Forced Selling Contributes To Stock Slide

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The Dow Jones industrial average had its biggest two-day percentage gain since October 1987, nearly 12 percent. The index followed Friday's big rally with a surge of nearly 400 points Monday. Still, the overall trend of the market is down. Some of that may be attributed to forced selling.

STEVE INSKEEP, host:

Believe it or not, the Dow has just had its biggest two-day gain in 21 years. Still, the overall trend is down. The Dow is off about 40 percent from its peak just over a year ago. To try to understand what's going on in the markets, we've been exploring the language of our economic misfortune. And today NPR's Chris Arnold takes a look at forced selling.

CHRIS ARNOLD: Stock prices haven't fallen this much since the Great Depression. That's kind of scary. It would be easy to get the impression that all the smart people on Wall Street must be predicting economic Armageddon. But you can't always trust the stock market.

Mr. ANDY KESSLER (Author; Former Hedge Fund Manager): Well, sometimes the stock market is a great predictor, and sometimes it's just a boldfaced liar.

ARNOLD: Andy Kessler is a former hedge fund manager turned author. He thinks the market right now is in its liar phase. In part that's because of something called forced selling. Some investors who don't want to be selling stocks right now have to.

Mr. KESSLER: In market panics, there are always dislocations because of forced selling. I mean, someone wakes up and their stock is down 50 percent, and their broker calls up and says, you know what, you got a margin call.

ARNOLD: Margin calls are one simple example of forced selling. When someone borrows money to buy stocks, that's called buying on margin. But if the account starts losing money, the brokerage firm wants to make sure that it gets paid back, so it will force you to raise the cash to cover your losses. For a lot of people, the easiest way to come up with the money is by selling stock.

Mr. KESSLER: You've got to sell half of your position to pay back the loan we gave you to buy those shares, and so there's just this forced selling.

ARNOLD: This has been happening even to some pretty prominent people lately.

Mr. KESSLER: Sumner Redstone, who runs Viacom and CBS, had a margin call in some other shares that he owned. And he had to sell Viacom and CBS shares to raise cash for that margin call and had to sell $400 million worth of shares.

ARNOLD: And selling so many shares of CBS and Viacom pushed down those stocks too, Kessler says, really for no good reason.

Mr. KESSLER: They're the big, high-profile name, but there are probably millions of individuals who are getting margin calls on tiny little portfolios. And they're distorting the market by having these forced sales that we don't even know about.

ARNOLD: Lots of money managers think the market has gotten unfairly beaten up here. Harry Clark is the CEO of Clark Capital Management Group.

Mr. HARRY CLARK (CEO, Clark Capital Management Group): The market right now is so oversold, it's unbelievable. I mean, good stocks have been taken out and shot for no reason, you know. It's crazy.

ARNOLD: Clark says it's not just margin calls. Some people sell stocks at the end of the year for tax purposes. Also, mutual funds and hedge funds are forced to sell stock when investors get nervous and yank out their money. Hedge funds especially right now are facing a wave of such so-called redemptions. Money poured into these funds in recent years. Now it's being pulled out. Many have until mid-December to sell a lot of stock. Andy Kessler.

Mr. KESSLER: When you have some giant hedge fund blowing out, there is nothing worse, because you get huge distortions in the market as these multibillion-dollar hedge funds are selling things to redeem investors.

ARNOLD: Fund managers even have to sell stocks that they like just to raise cash. That pushes stock prices even lower. Gus Sauter is the chief investment officer of Vanguard, the huge mutual fund company.

Mr. GUS SAUTER (Chief Investment Officer, Vanguard): Well, I do agree that the market itself has decoupled from the fundamentals of the economic environment.

ARNOLD: Sauter says beyond the margin calls and redemptions, sometimes the market volatility itself leads to forced selling or sometimes forced buying. He says these days hedge funds use a bunch of complicated trading strategies. That can mean if the market goes down sharply, they're forced to sell. And if it goes up, they have to buy.

Mr. SAUTER: You see these big swings, and they're exacerbated by these leveraged funds that are going in the direction of the swing.

ARNOLD: Andy Kessler says there's just so much confusing stuff going on right now with the market that most people should try to just look the other way for the next couple of months.

Mr. KESSLER: My suggestion is just ignore the market for a while. Don't try to read too much into it that it's the end of the world. It's just when it goes down that fast, you get all sorts of dislocations in the market. And that's what we're seeing today.

ARNOLD: Kessler says we are in a recession, so it makes sense that the stock market is down. But he thinks it's probably fallen an additional 10 or 20 percent because of all this forced selling. Chris Arnold, NPR News.

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