Roller Coaster Ride On Wall Street Tests Faith of Investors

Can you keep your cool in stormy weather?

For millions of Americans who own stocks, the market has shown a new instability that is testing the judgment of institutional and individual investors alike. The question now is not whether the market will correct, but by how much.

Stock markets go down. They often correct, comfortably, by about 10 percent after a sustained stay on the upside.

But after the Dow Jones industrial average lost almost 300 points in two consecutive days, analysts wonder whether the bull market will give way to the bears, bringing a drop of 20 percent or more.

The market this week seemed snowed under by concerns about higher interest rates, robust economic growth, and diminishing corporate profits.

The Dow fell 157 points March 31, following a 140 point loss March 27 (the market was closed for Good Friday). The crucial question, though, is not the next move from Wall Street but Main Street. If individual investors keep their faith in stocks and continue pouring millions of dollars into mutual funds, analysts expect the market to hold.

Still, the titans of Wall Street seem to be bracing themselves for additional turbulence.

In two trading days, investors lost hundreds of millions of dollars from their stock holdings, mutual funds, and pension plans.

The Dow, at the close of trade March 31, was off 7.5 percent from its high near 7,100 on March 10.

Many institutional traders - such as those who manage the investments of pension and mutual funds - are now yanking money out of stocks for the safety of money market funds or the lure of higher yields in the bond market.

10 percent adjustment

"The market has been so high for so long that there is just a lot of room for a steep fall on the downside," says Arnold Kaufman, editor of The Outlook, a review published by Standard & Poor's Corporation.

"The consensus view is that there's going to be a correction of about 10 percent. Unfortunately, the market rarely accommodates a consensus.

"My hunch is that there's either going to be a quick rebound," he says, and another run upward or another decline that can't be stopped until we're down 20 percent or more."

"Our economics department is now saying that if the long-bond, [the 30-year US Treasury bond] breaks the 7.2 percent to 7.25 percent level, that could be the straw that breaks the back of this bull market," Mr. Kaufman says.

The yield on the long bond has now moved through the 7 percent level, considered an important psychological checkpoint.

On March 31, the yield ended at 7.10 percent, rising on concerns about a stronger than expected US economy, which could bring inflation and the higher interest rates that usually follow.

When bond yields move higher, investors jump out of stocks, knowing the bonds offer a decent return. Higher yields draw investors away from stocks to bonds.

"I can only see a 10 percent or less correction at this point," says Larry Wachtel, a vice president with investment house Prudential Securities Inc.

"But you've got to look at the Dow as the last outpost in a correction that has been occurring over time for many months now."

The stocks of small and mid-sized companies, which are the backbone of such indexes as the Russell 2000 and the Nasdaq Composite Index, "have already been clobbered. Now it's the turn for large cap stocks on the S&P 500 index and the Dow," Mr. Wachtel says. "There's a lot out there that could bring down the market, and not too many things that could cause it to rally."

Investors took comfort from a new report that showed steady prices for materials in March. The report suggests that inflation is not heating up and the Fed may not need to boost short-terms rates again.

John Manley, a strategist with Smith Barney Inc., expects the market to find a bottom during the next week. "I think [the recent downturn] has shaken up investment professionals more than it's shaken up [individual] investors," he says.

With the economy "sound" and growing at a healthy pace, and with little inflation, there should not be a correction of more than 10 percent, says Daniel Seto, senior economist with Nikko Securities Co. International, in New York.

Strong fundamentals

Given strong underlying economic fundamentals - including high consumer confidence - "nothing in the long term has changed," says John Ryding, a senior economist at Bear, Stearns & Co. Inc.

"We're still in a bull market for equities, " he says.

Henry Kaufman, a veteran Wall Street analyst, believes the "fear that the Fed will quickly act to tighten monetary policy again is overblown."

The Fed, Mr. Kaufman reckons, will need "stronger supportive evidence" of faster inflation before it will raise rates again in June or July.

* Staff writers Shelley Donald Coolidge and David R. Francis contributed to this report.