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05.26.10

What's Scaring Wall Street?

The Dow closed below 10000 Wednesday for the first time since February, battered by bad news from abroad that the markets would normally shrug off. Randall Lane—author of the forthcoming book The Zeroes: My Misadventures in the Decade Wall Street Went Insane—on the temporary blindness that could have traders on edge through the summer.

Wednesday for the first time since February, battered by bad news from abroad that the markets would normally shrug off. Randall Lane—author of the forthcoming book The Zeroes: My Misadventures in the Decade Wall Street Went Insane—on the temporary blindness that could have traders on edge through the summer.

Shortly after 9/11, Admiral John Poindexter, fall guy of the Iran-Contra scandal, rejoined the Defense Department to launch something called the Policy Analysis Market. Its mission: a global trading exchange, where people could bet on the likelihood of terrorist attacks and assassinations. As prices went up, so could national defenses.

I talked with a half-dozen Wall Street insiders Tuesday. Three leaned bullish, three stood bearish—and all six were skittish.

Subject to immediate mocking—Senator Byron Dorgan called it “unbelievably stupid”—the program was disbanded in short order: A rogue running something that lets people make money from the deaths of innocents wasn’t politically palatable. Even if, in reality, it was a good idea. Rather than surveys or meticulous analyst reports, numerous studies have demonstrated that markets, where people put actual money where their mouth is, prove the most effective prediction device of all.

That’s exactly what made Tuesday—when the Dow spent most of the day down almost 3 percent, below the psychological barrier of 10,000, before yo-yoing almost all the way back—so damn scary. It was as if the collective radar had short-circuited.

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The markets usually resemble some creature from a menagerie: a bull, a bear, or perhaps a dead-cat, all perfectly acceptable, as traders and CEOs can make money and plans, respectively, during any of them. What Wall Street, and business in general, abhors is uncertainty. And the results from Tuesday—indeed, from most of this month, starting with the May 6 “ flash crash” which still hasn’t been fully explained—resemble an animal pattern more akin to a rabid bat.

Just look at the feeble factors driving the market's plummet on Tuesday: saber rattling in Korea and new debt problems for some of the European Union’s sicker members. With all due respect to these two headaches, which can and should have the folks in Washington scrambling, Wall Street would normally steamroll over such news.

“On a normal day, Korea might be good for one-quarter of a percent,” scoffs the managing director at one bank. In this rabid bat environment, however, paranoia rules. This managing director likens the vibe to the national mood after 9/11, when a prank call, however unconvincing or unfunny, could clear 10,000 people out of an office building.

Meanwhile, the issue with Europe goes past how far the troubles will extend—it illustrates how little control the U.S. maintains over its own market health right now. Greece is no longer the biggest worry—some kind of default has already been baked into prices worldwide. And increasingly, the markets are also bracing for a possible default from Spain.

But the debt problems in Europe are pernicious: Italy and Ireland are both basket cases, too, and while the consensus remains that some further bailouts are likely, it’s also a total blind guess. It only takes the most gentle whisper, “boo,” to send the markets screaming down.

Until they scream up again, as they did Tuesday, buoyed by some decent numbers on consumer confidence and home prices. Suddenly, the Dow’s huge loss for the day was largely erased, the S&P’s entirely so. If you went out for lunch you probably missed it. It was emotion compounding emotion—the foreign news shouldn’t have depressed prices so much, nor should have the mildly positive reports supercharged them.

“It doesn’t matter how big your [manhood] is,” sighs the managing director. “If it’s just red or black, it’s a roulette wheel, it’s scary. One man can’t make the market.”

He’d better get used to such volatility. I talked with a half-dozen Wall Street insiders Tuesday. Three leaned bullish, three stood bearish—and all six were skittish. That skittishness, combined with so many unknown variables, they all agreed, will lead to wild, unpredictable markets all summer.

Or perhaps longer. Steve Drobny, who co-manages Drobny Global, a top hedge fund adviser and who also wrote The Invisible Hands, says that record low interest rates mean that market dips are especially harsh right now because of deflation worries. “We’re right on the zero line,” says Drobny. “It’s almost whiplash.” And he doesn’t see that changing anytime soon.

All these trends point to one thread: U.S. markets that react and reflect, rather than lead and predict. While John Poindexter’s idea of markets as a de facto early warning system works in theory, it also is predicated on a common framework for what’s going on in the world. Right now, we don’t have that. That should worry all of us.

Randall Lane is the former editor in chief of Trader Monthly, Dealmaker, and P.O.V. magazines, and the former Washington bureau chief of Forbes. His book, The Zeroes: My Misadventures in the Decade Wall Street Went Insane, will be published in June.