Dow’s Worst Week Comes to an End

Stocks closed a volatile week with the widest intraday swing on record, in a fitting end to one of the most turbulent five-day periods in financial history.

For the first time in its 112-year existence, the Dow Jones Industrial Average swung in a range of more than one thousand points on an intraday basis. The blue-chip gauge had dropped sharply in early trading, falling more than 600 points and dropping through the 8000 level for the first time in five years. But stocks quickly came off their lows, and by the afternoon the industrials jumped more than 300 points.

In the end, the Dow industrials declined 128.00 points, or 1.5%, to 8451.19. It was helped by jumps of 9.1% for Citigroup and 13.5% for J.P. Morgan Chase. Other major market indexes were mixed. The S&P 500 sank by 10.70 points to 899.22 and the Nasdaq Composite Index gained 4.39 points to 1649.51.

Despite the late turnaround, the Dow tumbled 18% this week, worst in its 112-year history. The industrials also shed more points in a week — 1874.19 — than they ever had previously. The Nasdaq dropped 15% and the S&P 500 declined 18% on the week.

“In some ways, this is worse than ’87,” said James D. Baer, a managing member at Uhlmann Price Securities, a Chicago brokerage. Alluding to the previous session’s 678-point drop, he added: “Going down 600 points a day adds up, but you’re not getting a one-day purge,” to shake sellers out of the market and pave the way for a renewed rally.

Mr. Baer, who was a Treasury-futures trader on the floor of the Chicago Board of Trade in 1987, said, “I’ve never seen a credit market like this one. The fear has gotten way ahead of the fundamentals,” including an unprecedented round of coordinated central-bank rate cuts this week that would normally prompt banks to increase their lending to one another.

Tony Saliba, chief executive of the Chicago options brokerage LiquidPoint, said the market’s recent slide “has been anticipated to some extent, since you had the market at records without much behind it fundamentally.”

“Coming into this move, you’ve had a lot of people buying options for protection” against unexpected declines in their stock portfolios, said Mr. Saliba. “You have a lot more buying now, but anyone who’s doing that is coming late to the game.”

The Chicago Board Options Exchange Volatility Index, which surged 20% on Friday and climbed above 76 for the first time, ended up 8% at 69.03.

Many Wall Street veterans believe the roots of the selloff lie in the interbank lending market, where tensions aren’t easing. Three-month Libor, a key lending benchmark for loans of U.S. dollars, climbed to 4.81875% Friday, the highest in nearly 10 months, up from 4.75% a day earlier. The jump overshadowed a sharp drop in the overnight rate.

Three-month Treasury bills remained in high demand among investors looking for havens and willing to except extraordinarily low yields in return for that safety. The yield on those issues fell below 0.2% late Friday, down from more than 0.5% on Thursday.

The results for an auction of credit-default swaps tied to Lehman Brothers bonds had sent financial stocks lower earlier in the day. The auction set the recovery rate on the firm’s senior debt at 8.625 cents on the dollar, suggesting hefty losses for holders of the swaps.

The recent freeze-up in the CDS market has hurt many hedge funds, said David Kotok, president of Cumberland Advisors in Vineland, N.J. He said that much of the recent stock selloff has come as hedge funds unwound a popular trading strategy in which they would buy a company’s stock and then buy credit-default protection on the same company, since that protection would tend to go up in value as the stock or index went down.

But as CDS paper has become ever more difficult to value — or fallen in value in cases where a price can be set amid doubts that the sellers of the insurance-like contracts can make good on their commitments — many funds have been forced to raise cash to meet margin calls. To do that, they sell stock, which is easy to unload on a public exchange compared to opaque, privately negotiated CDS trades.

“As all this is going on, you have average Joe investors who are getting more nervous as they watch on the sidelines, they don’t quite understand the trade, and so they just pile on and sell their stock as well,” intensifying the market’s slide, said Mr. Kotok. “It’s just feeding on itself.”

The wild Friday in the U.S. followed a plunge in international markets, which itself came after a late-day rout Thursday in the U.S. In Asia, Tokyo’s Nikkei Index dropped 881.06 points, or 9.6%, to 8276.43, its lowest level since May 2003. Since the start of this week, the benchmark index has lost 24% of its value.

In Hong Kong, the Hang Seng Index plunged 7.2% after falling by more than 9.5% intraday. Australia’s S&P/ASX 200 ended down 8.3%, in its biggest one-day percentage loss ever. The U.K.’s FTSE 100 Index fell 8.4%.

This week has seen an unprecedented coordinated rate cut by six central banks, a comprehensive bailout plan for U.K. banks and a move by the U.S. Federal Reserve to lend directly to borrowers in the commercial paper market. And yet markets have continued to plunge.

“Despite the innovative and, in our view, comprehensive actions taken by the UK government and central banks, the sell-off in equity markets continues apace as relief in pricings of various credit and money markets have failed to materialise,” says Robert Quinn, equity strategist at Standard & Poor’s in London.

After a late-Thursday warning from Moody’s on the credit ratings of Morgan Stanley and Goldman Sachs, shares of the banks fell. Morgan Stanley recently slid 22% while Goldman dropped 12%.

Crude-oil futures continued a months-long slump, settling down $8.89 at 77.70 a barrel, leaving the front-month contract down 17% on the week.

“The oil market is in the same carnage and liquidation that we have seen in other markets,” said Peter Donovan, vice president with Vantage Trading, who was speaking from the trading floor at the New York Mercantile Exchange. “Everyday, we see the Dow Jones industrial get crushed, we are getting crushed,” he said. Oil traders have ignored the news of OPEC’s call for an emergency meeting on November 18.

“There’s such a herd mentality in every market, once the selling tide and wave starts, it’s really hard to stop it,” he said. While many believe the selloff in commodities is overdone, traders are still waiting on the sideline and reluctant to get back into the market as the general trend is pointing downward.

-Carolyn Cui contributed to this article

Write to Peter A. McKay at peter.mckay@wsj.com

OCTOBER 10, 2008, 4:38 P.M. ET

Source: The Wall Street Journal

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