling would be in deep trouble
because futures, like many other financial contracts, are leveraged betting
instruments.
At first glance, it appears that the managers of cash-rich big funds
could most afford to “sit on” their stock holdings rather than taking a
loss. But the sorry state of Soros' funds is testimony that this is often
not the case.
A major reason for this lies in the fact that they often highly leverage
their bets in their pursuit of high profits. Soros' Quantum Fund is claimed
to have achieved an average annual yield of more than 30% for 31 years.
That kind of yield is not achievable without highly risky leveraged bets.
It was not an accident that declining investment in productive activity
over the last few decades coincided with an explosion of the financial
markets worldwide. Falling profits in the “real” economy discouraged new
productive investments, luring funds to tradeable securities -- stocks
and bonds -- in anticipation of much more lucrative yields, much sooner.
Bonds are comprised of a big family of debt contracts issued by governments,
banks or other private businesses with a huge variety of degrees of risks
involved. But even the most risky contracts have attracted takers because
they usually offer the highest potential returns.
All these contracts form the credit market which is many times bigger
than the stock market. However, the stock market is traditionally the most
visible to the average person due partly to its rather low entry levels
which allow small players and more people's pockets are directly at stake.
In early capitalism, shares were issued by companies to help pool money
for productive activities, colonial expeditions and even wars between states.
But they soon also became an instrument of speculation which significantly
overshadowed their original roles.
A similar thing happened to currencies which originally were traded
mainly to facilitate international trade in goods. While this function
remains, a predominant portion of currencies that change hands every day
are geared to make a quick trading profit. A myriad of financial contracts
were created to allow punters “to take a position”, whether the currencies
involved appreciate or depreciate.
Given capitalists' overriding drive for profits, the different waves
of technological revolutions in the past few centuries have produced the
unintended effect of magnifying the growing problem of productive overcapacity
which exists along with unmet basic needs for the majority of humanity.
Instead of ploughing their profits into new productive activities, capitalists
put an increasing amount of them into speculative activities. To maximise
the possible yield, they leverage up their bets, reinforcing the need for
a gigantic credit market. Credits and speculation have become the key ingredients
of an increasingly volatile bubble that has helped keep capitalism afloat,
for now.
