The Dow Jones industrial average and the Nasdaq composite index racked up their biggest-ever point drops yesterday as inflation and interest-rate fears helped transform a weeklong sell-off into a full-fledged conflagration.
The Nasdaq fell 355.49 points, to close at 3,321.29. The 9.7 percent decline was the second-largest ever single-day slide, while the 25.3 percent loss for the week was the worst in the Nasdaq's 29-year history.
The Dow Jones industrial average fell 617.78 points, or 5.7 percent, to finish at 10,305.77. At one point late in the day, the Dow was down more than 700 points.
"The bull market is over," said Steve H. Hanke, professor of applied economics at the Johns Hopkins University and chairman of Friedberg Mercantile Group Inc., a currency-trading house.
Hanke, a columnist for Forbes magazine who has said for months that stocks were overvalued, said he sees more bloodletting to come.
Other market experts agreed.
"You probably will see some follow-through on Monday," said Morry Zolet, a senior vice president of investments for Ferris, Baker Watts Inc. in Baltimore. "I think what will happen is that, people will spend the weekend looking at their mutual fund statements, licking their wounds, and saying, 'Holy cow, I took it on the chin! Maybe I should lock in my gains.'"
Margin calls could also force more selling, at least in the short term. Many investors have been buying stocks on margin -- that is, with borrowed money. When stock prices fall and debt exceeds allowable limits, investors get a "call" and may have to sell stocks to raise cash. Since investors often buy speculative shares by borrowing against their blue-chip holdings, when stock prices start to fall, the speculative shares drop first, but blue chips join the rout.
Borrowings to buy shares rose to a record $278.5 billion in March.
Stocks had been in tailspin for most of the week. But it took yesterday's inflation report to push them into a nosedive. The Labor Department said U.S. consumer prices -- excluding energy and food, which are highly volatile from month to month -- last month rose at their fastest rate in more than five years.
That "core" rate rose 0.4 percent as costs increased for clothing, housing, medical care and airfares. It followed a 0.2 percent increase in February and was the largest increase since January 1995.
The overall Consumer Price Index number rose 0.7 percent, topping February's 0.5 percent rise, and brought the year-over-year inflation rate to a worrisome 3.7 percent -- the highest level since 1991, the last time oil prices spiked.
What the report did was to make investors fear that the U.S. economic expansion -- in its record 10th year -- has finally sparked serious inflation, which would force the Federal Reserve to stick with its strategy of repeatedly raising interest rates to slow the sizzling economy. The Fed's policy-making committee, led by Chairman Alan Greenspan, has raised interest rates five times since June 30.
Until recently, however, with higher oil prices pushing gasoline pump prices higher, inflation appeared absent. But Greenspan has also expressed concerns that a tight labor market and strong wage gains -- combined with the trillions in extra wealth generated by a soaring stock market -- were giving consumers extra spending power, as well as the confidence to use it.
Because consumer spending counts for more than two-thirds of all U.S. economic activity, all that extra consumer demand -- unchecked -- could eventually revive inflation. The reason: There would be too much demand, and not enough supply to satiate consumers, which could only lead to higher prices.
Greenspan is an avowed inflation-fighter, and most economists were predicting several more interest-rate increases by the nation's central bank.
Recent sell-off good?
Because of that -- in one of the ironies of economics -- the recent sell-off in stocks could be good for the economy.
Surveys show that consumer confidence had ebbed, and should slide still more, thanks to this week's market decline, said Gary Thayer, an economist with A.G. Edwards in St. Louis. Reduced confidence translates to reduced spending -- which reduces demand and, therefore, the threat of inflation.
The other key inflation threat right now -- steep oil prices -- also might be easing, since experts have said pump prices are on the decline.
Less frantic spending and lower oil prices might mean the Fed could get away with raising short-term interest rates only one more time this year -- most likely at the next Federal Open Market Committee meeting in mid-May.
Trying for 'soft landing'
Greenspan has been angling for a so-called "soft-landing," which consists of slow, sustainable growth with no inflation. But that's tricky to achieve. It's easy to overshoot by raising rates too much -- sparking an unwanted recession that depresses corporate profits and ends up with consumers getting thrown out of work through layoffs.
The current sell-off might be good for the economy for another reason: It's squeezing the speculative excesses out of investing, which could ultimately mute the wild swings that are becoming the norm on the major stock indexes.
Investors, market watchers said yesterday, will again start to focus on tangibles like sales and earnings that, over decades, have proven to be the best indicators of what a stock is worth. Getting back to basics could be a painful journey, as investors watch big profits evaporate. But that's how stock market bubbles disappear.
"The bubble has burst ... ,"said James Hardesty, president of Hardesty Capital Management. "This was an excess. When you see something happen to this degree, when the pendulum swings too far one way, it often swings too far back the other way" for a while.
Bloomberg News contributed to this article.