Dollar Plunge Leaves Stock Market Shaky

UNITED STATES stock and bond markets suddenly look more vulnerable. The plunging dollar has shaken investor confidence. Many Wall Street analysts are now predicting further price declines in the weeks ahead, although they see the long-term outlook for the market as more bullish than bearish.

"How far down will the market go now?" asks Prudential Securities analyst Hildegard Zagorski. "Who knows!" she laughs. "But we think there will be a lot more downside" in the immediate period ahead "before the market resumes its climb later this year. We don't believe the bull market is over yet, but there's definitely a possibility for a market correction now."

Earlier this week, the US stock market tumbled to its lowest level since April, shedding over 100 points and falling toward the 3,200 point level on the Dow Jones industrial average. Further, yields on benchmark 30-year Treasury bonds turned upward after declining all summer. Economists fear that higher long-term interest rates could abort the recovery.

Analysts link the faltering US stock and bond markets to the dollar's historic lows now being registered against the German mark. The falling US securities markets are "driven by asset demand," says Cynthia Latta, an economist with DRI/McGraw-Hill, an economic consulting firm in Lexington, Mass. She notes that the spread between German interest rates and US rates continues to widen, prompting investors to shun US securities for more lucrative German issues.

German short-term interest rates, for example, are now about 6.5 percent above those in the US, a postwar record. This tempts many global investors to sell dollar-linked assets in order to buy mark-linked German securities. Selling off US issues depresses US stock prices.

THERE is currently something of a `panic reaction' by many investors," Dr. Latta says. However, she does not see any bottoming of the dollar before the November presidential election. That could mean continuing pressure on US stock and bond prices.

A number of signs of pessimism are starting to appear on Wall Street. That is bad news for the Bush administration, already faced with a weak recovery. Elaine Garzarelli, a market forecaster with a wide following, sent shock waves through brokerage circles earlier this week when she told clients that a correction could shove stock prices down as much as 4 percent. Still, she remains upbeat over the long-term, holding that the market will resume its upward course.

In addition, two major brokerage houses - Salomon Brothers and Dean Witter Reynolds - have urged clients to reduce stock holdings.

About the only step that could push the US equities market back into full throttle would be another slash in interest rates by the Federal Reserve Board, Ms. Zagorski says. It is not certain whether the Fed will resist pressures to maintain present interest rates in order to protect the weak dollar or drop them further to boost the feeble economic recovery.

German monetary policy should stay tight for the remainder of this year, maintains David Rolley, an economist with DRI. Thus, a new US rate cut would merely widen the spread between US and German interest rates - possibly propelling more investors toward German securities.

The nightmare scenario worrying some investors here is that the Fed might be forced to raise interest rates in order to stabilize the dollar. But such a Draconian move is not expected, since higher rates would further weaken the recovery - and the stock market.

Not all analysts here see a US market correction as inevitable - or worrisome. "Today's weaknesses in the market should be a good buying opportunity for investors," says Dennis Jarrett, chief analyst for Kidder, Peabody and Company. It is possible that the Dow could momentarily stay below the 3,200 point level, he says. But more important "is the market's risk/reward ratio. The downside risk of the market is minimal compared to the upside potential" of gain as the US economy continues to rebound.