STILL ON A ROLL?

By Daniel Kadlec

New York City's 21 Club, a famed Midtown eatery, was expecting a group of 90 Wall Street types from Salomon Brothers, a famed investment house, for lunch last Monday. Only 40 showed. "And they were grim," recalls Swapan Rozario, who works 21's banquet room. Downtown, the stock market was having Solly and all the other big swinging brokerage houses for lunch, plunging a record 554 points in one nauseating session. The next day, Turnaround Tuesday, Salomon's traders, and everyone else, were too busy making money to have lunch, as the Dow reared up to gain back 337 points of that loss.

The mesmerizing pair of panics--the headlong retreat on Monday followed by a buying frenzy the next day--is causing policymakers, corporations and investors to make an abrupt re-evaluation of the economy and the stock market in the face of an unexpected jolt from the Far East. If the market is the sum of all investors' knowledge at any given moment, as many theorists argue, then what on earth is this barking dog trying to tell us?

For one thing, it says the notion that small investors, inexperienced in down markets, would bolt at the first sign of trouble is all wrong. It was the pros who fled on Monday: if these guys had been on the Titanic, they would have been fighting the children for lifeboats. The pros were saved by the little guys on Tuesday. Most folks did nothing; others couldn't wait to "buy the dips," just as they had been counseled to do so often. "I have been through this a few times," says Kooshy Afshar, the owner of a small printing company in Beverly Hills, Calif. "When the market goes down, I sit tight. I look at the market as a long-term investment."

But beyond that obvious message, is there a deeper meaning? It seems farfetched that such a panic could occur for no good reason and without consequence. We're way beyond normal price volatility here. Throughout history, daily Dow moves of 1% or 2% up or down have been relatively common. But Monday's 7% decline was the 12th worst ever; Tuesday's 4.7% gain, the best in a decade. Was the market right on Monday or on Tuesday?

We have been cruising along under the fuzzy notion that the '90s are different, that an economy with seemingly rock-solid fundamentals could withstand the buffeting of currency crises in countries half a world away. Federal Reserve Chairman Alan Greenspan, who likes this kind of excitement about as much as he does a rash, carefully reinforced his long-held belief that the Nirvana-like state of low unemployment and steady growth that correlates with his tenure can be sustained by riding herd on inflation. Said he: "Our economy has enjoyed a lengthy period of good economic growth, linked, not coincidentally, to damped inflation. The Federal Reserve is dedicated to contributing as best it can to prolonging this performance." And right on cue, data released Friday showed that inflation slowed dramatically this summer.

The consensus on Wall Street and in Washington, where, in both places, it is undeniably lucrative to be bullish, is that Monday was the mistake; Tuesday set things right. The believers in this sort of "new economy" school see the sell-off as an overreaction to an economic slowdown in Asia, a development that heralds only a modest drag on the U.S. economy and the earnings of U.S. companies.

Why? Only 4% of America's exports land in the more problematic Asian nations--Indonesia, Thailand, Malaysia and the Philippines--not nearly enough for troubles there to seriously cut into the earnings of U.S. companies, at least not directly. In fact, the Asian problems might not have even registered with American investors if not for the fact that stock prices in the U.S. are so high that they have become hypersensitive to any and all adverse news. "It doesn't take much to derail a market that has gone to the moon," says Stephen Roach, chief global economist for Morgan Stanley Dean Witter.

In Wall Street parlance, Monday's sharp decline was "a market event," meaning that it had little to do with the real economy and everything to do with the sheer unsustainable height of stock prices. That view makes the decline easy to swallow and lends credibility to the wisdom of staying happy and staying in stocks or, as the little guy did Tuesday, buying even more. "There is no reason to think the U.S. stock market is going to go into a bear market," says economist Allen Sinai at Primark Decision Economics. "The U.S. economy is not going to be knocked down by the crisis in Asia."

Soothing proclamations like that one came quickly and from many quarters, reverberating throughout brokerage firms, mutual-fund companies, barbershops and shopping malls all week. Mighty IBM announced that its shares were so attractive, it would spend as much as $3.5 billion buying them back. From her perch as co-chair of the investment-policy committee at venerable Goldman Sachs, Abby Joseph Cohen, the most consistently bullish--and correct--market forecaster of the 1990s, declared the sell-off a buying opportunity and promptly raised from 60% to 65% her portfolio's allocation to stocks.

No gesture seemed too small with a full-blown panic possibly still ahead. At half time of Monday Night Football, the NASDAQ stock market, a sponsor, stated its closing value as it usually does, but failed to mention, as it usually does, the index's change for the day. In this case, it was down a record 116 points, or 7%.

Perhaps the most soothing of all, though, were the carefully chosen words of Greenspan. In his inimitable style, the Fed chief called the swift market decline "a salutary event" that might be just what the economy needs to keep from overheating and allow the '90s expansion to continue for years.

Like a snake charmer, Greenspan talked the market into a catatonic state--or was it that traders were merely exhausted? Prices remained somewhat stable the rest of the week, and by Friday the Dow stood 9.9% below its all-time high and few investors seemed much worse for the wear. There were some casualties, among them speculator George Soros, whose company lost $2 billion on Monday. Several Fed presidents joined Greenspan in talking up the economy. "The basics of the U.S. economy are strong," said Cathy Minehan, president of the Boston Federal Reserve Bank. "I see no reason why that should change." Thomas Melzer, president of the St. Louis Federal Reserve, said the economy was doing "exceptionally well."

Here's how well:

--Last week the National Association of Realtors reported that Americans were buying existing homes at a record 4.3 million annual pace in September. New homes have been selling at the fastest rate in 19 years.

--Consumer prices rose at a 1.4% rate in the last quarter, according to one Commerce Department measure. That's less than half the 1996 rate.

--The Employment Cost Index, which the Fed chairman watches very closely, rose 0.8% in the third quarter of 1997, the same as the previous quarter. It's a signal that labor costs for businesses are not picking up even though the unemployment rate hovers at the lowest level in a generation.

--Corporate profits, which underpin stock prices, remain strong. Third-quarter profits have now exceeded estimates for the 19th consecutive quarter.

--Meanwhile, the government reported that the budget deficit for fiscal year 1997 shrank to $22.6 billion, better than what the White House had expected and the smallest amount of red ink since 1974.

Beneath the hubris of policymakers and moneymen, though, some quietly wonder if there isn't more going on. Maybe the barking dog really was trying to alert us to budding economic troubles before it was summarily dispatched to the pound. "It's always wise to take the message of the market seriously," says Hugh Johnson, chief investment strategist at the brokerage firm First Albany. "The message is that the currency crisis in Southeast Asia will affect not only the economies of Southeast Asia but also that of the U.S."

The dread scenario goes something like this: the emerging Asian economies--Thailand, Malaysia, Indonesia, Singapore and the Philippines--either slow sharply or sink into recession, and the ills spread throughout the rest of Asia, including Japan, which ships nearly half its exports to those countries. Japan's already sluggish economy buckles further, and because it is America's third largest trading partner, its difficulties are felt in the U.S., and ultimately throughout the world.

But even if that chain of events never occurs, some analysts believe the U.S. is headed for a recession, or severe slowdown, in 1998, all on its own. If they are right, Monday's plunge may have been the first shot across the proverbial bow, with others to follow. Those who so quickly dismissed the sell-off and are now boasting of buying at the bottom may find they were wrong.

Ron Reuss, economist at Piper Capital Management, based in Minneapolis, Minn., believes a recession could occur in the U.S. early next year. He pins his forecast on the debt-burdened consumer. Reuss estimates that half the households with less than $50,000 in annual income have non-mortgage debt equal to 24% of their take-home pay. "That is an all-time high," he notes, adding that the stress is apparent in rising bankruptcies and the recession-like 5% annual growth in consumer credit. A more normal credit growth rate is 10% to 15%. Now tack on uncertainties from a tumultuous stock market, and there is the real threat that consumers, whose spending accounts for two-thirds of the economy, will cut back.

Charles Clough, chief investment strategist at Merrill Lynch, is looking for 1% to 2% annual growth for the U.S. in the next few years, about a third lower than his more optimistic peers. He places only marginal emphasis on the hit U.S. companies and the domestic economy will take directly from the depressed levels of business activity in struggling Asia.

More important, he says, is that the whole world is heading for a deflationary environment stemming from a robust period of investment in the 1990s. Asia is just the first to feel it. There is too much manufacturing capacity worldwide, Clough says. Take the automobile industry. It will introduce 23 different sport-utility vehicles in the 18 months ending this coming June. "There is massive investment in anything that sells," he says. Companies cannot turn solid profits much longer with that type of competition.

Greenspan is still fretting over inflation. But look around you. Car prices are coming down. You can get a lot more PC today for $1,000 than you could three years ago for $2,000. With all the promotions, fast food is getting cheaper. This is the new era everyone has been talking about. It's driven by technological advances and global mergers that create enough savings to let companies cut costs without sacrificing profits.

But this too shall end. Heady profits have led to a global capital-investment binge, most easily seen in Asia. Most companies aren't paying much of a dividend to shareholders. They're choosing, in some cases, to buy back stock. But they are reinvesting the money in more and better manufacturing facilities, which further adds to the worldwide capacity to build, say, sport-utility vehicles. That drives prices lower as companies pump out goods, seeking to maximize the return on their investment.

By some estimates, two-thirds of American manufacturing industries are experiencing stable or declining prices. The recent round of currency devaluations in Asia leaves that region with even greater ability to lower costs to U.S. consumers, putting that much more pressure on U.S.-based companies to cut their own prices.

Productivity gains and new technology help offset some of the disadvantages of the strong dollar. But, especially with growth-starved Asia loaded to the gills with manufacturing capacity, U.S. companies will have a hard time matching price cuts from that region. Initially, that sounds wonderful. Lower prices mean you don't need a big raise to get ahead. But ultimately, this kind of deflation leads to razor-thin profit margins, fewer jobs and a wave of bankruptcies.

Others are concerned that there could be problems in Europe as it moves to a single currency. If the new currency, the euro, doesn't work, there could be ramifications around the globe. When it goes into effect on Jan. 1, 1999, individual European countries that are in the currency union will no longer be able to conduct their own monetary policy. That will be decided by one supranational European central bank, based in Frankfurt. Eurobanking means one short-term-interest-rate policy for all. That's fraught with risk because each European nation has its own economic needs.

It is humbling for Americans to ponder their economic link to the rest of the world, realizing that events beyond their control sometimes shape their future. But now, because of the slowdown in Asia, many are lowering their expectations for corporate earnings next year. The only question is whether the slower growth will trip harder times or, in the Greenspan view, merely hold back an economy that needs holding back. There are no clear answers, which is reflected in the stock market's wild gyrations.

Before Monday's near meltdown, there were already flickering signs of trouble. The markets in emerging Asia had been sliding for several months--a year in the case of Thailand. Those markets were down 20% to 40% even before the Monday panic. Somewhat suddenly a few weeks ago, the selling spread to more seasoned Hong Kong--the East's most solid economy--whose stock market declined 18% in the week leading to America's market problems. When the U.S. market finally buckled on Oct. 24, the stage had been set for a massive case of the jitters. As the week began, the selling resumed in the Far East, the first markets to open, and rolled over every major market not long after the sun rose. Latin American bourses were hit hard.

On the floor of the NYSE, traders had been edgy for days. It didn't help matters that on Friday, the U.S. market fell even though Hong Kong's battered Hang Seng index had rebounded sharply. That rebound was widely dismissed as a "dead-cat bounce," a graphic trader's term that refers to the notion that even a dead cat will bounce a little if it falls far enough. Arthur Cashin, vice president of PaineWebber and director of the firm's floor operations, concluded that "there was more work to be done on the downside."

Richard A. Grasso, NYSE chairman and CEO, remembers taking note of the situation on Friday, but not feeling any particular concern about how the market would behave come Monday. "There was a choppiness," Grasso told TIME. "There was a feeling that we had had two bad days. There was a feeling that the markets were weak in Asia and that there might be a spill-back. But no one expected a 550-point drop." Grasso felt confident enough to fly to Paris over the weekend for a Monday meeting. He was interrupted at 2 p.m. Monday in Paris--8 a.m. in New York City--by NYSE president William Johnston, who was calling to discuss what looked like a grim day ahead. By 6 p.m. Paris time, noon in New York, Grasso found he was making calls to Johnston every 15 minutes.

By then the anxiety in New York was too high to be ignored, and traders began to express concern that a "wall of fear" might start to build on itself. When the Dow dropped 350 points, the first circuit breaker kicked in, around 2:35 p.m., and trading was stopped for 30 minutes. "It was eerie," says an exchange clerk. "I was shocked when I heard the bell stop trading." It was the first time circuit breakers had been triggered since their introduction after the 1987 crash. But the break seemed to unnerve traders. The market reopened to another wave of selling. The second break came less than an hour later, at 3:30, when the market shut for the day a half hour early. It had dropped a one-day record in points, although the 7% decline was only a third as bad as the 1987 crash.

In Paris, Grasso had set up an open line to the exchange from his room in the luxurious Hotel de Crillon, where he was host of a dinner. Grasso found himself giving a blow-by-blow account of developments in New York to his guests. "It made for an exciting dinner," says Grasso. But a forgettable meal. He barely touched the exquisitely prepared lamb that had been placed in front of him. He was scheduled to fly to Cairo on Tuesday but returned promptly to New York. "It was clear," he says, "that we were going to have another test."

An uneasy silence settled over the floor when trading ended Monday. Normally, traders work for an hour or more after the exchange's closing to process transactions, but activity had stopped dead. Traders and clerks looked stunned, and some wandered the floor trying to figure out what had just happened. Said Frank Racanelli, a floor trader for Elton Securities, "It was orderly, very orderly. There was never any real panic. I think you will see some good buying opportunities on Tuesday."

He was right. That morning, the Dow was down an additional 190 points, but that proved to be a bottom. By 11 a.m., Peter Mancuso, floor manager and senior partner at Buttonwood Specialists, was on a roll. "All I hear is buy, buy, buy. It is unbelievable," he exclaimed. The excitement on the floor was uncontrollable. One floor trader shouted at a reporter, "Get out of my way. You're costing me money!"

After the closing, Mancuso said, "I don't think anyone thought we would rally 337 points. That we would do 1.2 billion shares, literally twice the old record. It's incredible. I think we told Hong Kong that we are the leading market in this world, and when it is time to go up, we will move the market up."

And for that, Mancuso and the rest of Wall Street can thank the stalwart individual investor. It was the institutions that sold Monday. Individuals simply never got the chance. Tuesday, the overwhelming response of the little guy was to either do nothing or buy more stock. As mutual-fund managers took note, they realized two things: they would not see a rash of redemptions that day, and thus did not have to worry about keeping a lot of cash on hand; and many stocks were quite a bit cheaper than they had been a day earlier, so maybe they ought to buy. Something bordering on a buying panic ensued.

But it was that keep-the-faith individual, this bull market's greatest ally, who ended, at least for the time being, what could have been a global catastrophe. "All day [Monday] I was hearing stories of gloom and doom, about the market being in the tank," says Susan Becker Doroshow, 40, a dentist in Evanston, Ill. "And when I got home, we started hearing from some of my husband's friends, who are very actively involved in the market. They were practically opening their veins."

No matter, she calmly reflects. "There really isn't much else to do with your money besides the stock market. There's no money in CDs or in the banks. And gold is ridiculous." Doroshow is emblematic of the massive faith in stocks that has gripped individuals across the country. Macie Huwiler, a Chicago advertising executive, is another such investor. "I'm one of those people who are basically blase" about the market, she says. "Virtually everything I have is in my 401(k), and since I can't touch any of it, I sort of figure, what the hell. There just doesn't seem to be any point in panicking."

Indeed, a TIME/CNN poll conducted by Yankelovich Partners last week showed that 88% of individuals made no changes to their portfolios during or after the Monday-Tuesday roller-coaster ride on Wall Street. Only 1% said they sold stocks. Between now and year's end, 34% expect to buy more stocks; 59% expect to make no changes.

Count Jim Stone, 38, of Clarksville, Tenn., among the faithful. "I thought the market went up too fast, too soon anyway," he says. "This is, as they say, a healthy correction." With any luck, Stone and the rest of the faithful have it right. One day, though, there will come a dip that is not a buying opportunity--and you have to at least wonder if that's what the market was barking about last Monday.

--Reported by Edward Barnes, Bernard Baumohl, William Dowell and Valerie Marchant/New York, James L. Graff/Chicago and Bruce van Voorst/Washington, with other bureaus

With reporting by EDWARD BARNES, BERNARD BAUMOHL, WILLIAM DOWELL AND VALERIE MARCHANT/NEW YORK, JAMES L. GRAFF/CHICAGO AND BRUCE VAN VOORST/WASHINGTON, WITH OTHER BUREAUS